A Tale of Two Effects

Paul Evans and Xiaojun Wang ()

No 200506, Working Papers from University of Hawaii at Manoa, Department of Economics

Abstract: This paper adopts a New Keynesian approach to analyze the relationship between nominal interest rates and prices. In this new framework, both a positive relation between interest rates and price levels (i.e., a positive Gibson effect) and a negative relation between interest rates and subsequent price changes (i.e., a negative Fama-Fisher effect) arise when money is supplied inelastically and prices are flexible. Such an economy is subject to Gibson’s Paradox, a long-standing puzzle in monetary economics, and a novel paradox identified here, a Fama-Fisher Paradox. By contrast, economies characterized by elastic money and sticky prices are not so paradoxical since nominal interest rates are positively related to subsequent inflation and ambiguously related to the price level. Empirical analysis of nearly two centuries of data for ten countries supports the new theory.

Keywords: Fama-Fisher Paradox; Gibson’s Paradox; inelastic money; flexible prices; gold standard (search for similar items in EconPapers)
JEL-codes: E31 E42 E43 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2005
New Economics Papers: this item is included in nep-mac
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http://www.economics.hawaii.edu/research/workingpapers/WP_05-6.pdf First version, 2004 (application/pdf)

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Journal Article: A Tale of Two Effects (2008)
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