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Interest rate, price level, and the inflation rate

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View the page of Taufiq Choudhry

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Taufiq Choudhry discusses the Gibson Paradox and the Fisher Effect for the UK during different metallic and non‐metallic regimes.

Image courtesy of interviewee. March 11, 2024

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The speaker discusses a research paper that investigates the Gibson's Paradox and the Fisher Effect in the UK from 1790 to 1931. The Gibson's Paradox refers to the positive correlation between interest rates and price levels, which contradicts traditional monetary theory suggesting no relationship between them. The Fisher Effect indicates a positive relationship between long-term interest rates and inflation rates.

The research focuses on the gold standard period in the UK and examines whether these two phenomena coexist during both gold standard and non-gold standard periods. The study utilizes high-frequency monthly data rather than annual data, which allows for more robust analysis. It employs modern econometric methods, particularly the ARDL method, to handle stationary and non-stationary time series data.

The results suggest that both Gibson's Paradox and the Fisher Effect are observed during the gold standard period (1821-1914). However, during non-gold standard periods, such as the Napoleonic Wars and World War I, evidence for these relationships is absent. The speaker concludes that the Gibson's Paradox is primarily a phenomenon of the gold standard era and that the Fisher Effect provides an explanation for its occurrence. The implication is that these relationships are not relevant in the current monetary context post-World War II. The speaker encourages further research on this topic using similar methodologies in different countries and contexts.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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I've always been involved in,

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and interested in historical aspect

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of economics and all that.

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Um, on this paper that I'm talking about,

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now basically infrequently investigates the Gibson's Paradox

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and the Fisher Effect for the UK from 1790 to 1931.

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Okay. The Gibson's paradox is, is the, is the set

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positive, positive relationship between interest rate

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and the price level.

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Uh, Gibson's in 1923,

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noticed this while he was doing research for

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a few hundred years of data.

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Uh, some people said Toki, actually saw this

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and mentioned this in 1838.

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Okay? The, the reason is the paradox is

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because it violates the basic monetary policy.

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Mor monetary theory. The monetary theory basically said the

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relationship should be, should be between interest rate,

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long-term interest rate and inflation rate.

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Inflation rate is a rate of change of prices. Yeah.

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It should not, there should be no relationship between

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interest rate and the level of prices.

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And, and because there was no real explanation for this,

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and it violates, basic multi theory Keynes in,

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1930 basically called it Gibson's Paradox.

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Okay? And what we do, in,

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and the reason, okay, the paper basically studies both

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Gibson's Paradox and Fisher Effect.

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Now, Fisher Effect is the positive relationship

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between long-term interest rate and the inflation rate.

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Okay? And it was done by Ivin Fisher in the 1920s

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or thirties himself, you know,

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and that people have since then come out

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and said Fisher Effect is basically the real reason why

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Gibson Paradox exists,

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or Fisher Effect actually explains the reason why Gibson

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Paradox may actually exist.

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And the paper that I'm working on is basically looks at the

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gold standard period of the uk.

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The UK was in Gold Standard since 17 something till 1931,

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but they were never constantly on Gold Standard.

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Every now and then, they did come out of Gold Standard, like

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during the Napoleonic War of 1797 to 1815,

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and then during Second World War from 1914 to 1925,

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they came out of Gold Standard, you know,

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but they went back to it.

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And finally in 1931, they came out completely.

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So some people who've done research on Gibson's Paradox

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and in and Fisher Effect have basically said it'll only hold

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during a metallic

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time period when gold was the standard.

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It'll not hold outside the gold standard. It won't hold.

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And that's what I'm studying in this time period,

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in this big 1790 to 1931.

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Does the G Gibsons paradox hold

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and does the Fisher Effect hold at the same time?

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There have been quite a few work.

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Like I said, this is, has been a very popular

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topic for a long time.

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It was sta studied in 1923 and all that.

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And, Martin Luther Friedman studied in, in, in the 1950s

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And all that, you know, so,

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and there were quite a few papers

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who studied for the uk.

