Relationship of inflation and economic growth

relationship of inflation and economic growth

This paper focuses on exploring the relationship between inflation and economic growth in Saudi Arabia. The real growth of non-oil measure is. Relationship between Inflation and Economic Growth in Malaysia -. An Econometric Review. hidden-facts.infon Datta. Reader, Department of Economics,. University of. RELATIONSHIP BETWEEN INFLATION AND. ECONOMIC GROWTH. Vikesh Gokal. Subrina Hanif. Working Paper. / December Economics.

If wages rise, firms costs increase and therefore firms pass these cost increases on to consumers. Also, with rising wages, workers have more disposable income to spend — causing a further rise in aggregate demand AD With higher economic growth, people may start to expect inflation — and this expectation of rising prices can become self-fulfilling. Diagram of Demand Pull Inflation Basically, If economic growth is above the long run trend rate average sustainable rate of growth over a period of time then inflation is likely to occur.

Lawson Boom — late s An example of high growth causing inflation was the Lawson boom of the s. High economic growth in the late s — led to high inflation. The recession ofbrought inflation down. Economic growth and low inflation It is possible that we can have economic growth without causing inflation. If growth is caused by increased productivity and investment, then the productive capacity of the economy can increase at the same rate as aggregate demand AD. This enables economic growth without inflation.

For example, between andthe UK experienced low inflationary growth. This is partly due to economic growth being sustainable i.

Conflict between economic growth and inflation

Low inflation causes long-term economic growth It is also argued that low inflation can contribute to a higher rate of economic growth in the long term. This is because low inflation helps promote stability, confidence, security and therefore encourages investment. This investment helps promote long-term economic growth. If an economy has periods of high and volatile inflation rates, then rates of economic growth tend to be lower.

The cost-push inflation of rising oil prices led to recession because the higher prices lead to declining disposable income.

September 18, ; Published: October 9, Abstract: This paper focuses on exploring the relationship between inflation and economic growth in Saudi Arabia. The real growth of non-oil measure is used as a dependent variable, whereas wholesale price is implemented as a proxy for inflation.

This study covers the period of The short and long-run relationships are estimated using co-integration techniques. The results support the existence of positive effects of inflation over economic growth. The threshold level of inflation for non-oil GDP is around a 10 percent.

In addition, the long-run causality is running from inflation to real growth of non-oil GDP. The impulse responses test points out that future responsiveness of growth due to impulse of inflation is negative and significant after a year and a half. Whereas, the inflation responsiveness due to a shock in growth is effective positively after three years and a half in the future.

The Review of Empirical Literature 3. The Model, Estimation and Discussions 3. The Threshold Model 3. The Unit Root Test 3. The Threshold Estimate 4. Conclusion and Policy Implications Appendix References 1. Introduction The objectives of macroeconomic policies in any country, as well as Saudi Arabia are, to maintain levels of economic growth coupled with low rates of inflation.

Applying fiscal policy with the goal of productivity growth, and monetary policy with the stability of price endeavor, should be implemented and executed well. There has been a tremendous debate on the existence and the nature of the correlation between inflation and growth. Some economists view low inflation is positively related to economic growth. In the classical theory, growth depends on capital and labor, factors in the standard classical production function.

In order to achieve economic growth, either capital or labor has to rise. So, Growth is determined by saving accumulation, through the negative relationship between interest rate and saving accumulation and hence, investment.

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Since money is neutral, no long-run effect on output rather than on prices. In the Keynesian view full employment is neglected, so, expansionary fiscal policy leads to an increase in output and prices. Thus, economic growth and inflation have a stable long-run positive relationship. The rigidity of wages and prices cause longer time to the economy to reach equilibrium.

Despite this view, moderate inflation stimulates economic growth. Other economists argue that, given rational expectations and inflationary spiral, gradual increase in price levels can be transformed into high price levels and macroeconomic uncertainty stems, and will be harmful for economic growth.

Monetarists, on the other hand, argue that there is a positive short-run relationship between inflation and economic growth, because of the decline in unemployment. However, this is true if the policy raising aggregate demand is not anticipated. However, new classical approach stresses that unexpected increase in prices or wages will surprise suppliers of labor and goods, and will have a real impact on the economy in the short-run until agents adjust their expectations.

Hence, expected increase in money supply will not affect the economy. Nevertheless, new Keynesians, stress that the rise in inflation will have a negative impact on economic growth.

Low and stable inflation causes economic growth and fair distribution of income.

relationship of inflation and economic growth

Furthermore, no consensus about the nature of inflation and economic growth. First, Sidrauski [ 22 ], predicts that there is no effect of inflation on growth. Hence, money is super neutral. Secondly, Tobin [ 24 ], assumes that money is a substitute for capital causing inflation to has a positive effect on long-run output and growth. Growth rate of inflation and growth rate of real non-oil GDP.

relationship of inflation and economic growth

Thirdly, Stockman [ 23 ], puts forward cash-in-advance model in which money is complementary to capital, causing a negative effect on long-run growth. Fourth, new models in which inflation has a negative effect on long-run growth, but only if inflation exceeds certain threshold level.

The purpose of this paper, is to examine theoretically and empirically the existence of coherent meaningful relationship between inflation and economic growth in the Saudi economy, using co-integration methodology. The analysis covers the period of Test for the threshold level of inflation is implemented.

Figure 1 shows true plot of growth rate of inflation and the growth in non-oil GDP. This paper is organized as follows. Section 1 is the introduction. Section 2 reviews the empirical studies on inflation and economic growth. Section 3 deals with the theoretical model and methodology, and discusses the empirical results and their meaningful interpretations.

Section 4 provides the conclusion and the policy implications. The, appendix is in section 5. The Review of Empirical Literature The relationship between inflation and economic growth is one of the most controversial issues in the field of economics. Economists and experts from different schools of thoughts, whether they are policy makers, or central banking officials everywhere, not yet reached a conclusive evidence concerning the impact of inflation on growth.

Fed's Fischer on Inflation, Wages, Economic Growth

The main issue is, whether inflation necessary for economic growth or it is detrimental to growth, and what threshold is to keep necessary growth. It is widely believed that moderate and stable inflation rates promote the development process of a country and hence, economic growth.

The relationship between inflation and economic growth (GDP): an empirical analysis

Moderate inflation supplements return to savers, enhances investment and therefore, accelerates economic growth. The suitable level of economic growth and thus the acceptable level of inflation is somewhere in the middle. Mild inflation might benefit the economy, whereas no inflation is harmful to the economic sectors.

Empirical studies are inconclusive yet regarding the impact of inflation on economic growth. Cooley and Hansen [ 4 ], postulate that there exists positive correlation between marginal product of capital and the quantity of labor.

If inflation rises then labor declines and, hence decline in return on capital.

relationship of inflation and economic growth

They concluded that inflation rise causes permanent decline in the output.