<abstract xmlns="http://www.w3.org/1999/xhtml"><p> The monetary policy rules used by central banks these days are based on the assumption that inflation could be reduced by increasing interest rate. On contrary, Tooke (1774-1858), the forefather of monetary economics, was of the view that the relationship between interest rate and inflation should be positive. His view was based on simple logic, ‘interest is a part of cost, and therefore, the increase in interest rate should increase inflation by increasing cost of production (Tooke, 1838)’. Tooke’s view has got support from a number of empirical evidence including Gibson (1923) who found positive correlation between two variables for UK data over a period of 200 years. On the other hand, mainstream economic thinking on which the actual monetary practices are based ignored any possibility of positive relationship between interest rate and inflation throughout the history. The existence of Tooke’s cost side effects of monetary policy is a serious concern because if these effects exist than the use of monetary policy would be counterproductive. Using the data from entire globe, I attempt to explore the nature of relationship between the interest rate and inflation. I found that the data supports the perception of Tooke and Gibson and denies that the effectiveness of monetary policy currently adapted by the correlation between interest rate and inflation is positive. The results are robust to sample size, sample period, and various definitions of interest rate and inflation.</p></abstract>

The monetary policy rules used by central banks these days are based on the assumption that inflation could be reduced by increasing interest rate. On contrary, Tooke (1774-1858), the forefather of monetary economics, was of the view that the relationship between interest rate and inflation should be positive. His view was based on simple logic, ‘interest is a part of cost, and therefore, the increase in interest rate should increase inflation by increasing cost of production (Tooke, 1838)’. Tooke’s view has got support from a number of empirical evidence including Gibson (1923) who found positive correlation between two variables for UK data over a period of 200 years. On the other hand, mainstream economic thinking on which the actual monetary practices are based ignored any possibility of positive relationship between interest rate and inflation throughout the history. The existence of Tooke’s cost side effects of monetary policy is a serious concern because if these effects exist than the use of monetary policy would be counterproductive. Using the data from entire globe, I attempt to explore the nature of relationship between the interest rate and inflation. I found that the data supports the perception of Tooke and Gibson and denies that the effectiveness of monetary policy currently adapted by the correlation between interest rate and inflation is positive. The results are robust to sample size, sample period, and various definitions of interest rate and inflation.

Revival of Legacy of Tooke and Gibson: Implications for Monetary Policy

International Institute of Islamic Economics, International Islamic University, Islamabad

Journal of Central Banking Theory and Practice

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

{"article-title":"Revival of Legacy of Tooke and Gibson: Implications for Monetary Policy"}

The monetary policy rules used by central banks these days are based on the assumption that inflation could be reduced by increasing interest rate. On...

Revival of Legacy of Tooke and Gibson: Implications for Monetary Policy

Published Online: May 15, 2015

Page range: 37 - 58

Received: Mar 07, 2015

Accepted: Mar 23, 2015

DOI: https://doi.org/10.1515/jcbtp-2015-0008

Keywords
Cost Channel, Gibson Paradox, Tooke Banking School Theory

© Central Bank of Montenegro

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Revival of Legacy of Tooke and Gibson: Implications for Monetary Policy

Published Online: May 15, 2015

Page range: 37 - 58

Received: Mar 07, 2015

Accepted: Mar 23, 2015

DOI: https://doi.org/10.1515/jcbtp-2015-0008

KeywordsCost Channel, Gibson Paradox, Tooke Banking School Theory

© Central Bank of Montenegro

This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 3.0 License.

Keywords
Cost Channel, Gibson Paradox, Tooke Banking School Theory