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One good thing about the uk, is that,

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we have maintained very good long-term data.

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You know, the data is available going back

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to the 17 hundreds

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and all that Bank of England maintains this historical data.

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So, and, what other people?

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The, the, the way my paper is different is two ways.

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Um, most people study using annual data,

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which is means one data point per year, you know,

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and they use 200 years of data or whatever, you know,

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but I found monthly data.

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So there's a data for January, February, March,

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April for each year.

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So there are 12 data points per year for from 1790

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to 1931.

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So I had a high frequency data.

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The more the data, the better results you get.

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You can have better analysis of implication of the results.

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And there's not many papers, at least I couldn't find,

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papers that use monthly data.

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And I used different methods,

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more robust economic econometric

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and statistical method to study the same relationship.

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And I took the 1790 to 1931 period

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and then broke it into smaller sub periods, you know,

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from 1821 to 1914,

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UK was constantly in gold standard.

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Yeah. And then for,

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and war break for First World War broke out.

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And from 1914 to 1925, they were offered.

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Then they came back for about seven,

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six years called Goal Exchange Standard.

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And in 1931,

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they could not maintain the gold standard at all.

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So they came out completely.

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And since then, we never really went back.

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And so I bake this into different phases, you know,

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sub periods,

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when they were completely in gold Standard 1821 to 1914,

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and then 1925 to 1931, I do the Nongo Standard period

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to the Onic War from E 1797 to 1815.

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I also studied from 1914 to 1925

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to see whether truly the Gibson's Paradox

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and the Fisher Effect coexist

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and do the truly exist during the gold standard

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or Nongo standard, or this is just some artifact of,

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of the econometrics.

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You know, a lot of people say it doesn't exist

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because in the literature,

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they found very little evidence of it.

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The Gibsons Paradox and Fisher Effect have been

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studied in many different ways.

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You know, where in the olden days, the fifties

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and forties when, Friedman

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and Anna Shortz did their research in 1955 or 56, I forget.

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And then Carmichael Stubbings did their research.

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You know, they used different econometrics method.

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One thing has that has improved, as you know, is,

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artificial intelligence, statistics and computers,

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and modeling and all

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that improved over the last 20, 30 years.

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Now, econometrics is much more statistical method is much

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more so first of all, I look at each individual cd,

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which is long-term interest rate and price level. Uh,

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And the inflation rate, inflation rate is created

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after the price level

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with inflation rate is basically a rate

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of change of the price level.

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So I, I take these three CDs, you know,

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a long-term interest rate, price level, and inflation.

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And I look at the sarcastic structure of each series

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to see if the best stationary or not.

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If a series is stationary,

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that means it can be forecasted, it is forecastable.

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If it is non stationary, then it's non forecastable.

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It just does not, never returns to its means.

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It just goes off, you know, to the tangent, you know,

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and the method I used,

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and most places inflation is stationary

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because inflation rate of change never goes,

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there's no trend to it.

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You know, it's always bouncing between two, three, 4%

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or whatever, where the inflation

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interest rate is never stationary

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because it's always rising, you know?

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So in the old method, they would do statistical

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analysis using a stationary

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and a non stationary series, which we now know is incorrect.

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You know, it's not, should be done this way.

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Now, the method I used was the ar DL method.

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The ar DL method is auto aggressive distributed lag,

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bounce method.

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It's, it's one of the unique ways

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to look at long-term relationship in a cointegration method,

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which takes a non series non-stationary and a stationary,

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and it lets you test between these two.

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It does not care about the stationary of the series, if it's

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so in this way, Fisher Effect can be studied that way

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because Fisher Effect is basically a series

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between stationary and non stationary.

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And Gibson's products is not that much of a problem

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because usually price level

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and interest rate are both non stationary.

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So I use this cointegration method,

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which is a bit more relaxed

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and not as restrictive as the two step method of Ang

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and Ranger or the co multi correlation method

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of Johansson method.

