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Inflation, Growth, and Credit Services

  • Max Gillman

    (CEU Budapest)

  • Michal Kejak


  • Akos Valentinyi

    (University of Southampton & CEPR)

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.

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Paper provided by EconWPA in its series Development and Comp Systems with number 0012007.

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Length: 35 pages
Date of creation: 16 Feb 2001
Date of revision:
Handle: RePEc:wpa:wuwpdc:0012007
Note: Type of Document - Acrobat PDF; pages: 35 ; figures: included
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  1. David R.F. Love & Jean-Francois Wen, 1999. "Inflation, Welfare, and the Time-Costs of Transacting," Canadian Journal of Economics, Canadian Economics Association, vol. 32(1), pages 171-194, February.
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  3. 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.
  4. Atish Ghosh & Steven Phillips, 1998. "Warning: Inflation May Be Harmful to Your Growth," IMF Staff Papers, Palgrave Macmillan, vol. 45(4), pages 672-710, December.
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  13. Robert J. Barro, 1996. "Inflation and growth," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 153-169.
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  17. Nouriel Roubini & Xavier Sala-i-Martin, 1991. "Financial Repression and Economic Growth," NBER Working Papers 3876, National Bureau of Economic Research, Inc.
  18. Stanley Fischer, 1991. "Growth, Macroeconomics, and Development," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 329-379 National Bureau of Economic Research, Inc.
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  20. 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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