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INFLATION AND GROWTH: A NON-MONOTONIC RELATIONSHIP IN AN INNOVATION-DRIVEN ECONOMY

Published online by Cambridge University Press:  03 September 2019

Zhijie Zheng ,
Chien-Yu Huang  and
Yibai Yang
Zhijie Zheng
Affiliation:
Southwestern University of Finance and Economics
Chien-Yu Huang*
Affiliation:
Nanjing Audit University
Yibai Yang
Affiliation:
University of Macau
*
Address correspondence to: Chien-Yu Huang, Institute of Urban Development, Nanjing Audit University, Nanjing, Jiangsu, 211815, China. e-mail: [email protected]. Phone: (+86) 18608044407.
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Abstract

This paper investigates the effects of monetary policy on long-run economic growth via different cash-in-advance (CIA) constraints on R&D in a Schumpeterian growth model with vertical and horizontal innovations. The relationship between inflation and growth is contingent on the relative extents of CIA constraints and diminishing returns to two types of innovation. This model can generate a mixed (monotonic or non-monotonic) relationship between inflation and growth, given that the relative strength of monetary effects on growth between different CIA constraints and that of R&D-labor-reallocation effects between different diminishing returns vary with the nominal interest rate. In the empirically relevant case where horizontal R&D is subject to larger diminishing returns than vertical R&D, inflation and growth can exhibit an inverted-U relationship when the CIA constraint on horizontal R&D is sufficiently larger than that on vertical R&D. Finally, we calibrate the model to the US economy and find that the growth-maximizing rate of inflation is around 2.4%, which is consistent with the recent empirical estimates.

Keywords

InflationEndogenous GrowthCIA Constraints on R&D
Type
Articles
Information
Macroeconomic Dynamics , Volume 25 , Issue 5 , July 2021 , pp. 1199 - 1226
Copyright
© Cambridge University Press 2019

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Footnotes

We are grateful to the editors (Alberto Bucci and Guido Cozzi) and one anonymous referee for their helpful comments and generous suggestions. We also thank Angus Chu and seminar/conference participants at the Finance and Economic Growth in the Aftermath of the Crisis Conference for the useful discussion and feedback, as well as Eugene Cao for technical support. Chien-Yu Huang also acknowledges the research support from China National Philosophy and Social Science Fund (16BJL089). The usual disclaimer applies.

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