The relationship between inflation and economic growth: Literature and empirical evidence

In which way inflation influences economic growth has been discussing in the macro economics literature for a long time. According to economists from Keynesian and Structural schools inflation influence economic growth in a positive way. However, empirical studies conducted on this issue could not reveal clear results. Obtained results depended only on observational data. The widely accepted approach today is that in the long-run inflation influences economic growth in a negative way, because inflation, especially high and unstable inflation, causes uncertainty about price level in the future and this uncertainty influences economic growth negatively through discouraging new investments. This study examines the relationship between inflation and economic growth in developed, developing countries and the case of Turkey. This study based on Grimes's (1991) model that enables to analyze the short and long-run impacts of inflation on economic growth. However, different from Grimes, who examined only 21 developed countries, in this study the relationship between inflation and economic growth is analyzed for developed, developing countries and the case of Turkey. This study investigated 72 countries. 23 of these countries are developed and the remaining 49 are developing countries. While testing the relationship between inflation and economic growth, three different econometric methods were employed, a) Cross-section analysis b) Panel data analysis c) Time series analysis. According to the results of all three analyses, both in developed and developing countries inflation influenced economic growth in a negative way. This result is consistent even if the developed and the developing countries were investigated together or separately. Furthermore, the results showed that in Turkey for the investigated period, inflation and uncertainty in inflation influenced economic growth negatively. However, in the long-run, the negative impact of uncertainty in inflation on economic growth was much greater compared to the impact of the inflation alone. Because of this, in order to increase economic growth and to keep it continuous, middle and long- run uncertainties due to high inflation should be absolutely eliminated. rx