The paradox of interest rates of the Greenback Era: A reexamination

The two leading explanations for the counterintuitive behavior of interest rates during the Greenback Era (1862–1878) – the resumption expectations model of Calomiris (1988) and the capital flow argument of Friedman and Schwartz (1963) – are inconsistent with each other in terms of their treatment of financial arbitrage. A methodology to identify unexploited arbitrage opportunities in financial data is proposed. Observable returns strongly suggest that the money market of the Greenback Era did not systematically admit arbitrage, except possibly around the times of the Gold Corner of 1869 and the Panic of 1873, which implies that Calomiris provides a more plausible explanation.

Research Highlights
► Explanations of the paradox make opposite assumptions about financial arbitrage.
► A methodology to identify unexploited arbitrage opportunities is proposed.
► The money market of the Greenback Era did not systematically admit arbitrage.
► The model of Calomiris (1988) likely gives a plausible explanation of the paradox.