Economic Growth and Price Stability

Abstract

Is there any reason to believe that a stable relationship exists between the rate of economic growth and the pace of inflation such that the more rapid the inflation the more rapid, ceteris paribus the rate of economic growth? If so, is this because rapid inflation contributes to economic growth, or because rapid economic growth contributes to inflation, or both? One way of approaching these important questions, which has been followed in several recent studies,¹ is to correlate the percentage increase in real gross domestic product and the percentage increase in the general price level. This approach, however, is bound to be somewhat inconclusive. There are two main reasons for this. In the first place, whatever the country or period studied, it is likely that many important factors, apart from the rate of increase of prices, will have contributed to the observed rate of increase in real gross domestic product, and vice versa. As a result, the findings of the correlation analysis will usually be very difficult to interpret. For example, suppose we observe a high correlation between the percentage increase in the general price level and the percentage increase in real gross domestic product. Does this reflect the existence of a stable positive relationship between inflation and growth; or does it mean that the two were quite unconnected but that the effective determinants of growth and the effective determinants of inflation happened to be operating at just the intensity required to produce the observed high correlation?