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Department of Economics Seminar with Professor Pierpaolo Benigno, University of Bern Gibson's Paradox and the Natural Rate of Interest
Abstract: Gibson's paradox–the strong positive correlation between the price level and long-term nominal interest rates observed under the Gold Standard–is not inherently linked to the Gold Standard per se. Rather, it originates from low-frequency movements in the natural rate of interest (commonly referred to as r*) under monetary regimes in which inflation is strongly mean-reverting and has an approximately zero mean. While the Gold Standard is the only historical instance of such a regime, Gibson's paradox can in principle emerge under a broader class of monetary arrangements. Indeed, once the deterministic component of the price level's drift is removed, the same co-movement patterns can be recovered from data generated under contemporary inflation targeting regimes. In line with the inefficiencies highlighted by the literature on metallic standards, this finding suggests that modern regimes are not immune to criticism, as fluctuations in r* account for significant portions of the variation of inflation and output.