Inflation and Growth

Abstract

Models of inflation and growth in the sixties emphasized the portfolio substitution mechanism by which higher inflation made capital more attractive to hold relative to money, leading to higher capital intensity, and in the transition period to higher growth.The empirical evidence, however, is that growth and inflation are negatively correlated. Reasons for this negative correlation are investigated, and then embodied in a simple monetary maximizing model. Higher inflation is associated with lower growth because lower real balances reduce the efficiency of factors of production, and because there may be a link between government purchases and the use of the inflation tax. Comparative steady states and comparative dynamics is analyzed and the generally negative association between inflation and growth, both in steady states and in transition processes, is demonstrated.