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But RDL method of, who came up

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with it sometime back is good for this, mixture

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of stationary, non stationary.

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And the third test I do, is a rolling correlation

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to see, when we do, when we say,

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or the correlation between X

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and Y is 0.1, that means they correlate it by 10%, you know,

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but that's a static correlation.

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A rolling correlation is, I take correlation for each month.

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Yeah. And see how the correlation changes from 1790 to 1931,

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you know, whether inflation and interest rate

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or, prices

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and interest rate, do the correlation between them change

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as we go from a gold standard to non gold standard

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and go back to gold standard.

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So I did several methods, you see how the, the,

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the relationship is stable or not,

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and first of all, is there a relationship?

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You know, and second of all, when is it, is it

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during the gold standard or off the goal standard

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or during both times?

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Third, do both of these guys, Gibson Paradox and

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The Fisher Effect, they both move together.

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Do they explain each other or not?

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The relationships are very interesting.

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I found relationship for both Gibson's Paradox

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and the Fisher Effect during the gold standard, you know,

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from 1821 to 1914, you know, and, that

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and 1821 to 1931.

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Now 1821 to 1931 also includes the six years, sorry,

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6, 7, 9, 9 years when we were not on the gold standard,

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you know, during the wartime and all that.

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But 1821 to 1914, regularly on the gold standard,

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I do find evidence of a Gibson's paradox,

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and I do find evidence

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of Fisher Effect now off the gold standard period,

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the Napoleon War, 9 17 97 to 1815,

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and during war 1914 to 9 25

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during the First World War in few years

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after that, there is no evidence of,

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there's absolutely no evidence.

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The only thing that I don't find the heydays

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of the gold standard is 1879 to 1914.

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That's when the majority

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of the countries in the world were on gold standard.

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us, Canada, the whole, most of Europe,

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even Japan, were the gold standard.

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But I don't find any evidence of that compared

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to other reach researchers in the past

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who have found evidence of the,

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of the Gibson Paradox during that time.

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My only explanation for that is they use annual data,

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they use annual data,

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and to me they use weaker statistical method

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5, 10, 20 years ago.

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But I'm using monthly data and I'm using a stronger method.

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And I don't find, gold, Gibson's Paradox

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or Fisher Effect during that time.

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But during the British Gold Standard,

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when they went gold standard nonstop from 1821, you know,

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after the Napoleon War, when they went back

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to Gold Standard in 1821, all the way to 1914,

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I find clear evidence of Gibson's paradox and Fisher Effect.

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The problem people deny Gibson's paradox was

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because if Gibson's power truly does exist,

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that means the Morty policy is going to be ineffective.

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Morty policy is one of the main thing is when they control

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the interest rate so they can control inflation

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and the price level, you know, in the olden days,

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not the modern monetary policy,

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the olden monetary policy used to be

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that they will move the interest rate up

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and down, so control the prices, whatever.

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But if the Gibson's paradox exists

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and then they can't control inflation, you know,

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but my conclusion is Gibson's paradox

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and fish, especially Gibson's paradox, is only a phenomenon

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during the gold standard in the modern period.

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We should not be worried about it. It it should not hold.

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Now, I did not study Gibson's paradox

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for the modern period since Second World War.

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You know, I've not, somebody else can do that.

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You know, maybe I will do that in the future, who knows?

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But it clearly shows that, it's not, it is,

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it is nothing to be concerned about.

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It was a phenomenal that time, you know, and I have

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A feeling the gold prices actually drove the phenomena,

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you know, it's one of the referees

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of my paper did raise this issue that,

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maybe the gold prices is doing it

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and maybe the gold prices should be part of the,

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of the test, but I did not include that.

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So, because the gold prices don't influence the

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interstate and all that anymore.

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So it's not, I don't think it's that big of a concern now,

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like it was during the Victorian time and

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before this first world war and all that.

12:19.185 --> 12:22.525
And secondly, I provide evidence, backing up,

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the Friedman and, shows that

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Fisher Effect is probably the best explanation why Gibson's

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Paradox Health, because my evidence clearly shows

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that they both coexisted at the same time.

