The Gibson Paradox and the Monetary Standard

Abstract

This paper analyzes the Gibson paradox, a strong positive correlation between prices and interest rates over the past 250 years. The phenomenon of Gibson's paradox is significant in Britain but not significant in the United States. However, there is a significant correlation between British interest rates and U.S. price levels. The price movements show a strong characteristic of random walk under the gold standard, but appear not to be random walk under the non-gold standard. Based on (a) the price random walk assumption and (b) the real return arbitrage assumption, this paper constructs a simple model to explain the above interesting empirical results.