Thomas Tooke and the Gibson Paradox

The Gibson Paradox is the name that Keynes suggested for a particular empirical regularity, namely: the positive correlation between the rate of interest and the price level. He had read about in a series of articles in the Banker's Magazine by A. H. Gibson, hence the name. Keynes suggested in his Treatise on Money that the Gibson Paradox was "one of the most completely established empirical facts in the whole field of quantitative economics." The graph below is from Gibson's 1926 piece.
However, the correlation was first noted by Thomas Tooke (for more see Pivetti's entry in the New Palgrave; subscription required), the leader of the Banking School, in the 19th century, and author of the massive and underappreciated History of Prices ( Vols. 1, 2, 3, 4, 5 and 6 available on-line).

In that book, and contrary to Ricardo and the Bullionist authors (the precursors of the Currency School), he argued that inflation during the Napoleonic Wars (1793-1814) was not caused by money printing by the Bank of England (bank notes were inconvertible from 1797 to 1821), but the result of bad crops and higher prices of agricultural goods, import restrictions associated to the blockade and higher import prices, and exchange rate depreciation that added to the costs of imported goods. The last cause he cites is associated to what Keynes called the Gibson Paradox (p. 347):
"A higher rate of interest, in consequence of the absorption by the war loans of a considerable proportion of the savings of individuals; such higher rate of interest constituting an increased cost of production."
In other words, the rate of interest enters the costs of production [some heterodox authors, like Lance Taylor, have referred to this as the Cavallo-Patman effect]. Note that there is no particular paradox in the effect, which according to Lawrence Klein [yes the same that won the Sveriges Riksbank Prize, aka the Nobel] is still doing fine (and yes also needs subscription; sorry).

The reason that the correlation seemed like a paradox to Keynes is because he thought along marginalist lines and assumed that a higher rate of interest would lead to lower investment, and hence reduce demand pressures on prices. He expected a negative correlation between the two variables. Wicksell noted that if the economy was hit by a real shock (to the marginal productivity of capital, for example) then you would have a bank rate of interest lower than the new and higher natural rate of interest (implying higher remuneration for the more productive capital), and the excess investment associated to this situation would lead to higher prices. Eventually, banks would note that the bank rate was too low, and would raise it, leading to an increase in the rate of interest together with higher prices (a positive correlation). Of course Wicksell and the natural rate cannot survive the capital critique. For more on Wicksell go here.


  1. “there is no such a thing as a natural rate of interest in the sense in which economists speak of a natural rate of profit and a natural rate of wages” (Marx, 1894: 362-363)

    "the rate of profit, as a ratio, has a significance, which is independent of any prices, and can well be ‘given’before the prices are fixed. It is accordingly susceptible of being determined from outside the system of production, in particular by the level of money rates of interest" (Sraffa, 1960: 33).


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