Skip to main content

Advertisement

SpringerLink
Log in

Institutional quality and the relationship between inflation and economic growth

  • Published:
Empirical Economics Aims and scope Submit manuscript

Abstract

While a bulk of literature in the last two decades confirms a nonlinear relationship between inflation and output growth, the inflation thresholds above which it reduces output growth remain high for developing countries compared to their developed counterparts. Cukierman et al. (Am Econ Rev 82(3):537–555, 1992) posit that the developing economies observe strong political instability and polarization, which makes inflation tax optimal choice for these countries. This study empirically supports these views by using an innovative threshold model and system GMM approaches for a large panel of 113 economies over the period 1981–2015. Moreover, our results show a minimum level of institutional quality above which the inflation–growth relationship is negative and below it is nonexistent.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. For the emerging economies, Khan and Senhadji (2001) suggest 11% inflation rate, Sarel (1996) identifies 8% inflation rate and López-Villavicencio and Mignon (2011) and Kremer et al. (2013) find further higher threshold levels at around 17%. All of these studies contend that the growth-inhibiting effects of inflation start appearing after these levels.

  2. Bruno and Easterly (1998) reveal an important aspect of this negative relationship. Their study shows that this inverse relationship is mainly driven by high-inflation episodes and that averaging the data for longer time periods eliminates this effect.

  3. A parallel line of literature associates the cost of inflation to countries’ trade structure. Romer (1993) argues that unanticipated monetary expansion causes real exchange rate depreciation. Since the cost of depreciation depends upon level of openness to trade, the benefits of surprise inflation—in terms of higher output—are higher for closed economies. Lane (1997) modifies this argument by claiming that openness–inflation relation is due to imperfect competition and nominal price rigidity in the non-traded sector. The study argues that surprise monetary expansions cause increase in the output of non-traded sector, given its predetermined prices. This output expansion is socially optimal because of the inefficient monopolistic underproduction in the non-traded sector in the equilibrium before the shock.

  4. It is important to mention that in case of multiplicative interaction models, the individual effect of x (independent variable) on y (dependent variable) is sometimes illogical because it estimates the conditional effects when z (intervening variable) takes zero value. However, a zero value of z can be out of sample in many cases (see Brambor et al. 2006).

  5. These include Argentina, Armenia, Bolivia, Bulgaria, Brazil, Croatia, Iraq, Kazakhstan, Nicaragua, Peru, Russian Federation, Turkey, Ukraine, Zambia and Zimbabwe.

References

  • Acemoglu D, Johnson S, Robinson JA (2002) Reversal of fortune: geography and institutions in the making of the modern world income distribution. Quart J Econ 117:1239–1294

    Google Scholar 

  • Acemoglu D, Johnson S, Robinson J (2004) Institutions as the fundamental causes of long-run growth. NBER working paper 10481

  • Aghion P, Bacchetta P, Rancière R, Rogoff K (2009) Exchange rate volatility and productivity growth: the role of financial development. J Monet Econ 56:494–513

    Google Scholar 

  • Aisen A, Veiga FJ (2006) Does political instability lead to higher inflation? A panel data analysis. J Money Credit Bank 38(5):1379–1389

    Google Scholar 

  • Aisen A, Veiga FJ (2008) A political economy of seigniorage. J Dev Econ 87:29–50

    Google Scholar 

  • Aizenman J (1992) Competitive externalities and the optimal seigniorage. J Money Credit Bank 24(1):61–71

    Google Scholar 

  • Arellano M, Bover O (1995) Another look at the instrumental-variable estimation of error components models. J Econom 68:29–52

    Google Scholar 

  • Barro RJ (1987) Interest rate smoothening. University of Rochester, Rochester

    Google Scholar 

  • Barro RJ (1991) Government spending in a simple model of endogenous growth. J Polit Econ 98(5):103–125

    Google Scholar 

  • Barro RJ, Lee J (2010) A new data set of educational attainment in the world 1950–2010. NBER working paper 15902

