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Inflation, Liquidity Risk and Long-run TFP - Growth

  • Evers, Michael
  • Niemann, Stefan
  • Schiffbauer, Marc

    (ESRI)

This paper demonstrates a negative relation between inflation and long-run productivity growth. Inflation generates long-run real effects due to a link from the short-run nominal and financial frictions to a firm's qualitative investment portfolio. We develop an endogenous growth model whose key ingredients are (i) a nominal short-run portfolio choice for households, (ii) an agency problem which gives rise to financial market incompleteness, (iii) a firm-level technology choice between a return-dominated but secure and a more productive but risky project. In this framework, inflation increases the costs of corporate insurance against productive but risky projects and hence a firm's choice of technology. It follows that each level of inflation is associated with a different long-run balanced growth path for the economy as long as financial markets are incomplete. Finally, we apply U.S. industry and firm level data to examine the relevance of our specific microeconomic mechanism. We find that (i) firms insure systematically against risky R&D investments by means of corporate liquidity holdings, (ii) periods of higher inflation restrain firm-level R&D investments by reducing corporate liquidity holdings.

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File URL: http://www.esri.ie/research/research_areas/international_economics/dynreg/papers/WP48.pdf
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Paper provided by Economic and Social Research Institute (ESRI) in its series Papers with number DYNREG48.

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Length: 40 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:esr:wpaper:dynreg48
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  1. repec:ner:tilbur:urn:nbn:nl:ui:12-3125519 is not listed on IDEAS
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  12. Levine, Ross & Loayza, Norman & Beck, Thorsten, 2000. "Financial intermediation and growth: Causality and causes," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 31-77, August.
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  17. Barro, Robert J & Lee, Jong Wha, 1996. "International Measures of Schooling Years and Schooling Quality," American Economic Review, American Economic Association, vol. 86(2), pages 218-23, May.
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  21. Edward C. Prescott, 1997. "Needed: a theory of total factor productivity," Staff Report 242, Federal Reserve Bank of Minneapolis.
  22. De Gregorio, Jose, 1993. "Inflation, taxation, and long-run growth," Journal of Monetary Economics, Elsevier, vol. 31(3), pages 271-298, June.
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