Abstract

This study investigates the presence of the Gibson paradox in the transitional countries. The Gibson law has been a source of widespread academic discussion on the dynamics of long-term interest rates and the price level. Today the Gibson law re-emerges on the economic science stage since historically low-interest rates and deflationary pressures are present worldwide. This paper studies the correlation between cyclical components of interest rates and prices for CEE (Central and Eastern Europe) states over the 2000-2014 period. Empirical results show only a weak correlation between the cyclical components implying no long run (cointegrating) relationship between bond yields and prices. Evidence presented in the study shows Gibson law is not valid for the CEE states, advancing the possibility that fixed exchange regimes, lack of the gold reserves, and monetary stabilization policies are the forces driving the law outside the CEE area. The results show that Gibson paradox is not present in CEE states but also point to the possible non-linear nature of the paradox. In order to investigate the non-linear nature of the paradox in CEE, because of constant changes and adaptation of the monetary policies in CEE states, future studies should use a long memory approach. The paper shows limited theoretical explanation for the non-existent Gibson law in CEE economies but still advances an explanation – lack of gold reserves, fixed exchange regimes and restrictive monetary policy. Policy makers should monitor the nature of the paradox in relation to the historically low levels of interest rates in order to avoid or at least alleviate future financial crisis.

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