The ‘Gibson Paradox’, The General Theory and beyond

Abstract

The Gibson Paradox states that interest rates and the price level are often positively correlated. This contradicts the doctrine that high interest rates dampen economic activity and the price level. In 1930 Keynes names, confirms and emphasises this phenomenon in his Treatise on Money. In 1936, in The General Theory, it is totally ignored. But Keynes’s new concept of given future effective demand as being related to entrepreneurs’ present outlay at a given degree of competition requires that higher discounting costs are compensated by higher prices. Macroeconomic modelling has to be wary of the contradictory influences of interest rates. As producers’ cost they affect the ‘supply channel’. As financing costs they affect an opposite ‘demand channel’. Recent empirical literature confirms the relevance of both channels. The chapter accentuates these issues in a minimalist simultaneous equations model. It stresses the problem of finding the balance between the two channels and it mentions Keynes’s appeal to maintain low interest rates for a continuous ‘quasi boom’.