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vol l no 37
1 Introduction
hile there is a consensus among mainstream theorists that there is no trade-off between inflation and
output in the long run, there is no unanimity on the
short-run effect of inflation on economic growth. Positive effects of inflation on economic growth may be due to the fact
that higher inflation makes capital more attractive to hold relative to money. It reduces the value of debt and makes labour
markets more efficient by making real wages more variable
than otherwise. Hence, an increase in the expected rate of inflation can cause a rise in capital accumulation and overall
growth in the economy. On the other hand, the negative
effects of inflation on economic growth can be manifold.
High rates of inflation can discourage savings and productive
investment, encouraging consumption and speculative asset
buying. They can undermine a countrys export competitiveness, reducing exports and increasing imports, and perhaps
also encouraging capital flight. This will put pressure on both
the exchange rate and on interest rates. Inflation may also
have adverse effects on income distribution which may also
cause political instability. Typically, volatility of inflation is
high during periods of high inflation.
Researchers have found unanticipated inflation to be one of
the most important determinants of investment and economic
growth (Bruno 1993; Pindyck and Solimano 1993; Andrs and
Hernando 1999; Freedman and Laxton 2009). If an investor
undertakes a long-term project with long-term debt during a
period of high inflation, the risk of losses rises significantly in
the case of an unexpected disinflation (Freedman and Laxton
2009). The rate of return on capital and investment would fall,
which could lead to a fall in output. If the relationship between
inflation and economic growth is positive at a low rate of inflation, but negative at a high rate, it means that there exists a
non-linear relationship between these two variables. In other
words, it should be possible, at least in principle, to find an
inflexion point at which the sign of this relationship switches
from positive to negative (Khan and Senhadji 2001).
Inconclusive findings on the growth-effects of inflation raise
an important question: What is the rate of inflation at which the
negative effects on growth prevail over its positive effects? Recent
empirical studies recognise the importance of these questions
and therefore, attempt to examine the threshold level of inflation
at which the relationship between inflation and economic growth
becomes negative. While the seminal paper by Fischer (1993)
first identified the possibility of a positive inflationgrowth
59
SPECIAL ARTICLE
The data set used in this paper runs from 1971 to 2010 and
includes 54 developing countries. Eleven of these are from
Asia, 19 are from Latin America and the Caribbean, and 24
countries are from the Sub-Saharan Africa (Table 1, p 61).
september 12, 2015
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SPECIAL ARTICLE
Table 1: List of Countries
Asia
Sub-Saharan Africa
Bangladesh
China
India
Indonesia
Malaysia
Nepal
Pakistan
Philippines
Sri Lanka
Thailand
Vietnam
Belize
Bolivia
Chile
Colombia
Costa Rica
Dominican Republic
Ecuador
El Salvador
Guatemala
Guyana
Honduras
Jamaica
Mexico
Nicaragua
Panama
Paraguay
Peru
Uruguay
Venezuela
Benin
Botswana
Burundi
Cameroon
Central African Republic
Congo, Republic
Congo, Democratic
Cote dIvoire
Gabon
Gambia
Ghana
Kenya
Lesotho
Malawi
Mali
Mauritania
Mauritius
Niger
Sierra Leone
Swaziland
Tanzania
Togo
Uganda
Zambia
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61
SPECIAL ARTICLE
Pooled OLS
Fixed Effect
Inflation
0.087**
(0.04)
-0.003***
(0.10)
14.50
54
0.142***
(0.04)
-0.003***
(0.09)
23.67
54
Inflation squared
Threshold inflation rate (TIR)
Number of groups
Random Effect
0.117***
(0.04)
-0.003**
(0.09)
19.50
54
(1) Standard errors are in the parentheses. (2) *** and ** represent 1% and 5% levels of
significance respectively. (3) TIRs are calculated using equation 2.
results. First, while we do not contend that inflation is a positive engine of growth, with the increase in aggregate demand
and growth, economies in the developing countries may experience some inflationary pressure. However, as Pollin and Zhu
(2006: 595) argued, some inflationary pressures are likely
to emerge in this scenario as a relatively benign by-product.
Second, our results support any policy that allows governments and policymakers in developing countries to promote
economic growth and employment even while maintaining
double-digit inflation rates.
Table 3: InflationGrowth Nexus in Asia: 19712010
Dependent Variable: GDP Growth
Variable
Pooled OLS
Fixed Effect
Inflation
0.417***
(0.10)
-0.020***
(0.59)
10.43
11
0.461**
(0.20)
-0.022***
(0.82)
10.48
11
Inflation squared
TIR
Number of groups
Random Effect
0.453***
(0.11)
-0.021***
(0.61)
10.79
11
Inflation
Inflation squared
TIR
Number of groups
Pooled OLS
Fixed Effect
Random Effect
-0.008 (0.05)
-0.001 (0.12)
19
0.141** (0.07)
-0.003** (0.13)
23.5
19
0.022 (0.05)
-0.001 (0.12)
19
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similar, irrespective of the type of the techniques used. Calculated threshold rates are 23.6%, 22%, and 23.6%, respectively.
In other words, economic growth rises by around 0.18%
0.24% for every percentage point increase in the inflation rate
up to a 24% threshold for the Sub-Saharan Africa region.
Table 5: InflationGrowth Nexus in Sub-Saharan Africa: 19712010
Dependent Variable: GDP Growth
Variable
Pooled OLS
Inflation
0.181***
(0.05)
-0.004***
(0.12)
23.63
24
Inflation squared
TIR
Number of groups
Fixed Effect
0.176**
(0.06)
-0.004**
(0.14)
22
24
Random Effect
0.236***
(0.05)
-0.005***
(0.13)
23.6
24
JANDHYALA B G TILAK
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