Inflation and Innovation-driven Growth
This paper models the relationship between inflation and steady state growth in a model combining standard Schumpeterian growth with a standard New Keynesian specification of nominal price rigidity. Positive money growth has two clear-cut countervailing effects on the incentive to innovate. Past price rigidity causes the use of an inefficiently large quantity of cheap old intermediate goods, reducing demand for new ones and hence, the incentive to innovate. Future price rigidity erodes the new good’s relative price, increasing demand and therefore the current incentive to innovate. In numerical calibrations the negative effect of inflation on growth dominates.
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