Inflation Volatility Versus Institutions: A Growth and Development Study

Abstract

here are many studies addressing the role of the economic policy versus the role of institutions in growth. However, few of these studies have addressed the role of the second moments of the policy instead of the policy itself in affecting growth. In this study, the role of inflation volatility versus the role of institutions in growth is studied by adding the volatility of inflation and its interaction term with legal and financial institutions to the growth regression. The aim is to determine how the total effect of inflation volatility on growth is affected by the level of institutional development. The main contribution of this chapter is that it shows that while the level of inflation does not have a significant effect on growth, which is in line with previous studies; inflation volatility does significantly impact growth. Thus, inflation volatility does have an effect on growth even for countries with moderately high levels of inflation. This chapter also finds that improving either legal or financial institutions will statistically significantly help to reduce the harmful effects of inflation volatility on growth. In addition and in contrast to the results of Acemoglu, Johnson, Robinson and Thaicharoen and Easterly, the chapter shows that inflation volatility does not act as a proxy for either type of institutions.