A Tale of Two Effects

Paul Evans and Xiaojun Wang ()

The Review of Economics and Statistics, 2008, vol. 90, issue 1, 147-157

Abstract: This paper investigates the relationship between nominal interest rates and prices using nearly two centuries of data from ten industrial countries. Both a positive relationship between interest rates and price levels (that is, a positive Gibson effect) and a negative relationship between interest rates and subsequent price changes (that is, a negative Fama-Fisher effect) prevailed until World War I. We propose a simple explanation wherein this doubly paradoxical juxtaposition of effects arises when money is supplied inelastically and prices are flexible. This double paradox disappeared after World War II when economies became mostly characterized by elastic money and sticky prices. During that period, a positive Fama-Fisher effect emerged while the Gibson effect largely dissipated. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Date: 2008
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