  • Barro RJ, Sala-i-Martin X (1995) Economic growth. McGraw Hill, New York

    Google Scholar 

  • Benhabib J, Spiegel MM (1994) The role of human capital in economic development: evidence from aggregate cross-country data. J Monet Econ 34:143–173

    Google Scholar 

  • Berg C (2005) Experience of inflation targeting in 20 countries. Econ Rev 20:47–54

    Google Scholar 

  • Bernanke BS, Laubach T, Mishkin FS, Posen AS (1999) Inflation targeting: lessons from the international experience. Princeton University Press, Princeton

    Google Scholar 

  • Blundell R, Bond S (1998) Initial conditions and moment restrictions in dynamic panel data models. J Econom 87:115–143

    Google Scholar 

  • Brambor T, Clark WR, Golder M (2006) Understanding interaction models: improving empirical analysis. Polit Anal 14(1):63–82

    Google Scholar 

  • Brock WA (1974) Money and growth: the case of long-run perfect foresight. Int Econ Rev 15(3):750–777

    Google Scholar 

  • Bruno M, Easterly W (1998) Inflation crisis and long-run growth. J Monet Econ 41(1):3–26

    Google Scholar 

  • Burdekin RCK, Denzau AT, Keil MW, Sitthiyot TT, Willett TD (2004) When does inflation hurt economic growth? Different nonlinearities for different economies. J Macroecon 26:519–532

    Google Scholar 

  • Cecchetti SG (1999) Legal structure, financial structure, and the monetary policy transmission mechanism. Fed Reserve Bank N Y Econ Policy Rev 5:9–28

    Google Scholar 

  • Chelliah R, Hessel B, Margaret K (1975) Tax ratios and tax effort in developing countries 1969–1971. IMF Staff Pap 22:187–205

    Google Scholar 

  • Click RW (1998) Seigniorage in a cross section of countries. J Money Credit Bank 30(2):154–171

    Google Scholar 

  • Cukierman A, Sebastian E, Guido T (1992) Seigniorage and political economy. Am Econ Rev 82(3):537–555

    Google Scholar 

  • de Haan J, Kooi W (2000) Does central bank independence really matter? New evidence for developing countries using a new indicator. J Bank Financ 24:643–664

    Google Scholar 

  • Edwards S, Tabellini G (1991) Explaining fiscal policy and inflation in developing countries. J Int Money Financ 10:16–48

    Google Scholar 

  • Eggoh JC, Khan M (2014) On the nonlinear relationship between inflation and economic growth. Res Econ 68:133–143

    Google Scholar 

  • Ericsson NR, Irons JS, Tryon RW (1993) Output and inflation in the long run. Unpublished manuscript, Board of Governors of Federal Reserve System

  • Fischer S (1993) The role of macroeconomic factors in growth. J Monet Econ 32(3):485–511

    Google Scholar 

  • Galbis V (1979) Money, investment and growth in Latin America. Econ Dev Cult Change 27(3):423–443

    Google Scholar 

  • Grier R (2005) The interaction of human and physical capital accumulation: evidence from Sub-Saharan Africa. Kyklos 58(2):195–211

    Google Scholar 

  • Hall RE, Jones CI (1999) Why do some countries produce so much more per worker than others? Quart J Econ 114(1):83–116

    Google Scholar 

  • Haslag HJ (1997) Output, growth, welfare and inflation: a survey. Fed Reserve Bank Dellas Econ Rev Second Quart 1:11–21

    Google Scholar 

  • Heylen F, Pozzi L (2007) Crises and human capital accumulation. Can J Econ 40(4):1261–1285

    Google Scholar 

  • Hineline DR (2007) Examining the robustness of the inflation and the growth relationship. South Econ J 73(4):1020–1037

    Google Scholar 

  • Ibarra R, Turpkin DR (2016) Reexamining the relationship between inflation and growth: do institutions matter in developing countries? Econ Model 2016:332–351

