Does inflation matter for growth?

The interaction between inflation and economic growth is studied within a s imple model incorporating money and finance into an optimal growth framewor k with constant returns to capital. The model includes the potential impact of inflation on growth, via (a) saving and real interest rates, (b) veloci ty and financial development, (c) the government budget deficit through the inflation tax and tax erosion, and (d) efficiency in production through th e wedge between the returns to real and financial capital. The hypothesized effect of inflation on long-run growth through these channels is estimated by applying the random-effects panel model to two sets of unbalanced panel data side by side, from the Penn World Tables and from the World Bank, cov ering 170 countries from 1960 to 1992. The cross-country links between infl ation and growth are economically and statistically significant and robust. Specifically, the results show that inflation in excess of 10-20 percent p er year is generally detrimental to growth. (C) 2001 Elsevier Science B.V. All rights reserved.