The effects of different levels of inflation on economic growth: An empirical study of industrial and developing countries

This dissertation examines the relationship between inflation and economic growth in both industrial and developing countries. It is widely agreed that inflation is harmful to economic performance because inflation, especially high or unstable inflation, generates uncertainty about the future path of the price level. This inflation uncertainty has a negative effect on economic growth because it discourages new investment. Nevertheless, in the short run, inflation might boost the economy if economic agents misperceive aggregate price changes as relative price level movements, or if wages and prices are sticky.; My work is based on a model developed by Grimes (1991) which incorporates both long-run and short-run relationships between inflation and economic growth in its specification. Unlike Grimes, who studies only industrial countries, we investigate both industrial and developing countries. Little work to date has examined the relationship between inflation and economic growth in developing countries.; I investigate twenty-three industrial countries and forty-nine developing countries. I use two approaches to examine the relationship between inflation and economic growth: individual country analysis and panel estimation. The individual country analysis provides stronger evidence of a negative link between inflation and economic growth for industrial countries than for developing countries. Evidence of a short-run Phillips-curve relationship is mixed for both industrial and developing countries.; According to panel estimation results, however, inflation reduces economic growth for both industrial and developing countries. These results are consistent whether the panel estimation method is applied to all countries under investigation or to industrial and developing countries separately. Interestingly, the evidence shows that the cost of inflation is higher in industrial countries than in developing countries.; I also find that there is a threshold inflation rate, below which inflation does not appear to have a substantial negative effect on economic growth. The threshold inflation rate for industrial countries and for developing countries is not the same: It lies between 5 and 11 percent for industrial countries and between 7 and 37 percent for developing countries. Above the threshold inflation rate, there is strong evidence that inflation has a damaging effect on economic performance. However, there is evidence that inflation is beneficial to developing economies if the inflation rate is less than 10 percent per year. For industrial countries, low inflation is, at best, neutral.