Gibson's Paradox and the Gold Standard

Abstract

This paper provides a new explanation for Gibson's Paradox -- the observation that the price level and the nominal interest rate were positively correlated over long periods of economic history. We explain this phenomenon interms of the fundamental workings of a gold standard. Under a gold standard, the price level is the reciprocal of the real price of gold. Because gold is adurable asset, its relative price is systematically affected by fluctuations inthe real productivity of capital, which also determine real interest rates. Our resolution of the Gibson Paradox seems more satisfactory than previous hypotheses. It explains why the paradox applied to real as well as nominal rates of return, its coincidence with the gold standard period, and the co-movement of interest rates, prices, and the stock of monetary gold during the gold standard period. Empirical evidence using contemporary data on gold prices and real interest rates supports our theory.