A nominal theory of the nominal rate of interest and the price level with the integration of both the asher effect and the gibson paradox

Abstract

This paper develops a simple theory of nominal income interest determination under three key assumptions: firstly, the only relevant distinction between money and government bonds lies in their holding periods. Secondly, individuals take full account of the government budget constraint and do not concern themselves with discounting future tax liabilities associated with the issue of government bonds. Finally, the model incorporates a private credit market for individuals borrowings and lendings. According to this theory, the nominal rate of interest is determined by two separable influences,the bond/money ratio and the rate of expansion of the money supply. The first of these influences can give rise to a positive correlation between nominal interest rates and price levels and the second can generate a close relationship between the level of these nominal rate and the rates of expansion of the price level. Therefore, this theory coherently accounts for both the Gibson Paradox and the Fisher-effect.