Barsky and Summers and Krugman on Gibson’s Paradox

From Barsky and Summers:

This paper contributes a new element to the explanations of the Gibson paradox, the puzzling correlation between interest rates and the price level seen during the gold-standard period. A shock that raises the underlying real rate of return in the economy reduces the equilibrium relative price of gold and, with the nominal price of gold pegged by the authorities, must raise the price level. The mechanism involves the allocation of gold between monetary and nonmonetary uses. The authors’ explanation helps to resolve some important anomalies in previous work and is supported by empirical evidence along a number of dimensions.

The paper is here.  Paul Krugman offers a very good explanation of a related hypothesis.  It’s one useful way of thinking about why the price of gold is rising in a deflationary time (without requiring one to deny the potential relevance of other factors).  The presentation also explains the behavior of gold prices in a TGS era, namely with low real rates of return.

I very much enjoy this puzzle.  It requires a working knowledge of many different parts of economics, not just a few.


I am not sure if this is really that complex. A few days ago I asked my son (age 19) why Gold prices were so low (compared to now) back around 2000. His immediate answer was "everybody expected Tech stocks to boom forever".

You might find interesting to know that the correlation between gold and 30-yr treasuries has been extremly high off late (let's say the last 9 months)... I think that's quite supportive of krugman's argument... The year to return on a 40 year strip has been almost identical to the ytd on gold...

correlation between gold and 30-yr treasuries has been extremly high off late

If i pick 200 different variables randomly, gold will be correlated with a few, just by chance. Especially if i also get to choose the time period. the proof of a relationship is its persistence through several business cycles. treasuries and gold? not so much.

This model takes into account the Summers/Barksy paper.

I've been using this mind frame to 'time the market' in gold. So I hold a very large long position in gold and I'll hold it until real short yields start turning positive, at which point I sell it all.

All that matters to the investor/trader is real yields and opportunity cost in my opinion, not the monetary aggregates or CPI.

And increasing money supply during demand side caused deflation keeps yields down. Competitive currency devaluations also keep yields down. etc etc.

That Summers/Barksy paper is simple and straightforward and its view of gold as the anti-currency makes sense.

Paul Krugman uses his immense intelligence, skills, and resources to come up with the strongest arguments that don't require him to change his views.

It would be most interesting to create a economic model that incorporates the degree of contempt for US political leadership. To me, that's the number one mover of gold prices.


I did a little checking and found that inflation rates appear to be rising in many countries around the world. The U.S. CPI is up 3.6 yty. Eurozone inflation is around 2.5% yty (and declining). Japan's inflation rate is roughly zero. However, BRIC inflation is quite high (Brazil 7.23%, Russia 9.0%, India 8.43%, China 6.5%). Some developed countries have relatively high inflation. The UK is at 4.4% Australia is at 3.6% and New Zealand has reached 5.3% (as has S. Korea).

Perhaps Krugman has succumbed to an unduly U.S. centric perspective. Given the reality of high (and rising) inflation rates in the ROW, Gold prices may indeed be reflecting both actual inflation and expected future inflation. The inflationistas may well be right if you look beyond our borders and 3.6% isn't that low an inflation rate for a country with 9+% unemployment.

The converse is that multiple mechanisms can easily be at work hear. Declining real rates of return (and expected rates of return) should also boost Gold prices. Uncertainty (stated bluntly as fear) should also raise Gold prices. Insisting on a single explanation for something when multiple factors may be at work is a mark of intellectual rigidity or political polemics in my opinion.


See for a simple table of global inflation rates.

Excuse me, I meant the Elfenbein essay, which references the Summers/Barsky paper.

Krugman's piece is interesting but he reaches the wrong conclusion. We have negative real interest rates not because of deflation fear, but because the Fed has created expectations of positive future inflation. In other words, at the zero bound for the nominal interest rates, real interest rates would be positive in the absence of Fed-induced inflation expectations. One example of this is Japan: ZIRP has consistently produced positive real rates.

In other words, gold is rising because real interest rates are negative; real interest rates are negative because the Fed wants us to have positive inflation expectations.

"In other words, at the zero bound for the nominal interest rates, real interest rates would be positive in the absence of Fed-induced inflation expectations."

I feel I'm missing something basic.

The zero lower bound is currently only in effect for short-term rates, so we can only possibly be talking about short-term rates. But to the extent that short-term rates are driven by inflation, they are driven by current inflation, not expected inflation. So how can the Fed's desire to produce positive inflation expectations possibly push short-term nominal rates to zero?

Well, in some sense the question answers itself: the Fed's *mechanism* for creating positive inflation expectations is to push short-term nominal rates to zero. But if that is what you meant, why not just say that?

I think one reason Krugman reaches the wrong conclusion is because he assumes that low rates are a function of deflation fear. This is true of nominal, but not real rates. It seems impossible to have a situation under which deflation fears result in negative real interest rates: these have to be an artifact of Fed policy.

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