Institut
für Höhere Studien (IHS), Wien
Institute
for Advanced Studies, Vienna
Reihe Transformationsökonomie
/ Transition Economics Series No. 13
December 1999
Inflation,
Growth, and Credit Services
Max Gillman, Michal Kejak,
Ákos Valentinyi
Institut für
Höhere Studien
Stumpergasse
56, A-1060 Wien
Fax: +43/1/599
91-163
Max Gillman
Department
of Economics
Central European
University
Nador ut.
9
H-1051 Budapest,
HUNGARY
Phone: +36/1/327-3227
Fax: +36/1/327-3232
E-mail: Gillman@ceu.hu
Michal Kejak
CERGE-EI
Politickych
veznu 7
CZ-111 21
Prague 1, CZECH REPUBLIC
Phone: +420/2/2400-5186
Fax: +420/2/2422-7143
E-mail: Michal.Kejak@cerge.cuni.cz
and
Institute
for Advanced Studies, Vienna
Ákos
Valentinyi
Department
of Economics
University
of Southampton & CEPR
Highfield
Southampton
SO17 1 BJ, UNITED KINGDOM
Phone: +44/1703-595000
Fax: +44/1703-593939
E-mail: A.Valentinyi@soton.ac.uk
Institut
für Höhere Studien (IHS), Wien
Institute
for Advanced Studies, Vienna
The Institute
for Advanced Studies in Vienna is an independent center of postgraduate
training and research in the social sciences. The publication of working
papers does not imply a transfer of copyright. The authors are fully responsible
for the content.
Abstract
The empirical
evidence suggests that there is a significant, negative relationship between
inflation and economic growth. Conventional monetary growth models, however,
predict a significantly smaller growth effect. This paper proposes a monetary
growth model with an explicit credit service sector to explain the observed
magnitude. Since credit services are assumed costly to produce, the consumers
equate the opportunity cost of holding money with the marginal cost of
credit. Therefore the technology of the financial sector influences the
velocity of money, and consequently, how inflation affects leisure, the
time spent accumulating human capital, and the growth rate of output. The
calibration shows that the model generates an inflation-growth effect whose
magnitude falls in the range found by the empirical studies. Moreover,
in contrast to previous works, we are also able to explain an inflation-growth
effect that becomes increasingly weak as the inflation rate rises, as the
evidence seems to suggest. Analysis of the welfare cost of inflation further
illuminates the inflation-growth effect and how the model compares to the
literature.
Keywords
Economic growth,
inflation, costly credit
JEL Classifications
O11, E31
Comments
We are grateful
to participants at the 1999 Midwest Spring Macroeconomics Conference at
seminars at the three affiliate institutions of the authors, and Michal
Pakos for helpful comments, and to Krisztina Molnár for excellent
research assistance. The first two authors kindly acknowledge support from
the Institute for Advanced Studies in Vienna, and the last author from
the European Union's Phare ACE programme 1996, P96-6158-R.
Contents
1. Introduction
1
2. Inflation
and Growth: Evidence and Theory 2
3. Economic
Environment 7
4. Balanced
Growth Path 9
4.1 Competitive
Equilibrium 9
4.2 Credit
Services and Money Demand 11
5. Balanced
Growth Path: The Log-utility Case 12
5.1 Consumption,
Leisure, and the Growth Effect of Inflation 13
5.2 Interest
Elasticity and the Growth Effect of Inflation 15
5.3 The Welfare
Cost of Inflation and the Cost of Credit Services 18
6. Calibration
20
7. Conclusions
and Qualifications 23
Appendix
A: Equivalence of Explicit and Implicit Banking
Sectors
26
Appendix
B: The Existence of the Balanced-growth Equilibrium 29
6. References
32