Inflation Crises and Long-Run Growth

56 Pages Posted: 11 Nov 2004

See all articles by William Easterly

William Easterly

New York University - Department of Economics

Michael Bruno

Hebrew University (Deceased)

Multiple version iconThere are 3 versions of this paper

Date Written: September 1995

Abstract

After excluding countries with high-inflation crises - periods when annual inflation is above 40 percent - the data reveal no evidence of a consistent relationship between growth and inflation, at any frequency. But growth does tend to fall sharply during discrete crises of high inflation and to recover surprisingly strongly after inflation falls. Perhaps inflation crises are purely cyclical, or perhaps in the long run they have a favorable purgative effect.

Recent literature suggests that long-run averages of growth and inflation are only weakly correlated and that such correlation is not robust to the exclusion of observations of extreme inflation. Including time series panel data has improved matters, but an aggregate parametric approach remains inconclusive.

Bruno and Easterly propose a nonparametric definition of high-inflation crises as periods when annual inflation is above 40 percent. Excluding countries with high-inflation crises, they find no evidence of a consistent relationship between growth and inflation, at any frequency. They do find that growth falls sharply during discrete crises of high inflation, then recovers surprisingly strongly after inflation falls. The fall in growth during a crisis and the recovery of growth after the crisis tend to average out to nearly zero (even slightly above zero); hence no robust cross-section correlation.

Their findings could be consistent either with trend stationarity of output (in which inflation crises are purely cyclical phenomena) or with models in which crises have a favorable long-run purgative effect. Their findings do not support the view that reducing high inflation carries heavy output costs in the short to medium run.

This paper - a joint product of the Office of the Vice President, Development Economics, and the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the Bank to examine the determinants of economic growth.

JEL Classification: E31, O1, O10

Suggested Citation

Easterly, William and Bruno, Michael, Inflation Crises and Long-Run Growth (September 1995). World Bank Policy Research Working Paper No. 1517. Available at SSRN: https://ssrn.com/abstract=3789

William Easterly (Contact Author)

New York University - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

Michael Bruno

Hebrew University (Deceased)

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