DP1503 Does Inflation Matter for Growth?

Author(s): Thorvaldur Gylfason, Tryggvi Thor Herbertsson
Publication Date: December 1996
Keyword(s): Economic Growth, Inflation
JEL(s): C5, E3, O4
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1503

Some channels through which increased inflation tends to reduce economic growth, and vice versa, are studied within a simple model incorporating money into an optimal growth framework with constant returns to capital. The model includes the potential impact of inflation on: (a) saving through real interest rates (or uncertainty); (b) the income velocity of money; (c) the government budget deficit through the inflation tax and tax erosion; and (d) efficiency in production through the wedge between the returns to real and financial capital. The effect of inflation on growth is estimated using the random-effects panel model applied to two sets of unbalanced panel data side-by-side, from the Penn World Tables and from the World Bank, covering 170 countries from 1960 to 1993. The cross-country links between inflation and growth are economically and statistically significant and robust.