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And the Fisher effect, this causality from interest rate

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to inflation and inflation to interest rate,

12:41.565 --> 12:42.925
that they're both affecting each other,

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which is the first sign that prices will get affected,

12:46.425 --> 12:48.205
by interest rate and other way around.

12:48.465 --> 12:51.405
And Gibson's paradox also, when I do the causality test,

12:51.765 --> 12:55.165
I do see mostly prices affecting interest rate

12:55.165 --> 12:56.485
and not the other way around.

12:57.445 --> 13:00.265
So the implication is, is is nothing

13:00.285 --> 13:02.705
to panic about now because it probably won't exist now.

13:02.925 --> 13:05.825
And second of all, I give evidence

13:06.005 --> 13:09.625
and backup some of the papers from the past, the,

13:09.645 --> 13:12.825
the Carmichael's paper and, and I showed the Friedman

13:12.825 --> 13:16.665
and Hortz paper that Fisher Effects probably is the main

13:16.665 --> 13:18.265
reason why Gibson Power existed.

13:18.445 --> 13:21.105
And it only exists during gold standard period.

13:21.215 --> 13:24.705
It's up to other people now to test the same, same

13:25.225 --> 13:27.105
phenomena for other countries using data

13:27.205 --> 13:28.225
for gold standard period.

13:28.225 --> 13:31.665
Because gold standard from 17 18, 79 to 1914,

13:31.725 --> 13:34.905
pretty much all of Western country along Japan were on the

13:34.905 --> 13:35.345
gold standard.

00:00 - I've always been involved in, and interested in historical aspect of economics and all that. on this paper that I'm talking about, now basically infrequently investigates the Gibson's Paradox and the Fisher Effect for the UK from 1790 to 1931.

00:15 - Okay. The Gibson's paradox is, is the, is the set positive, positive relationship between interest rate and the price level. Gibson's in 1923, noticed this while he was doing research for a few hundred years of data. some people said Toki, actually saw this and mentioned this in 1838. Okay? The, the reason is the paradox is because it violates the basic monetary policy.

00:44 - Mor monetary theory. The monetary theory basically said the relationship should be, should be between interest rate, long-term interest rate and inflation rate. Inflation rate is a rate of change of prices. Yeah. It should not, there should be no relationship between interest rate and the level of prices. And, and because there was no real explanation for this, and it violates, basic multi theory Keynes in, 1930 basically called it Gibson's Paradox. Okay? And what we do, in,

01:16 - and the reason, okay, the paper basically studies both Gibson's Paradox and Fisher Effect. Now, Fisher Effect is the positive relationship between long-term interest rate and the inflation rate. Okay? And it was done by Ivin Fisher in the 1920s or thirties himself, you know, and that people have since then come out and said Fisher Effect is basically the real reason why Gibson Paradox exists, or Fisher Effect actually explains the reason why Gibson

01:45 - Paradox may actually exist. And the paper that I'm working on is basically looks at the gold standard period of the uk. The UK was in Gold Standard since 17 something till 1931, but they were never constantly on Gold Standard. Every now and then, they did come out of Gold Standard, like during the Napoleonic War of 1797 to 1815, and then during Second World War from 1914 to 1925, they came out of Gold Standard, you know, but they went back to it.

02:16 - And finally in 1931, they came out completely. So some people who've done research on Gibson's Paradox and in and Fisher Effect have basically said it'll only hold during a metallic time period when gold was the standard. It'll not hold outside the gold standard. It won't hold. And that's what I'm studying in this time period, in this big 1790 to 1931. Does the G Gibsons paradox hold and does the Fisher Effect hold at the same time?

02:46 - There have been quite a few work. Like I said, this is, has been a very popular topic for a long time. It was sta studied in 1923 and all that. And, Martin Luther Friedman studied in, in, in the 1950s And all that, you know, so, and there were quite a few papers who studied for the uk. One good thing about the uk, is that, we have maintained very good long-term data.

