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Inflation, growth and credit services

  • Gillman, M.
  • Kejak, M.
  • Valentinyi, A.

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 Keywords; economic growth, inflation, costly credit

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Paper provided by Economics Division, School of Social Sciences, University of Southampton in its series Discussion Paper Series In Economics And Econometrics with number 9913.

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Date of creation: 01 Jan 1999
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Handle: RePEc:stn:sotoec:9913
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  1. Friedman, Milton, 1971. "Government Revenue from Inflation," Journal of Political Economy, University of Chicago Press, vol. 79(4), pages 846-56, July-Aug..
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  18. 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.
  19. 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.
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