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Money and the Welfare Cost of Inflation in an R&D-Growth Model

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Abstract

This study analyzes the effects of inflation on R&D and innovation-driven growth. In the theoretical section, we incorporate money demand into a quality-ladder model with elastic labor supply and derive the following results. If the elasticity of substitution between consumption and the real money balance is less (greater) than unity, then R&D and output growth are decreasing (increasing) in inflation. If either labor supply is inelastic or the elasticity of substitution between consumption and the real money balance is unity, then social welfare monotonically increases as the nominal interest rate approaches zero (i.e. the Friedman rule). Quantitatively, decreasing inflation in the US to achieve price stability improves welfare (equivalent to a permanent increase in consumption of at least 0.5%). In the empirical section, we use cross-country data to establish a negative and statistically significant relationship between inflation and R&D.

Suggested Citation

  • Angus C. Chu & Ching-Chong Lai, 2010. "Money and the Welfare Cost of Inflation in an R&D-Growth Model," IEAS Working Paper : academic research 10-A003, Institute of Economics, Academia Sinica, Taipei, Taiwan.
    • Handle: RePEc:sin:wpaper:10-a003
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    Keywords

    economic growth; inflation; money; R&D;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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