03:09 - You know, the data is available going back to the 17 hundreds and all that Bank of England maintains this historical data. So, and, what other people? The, the, the way my paper is different is two ways. most people study using annual data, which is means one data point per year, you know, and they use 200 years of data or whatever, you know, but I found monthly data. So there's a data for January, February, March,

03:37 - April for each year. So there are 12 data points per year for from 1790 to 1931. So I had a high frequency data. The more the data, the better results you get. You can have better analysis of implication of the results. And there's not many papers, at least I couldn't find, papers that use monthly data. And I used different methods, more robust economic econometric

04:03 - and statistical method to study the same relationship. And I took the 1790 to 1931 period and then broke it into smaller sub periods, you know, from 1821 to 1914, UK was constantly in gold standard. Yeah. And then for, and war break for First World War broke out. And from 1914 to 1925, they were offered. Then they came back for about seven, six years called Goal Exchange Standard.

04:29 - And in 1931, they could not maintain the gold standard at all. So they came out completely. And since then, we never really went back. And so I bake this into different phases, you know, sub periods, when they were completely in gold Standard 1821 to 1914, and then 1925 to 1931, I do the Nongo Standard period to the Onic War from E 1797 to 1815. I also studied from 1914 to 1925

04:56 - to see whether truly the Gibson's Paradox and the Fisher Effect coexist and do the truly exist during the gold standard or Nongo standard, or this is just some artifact of, of the econometrics. You know, a lot of people say it doesn't exist because in the literature, they found very little evidence of it. The Gibsons Paradox and Fisher Effect have been studied in many different ways.

05:20 - You know, where in the olden days, the fifties and forties when, Friedman and Anna Shortz did their research in 1955 or 56, I forget. And then Carmichael Stubbings did their research. You know, they used different econometrics method. One thing has that has improved, as you know, is, artificial intelligence, statistics and computers, and modeling and all that improved over the last 20, 30 years. Now, econometrics is much more statistical method is much

05:49 - more so first of all, I look at each individual cd, which is long-term interest rate and price level. And the inflation rate, inflation rate is created after the price level with inflation rate is basically a rate of change of the price level. So I, I take these three CDs, you know, a long-term interest rate, price level, and inflation. And I look at the sarcastic structure of each series to see if the best stationary or not.

06:16 - If a series is stationary, that means it can be forecasted, it is forecastable. If it is non stationary, then it's non forecastable. It just does not, never returns to its means. It just goes off, you know, to the tangent, you know, and the method I used, and most places inflation is stationary because inflation rate of change never goes, there's no trend to it. You know, it's always bouncing between two, three, 4%

06:40 - or whatever, where the inflation interest rate is never stationary because it's always rising, you know? So in the old method, they would do statistical analysis using a stationary and a non stationary series, which we now know is incorrect. You know, it's not, should be done this way. Now, the method I used was the ar DL method. The ar DL method is auto aggressive distributed lag, bounce method.

07:09 - It's, it's one of the unique ways to look at long-term relationship in a cointegration method, which takes a non series non-stationary and a stationary, and it lets you test between these two. It does not care about the stationary of the series, if it's so in this way, Fisher Effect can be studied that way because Fisher Effect is basically a series between stationary and non stationary. And Gibson's products is not that much of a problem because usually price level

07:37 - and interest rate are both non stationary. So I use this cointegration method, which is a bit more relaxed and not as restrictive as the two step method of Ang and Ranger or the co multi correlation method of Johansson method. But RDL method of, who came up with it sometime back is good for this, mixture of stationary, non stationary. And the third test I do, is a rolling correlation

08:03 - to see, when we do, when we say, or the correlation between X and Y is 0.1, that means they correlate it by 10%, you know, but that's a static correlation. A rolling correlation is, I take correlation for each month. Yeah. And see how the correlation changes from 1790 to 1931, you know, whether inflation and interest rate or, prices and interest rate, do the correlation between them change as we go from a gold standard to non gold standard

08:36 - and go back to gold standard. So I did several methods, you see how the, the, the relationship is stable or not, and first of all, is there a relationship? You know, and second of all, when is it, is it during the gold standard or off the goal standard or during both times? Third, do both of these guys, Gibson Paradox and The Fisher Effect, they both move together. Do they explain each other or not?

