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Inflation, Growth, and Credit Services

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  • Max Gillman
  • Michal Kejak
  • Akos Valentinyi

Abstract

The empirical evidence suggests that there is a significant, negative relationship between inflation and economic growth. Conventional monetary growth models, however, predict a significantly smaller growth effect. This paper proposes a monetary growth model with an explicit credit service sector to explain the observed magnitude. Since credit services are assumed costly to produce, the consumers equate the opportunity cost of holding money with the marginal cost of credit. Therefore the technology of the financial sector influences the velocity of money, and consequently, how inflation affects leisure, the time spent accumulating human capital, and the growth rate of output. The calibration shows that the model generates an inflation-growth effect whose magnitude falls in the range found by the empirical studies. Moreover, in contrast to previous works, we are also able to explain an inflation-growth effect that becomes increasingly weak as the inflation rate rises, as the evidence seems to suggest. Analysis of the welfare cost of inflation further illuminates the inflation-growth effect and how the model compares to the literature.

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Bibliographic Info

Paper provided by The Center for Economic Research and Graduate Education - Economic Institute, Prague in its series CERGE-EI Working Papers with number wp154.

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Date of creation: Apr 2000
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Handle: RePEc:cer:papers:wp154

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Keywords: economic growth; inflation; costly credit;

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References

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  1. Stanley Fischer, 1991. "Growth, Macroeconomics, and Development," NBER Working Papers 3702, National Bureau of Economic Research, Inc.
  2. David R.F. Love & Jean-Francois Wen, 1999. "Inflation, Welfare, and the Time-Costs of Transacting," Canadian Journal of Economics, Canadian Economics Association, vol. 32(1), pages 171-194, February.
  3. Roubini, Nouriel & Sala-i-Martin, Xavier, 1992. "Financial repression and economic growth," Journal of Development Economics, Elsevier, vol. 39(1), pages 5-30, July.
  4. Atish Ghosh & Steven Phillips, 1998. "Warning: Inflation May Be Harmful to Your Growth," IMF Staff Papers, Palgrave Macmillan, vol. 45(4), pages 672-710, December.
  5. Stanley Fischer, 1991. "Growth, Macroeconomics, and Development," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 329-379 National Bureau of Economic Research, Inc.
  6. Robert J. Barro, 1996. "Inflation and growth," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 153-169.
  7. Andres, Javier & Domenech, Rafael & Molinas, Cesar, 1996. "Macroeconomic performance and convergence in OECD countries," European Economic Review, Elsevier, vol. 40(9), pages 1683-1704, December.
  8. Fischer, S., 1991. "Growth, Macroeconomics, and Development," Working papers 580, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. S. Rao Aiyagari & R. Anton Braun & Zvi Eckstein, 1995. "Transaction services, inflation, and welfare," Working Papers 551, Federal Reserve Bank of Minneapolis.
  10. Cooley, T.F. & Hansen, G.D., 1988. "The Inflation Tax In A Real Business Cycle Model," RCER Working Papers 155, University of Rochester - Center for Economic Research (RCER).
  11. Kormendi, Roger C. & Meguire, Philip G., 1985. "Macroeconomic determinants of growth: Cross-country evidence," Journal of Monetary Economics, Elsevier, vol. 16(2), pages 141-163, September.
  12. Gillman, Max, 1993. "The welfare cost of inflation in a cash-in-advance economy with costly credit," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 97-115, February.
  13. Paul Gomme, 1991. "Money and growth revisited," Discussion Paper / Institute for Empirical Macroeconomics 55, Federal Reserve Bank of Minneapolis.
  14. Larry E. Jones & Rodolfo E. Manuelli, 1993. "Growth and the Effects of Inflation," NBER Working Papers 4523, National Bureau of Economic Research, Inc.
  15. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
  16. Michael Dotsey & Peter Ireland, 1994. "The welfare cost of inflation in general equilibrium," Working Paper 94-04, Federal Reserve Bank of Richmond.
  17. Friedman, Milton, 1971. "Government Revenue from Inflation," Journal of Political Economy, University of Chicago Press, vol. 79(4), pages 846-56, July-Aug..
  18. V.V. Chari & Larry E. Jones & Rodolfo E. Manuelli, 1996. "Inflation, growth, and financial intermediation," Review, Federal Reserve Bank of St. Louis, issue May, pages 41-58.
  19. Schreft, S L, 1992. "Transaction Costs and the Use of Cash and Credit," Economic Theory, Springer, vol. 2(2), pages 283-96, April.
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Cited by:
  1. Hromcová, Jana, 2008. "Learning-or-doing in a cash-in-advance economy with costly credit," Journal of Economic Dynamics and Control, Elsevier, vol. 32(9), pages 2826-2853, September.
  2. Dabus, C. & Viego, V., 2003. "Inflación, Precios Relativos y Crecimiento: Evidencia de América Latina," Estudios de Economía Aplicada, Estudios de Economía Aplicada, vol. 21, pages 91-107, Abril.
  3. Hromcová, Jana & Callado-Muñoz, Francisco J. & Utrero-González, Natalia, 2014. "Effects of direct pricing of retail payment methods in Norway," Economic Modelling, Elsevier, vol. 37(C), pages 428-438.

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