    Google Scholar 

  • IMF (2012) West African Economic and Monetary Union (WAEMU). International monetary fund, country report no. 12/59

  • Ireland PN (1994) Money and growth: an alternative approach. Am Econ Rev 84(1):47–65

    Google Scholar 

  • Khan MS, Senhadji A (2001) Inflation and financial depth. Working paper 01/44. IMF, Washington DC

    Google Scholar 

  • Kremer S, Alexander B, Nautz D (2013) Inflation and growth: new evidence from a dynamic panel threshold analysis. Empir Econ 44:861–878

    Google Scholar 

  • La Porta R, López de Silanes F, Schleifer A, Vishny R (1998) Law and Finance. J Polit Econ 106(6):1013–1155

    Google Scholar 

  • Lane PR (1997) Inflation in open economies. J Int Econ 42:327–347

    Google Scholar 

  • Levine R, Renelt D (1992) A sensitivity analysis of cross-country growth regressions. Am Econ Rev 82(4):942–963

    Google Scholar 

  • López-Villavicencio A, Mignon V (2011) On the impact of inflation on output growth: does the level of inflation matter? J Macroecon 33:455–464

    Google Scholar 

  • Mauro P (1998) Corruption and the composition of government expenditure. J Public Econ 69:263–279

    Google Scholar 

  • Narayan PK, Narayan S, Mishra S (2011) Do remittances induce inflation? Fresh evidence from developing countries. South Econ J 77(4):914–933

    Google Scholar 

  • North DC (1991) Institutions. J Econ Perspect 5(1):97–112

    Google Scholar 

  • Omay T, Kan EO (2010) Re-examining the threshold effects in the inflation–growth nexus with cross-sectionally dependent nonlinear panel: evidence from six industrialized economies. Econ Model 27:996–1005

    Google Scholar 

  • Phelps ES (1973) Inflation in the theory of public finance. Swed J Econ 75(1):67–82

    Google Scholar 

  • Rodrik D (2000) How far will international economic integration go? J Econ Perspect 14(1):177–186

    Google Scholar 

  • Romer PM (1990) Endogenous technological change. J Polit Econ 3:500–521

    Google Scholar 

  • Romer D (1993) Openness and inflation: theory and evidence. Quart J Econ 108(4):869–903

    Google Scholar 

  • Sala-i-Martin (1997) I just ran four million regressions. NBER working paper no. 6252

  • Sarel M (1996) Non-linear effects of inflation on economic growth. IMF Staff Pap 43(1):199–215

    Google Scholar 

  • Sidrauski M (1967) Inflation and economic growth. J Polit Econ 75(6):796–810

    Google Scholar 

  • Solow R (1956) A contribution to the theory of economic growth. Quart J Econ 70(1):65–94

    Google Scholar 

  • Stockman AC (1981) Anticipated inflation and the capital stock in a cash-in-advance economy. J Monet Econ 8:387–393

    Google Scholar 

  • Tobin J (1965) Money and economic growth. Econometrica 33:671–684

    Google Scholar 

  • Walsh C (1995) Recent central-bank reforms and the role of price stability as the sole objective of monetary policy. In: Bernanke B, Rotemberg J (eds) NBER macroeconomics annual. MIT Press, Cambridge, pp 237–252

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Social Sciences, IQRA University (Islamabad Campus), 05 Khayaban-E-Johar, H-9, Islamabad, Pakistan

    Muhammad Khan

  2. COMSATS Institute of Information Technology, Near Officers colony, Kamra Road, Attock, Pakistan

    Waqas Hanif

Authors
  1. Muhammad Khan
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Waqas Hanif
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Muhammad Khan.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Khan, M., Hanif, W. Institutional quality and the relationship between inflation and economic growth. Empir Econ 58, 627–649 (2020). https://doi.org/10.1007/s00181-018-1479-7

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s00181-018-1479-7

Keywords

JEL Classification

Search

Navigation