08:59 - The relationships are very interesting. I found relationship for both Gibson's Paradox and the Fisher Effect during the gold standard, you know, from 1821 to 1914, you know, and, that and 1821 to 1931. Now 1821 to 1931 also includes the six years, sorry, 6, 7, 9, 9 years when we were not on the gold standard, you know, during the wartime and all that. But 1821 to 1914, regularly on the gold standard, I do find evidence of a Gibson's paradox,

09:34 - and I do find evidence of Fisher Effect now off the gold standard period, the Napoleon War, 9 17 97 to 1815, and during war 1914 to 9 25 during the First World War in few years after that, there is no evidence of, there's absolutely no evidence. The only thing that I don't find the heydays of the gold standard is 1879 to 1914. That's when the majority

10:00 - of the countries in the world were on gold standard. us, Canada, the whole, most of Europe, even Japan, were the gold standard. But I don't find any evidence of that compared to other reach researchers in the past who have found evidence of the, of the Gibson Paradox during that time. My only explanation for that is they use annual data, they use annual data, and to me they use weaker statistical method

10:24 - 5, 10, 20 years ago. But I'm using monthly data and I'm using a stronger method. And I don't find, gold, Gibson's Paradox or Fisher Effect during that time. But during the British Gold Standard, when they went gold standard nonstop from 1821, you know, after the Napoleon War, when they went back to Gold Standard in 1821, all the way to 1914, I find clear evidence of Gibson's paradox and Fisher Effect. The problem people deny Gibson's paradox was

10:54 - because if Gibson's power truly does exist, that means the Morty policy is going to be ineffective. Morty policy is one of the main thing is when they control the interest rate so they can control inflation and the price level, you know, in the olden days, not the modern monetary policy, the olden monetary policy used to be that they will move the interest rate up and down, so control the prices, whatever. But if the Gibson's paradox exists

11:18 - and then they can't control inflation, you know, but my conclusion is Gibson's paradox and fish, especially Gibson's paradox, is only a phenomenon during the gold standard in the modern period. We should not be worried about it. It it should not hold. Now, I did not study Gibson's paradox for the modern period since Second World War. You know, I've not, somebody else can do that. You know, maybe I will do that in the future, who knows? But it clearly shows that, it's not, it is,

11:48 - it is nothing to be concerned about. It was a phenomenal that time, you know, and I have A feeling the gold prices actually drove the phenomena, you know, it's one of the referees of my paper did raise this issue that, maybe the gold prices is doing it and maybe the gold prices should be part of the, of the test, but I did not include that. So, because the gold prices don't influence the interstate and all that anymore.

12:10 - So it's not, I don't think it's that big of a concern now, like it was during the Victorian time and before this first world war and all that. And secondly, I provide evidence, backing up, the Friedman and, shows that Fisher Effect is probably the best explanation why Gibson's Paradox Health, because my evidence clearly shows that they both coexisted at the same time. And the Fisher effect, this causality from interest rate to inflation and inflation to interest rate,

12:41 - that they're both affecting each other, which is the first sign that prices will get affected, by interest rate and other way around. And Gibson's paradox also, when I do the causality test, I do see mostly prices affecting interest rate and not the other way around. So the implication is, is is nothing to panic about now because it probably won't exist now. And second of all, I give evidence and backup some of the papers from the past, the,

13:09 - the Carmichael's paper and, and I showed the Friedman and Hortz paper that Fisher Effects probably is the main reason why Gibson Power existed. And it only exists during gold standard period. It's up to other people now to test the same, same phenomena for other countries using data for gold standard period. Because gold standard from 17 18, 79 to 1914, pretty much all of Western country along Japan were on the gold standard.

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