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Does Inflation Matter for Growth?

  • Gylfason, Thorvaldur
  • Herbertsson, Tryggvi Thor

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1503.

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Date of creation: Dec 1996
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Handle: RePEc:cpr:ceprdp:1503
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