Some Empirical Aspects regarding the Relationship between Inflation and Economic Growth in Romania – the Speed Limit Effect

This study briefly presents theoretical aspects related to the relationship between inflation and economic growth and provides an empirical study for the Romanian economy, for the period 2000 – 2011. The econometric methodology used is that of vector auto-regressions. The results showed that a sudden increase in the change of the output gap (i.e. a shock to the growth rate of the output gap) does not determine an increase in CPI. Hence, the hypothesis of the existence of a speed limit effect in Romania is rejected. In concrete terms, this means that the monetary authorities should not fear for eventual inflationary pressures when sudden increases of demand arise, if the output gap is negative (the potential output is higher that the effective output). The National Bank of Romania may avoid, therefore, taking some monetary policy decisions meant to temper the rise in inflation (as would have been the case if a speed limit effect was present) but which would have induced unnecessary volatility into the output. However, the study indicates that National Bank of Romania should communicate to the public the state of the economy in order to timely anchor the inflation expectations. This is a very important aspect, since the inflation expectations firmly react to a shock into the growth rate of the output gap, i.e. to a strong increase in the effective output. The study also showed a positive response of the growth rate of the output gap to a positive shock in inflation, with a maximum effect after three quarters. This shows that the inflation was mainly driven by demand factors in the analysed period, with the consumers increasing current consumption in order to avoid the future higher prices and with the economic agents increasing the supply such as to maximise the unitary profits. Also, this result shows a rather inelastic demand or a possible captivity of consumers in the face of producers.