countries, industrialized and developing, one of the most fundamental
objectives of macroeconomic policies is to sustain high economic growth
together with low inflation. The variable inflation is very important to
macroeconomists, financial analyst, academicians, policy makers and central
bankers officials in understanding the responsiveness to Gross Domestic Product
(GDP) to the change in general level and thus come up with the relevant
policies so as to keep prices at the reasonable rate that stimulate production.
In this present paper, the effect of inflation, interest rates, and exchange
rates on the economic growth of a country is investigated.
The relationship between inflation
and economic growth have already been investigated in the economic literature. Keynesian
Model explains that there is a short run tradeoff between output and the change
of inflation but no permanent tradeoff between output and inflation. The Mundell-Tobin
effect suggests that nominal interest rates would rise less than one-for-one
with inflation. In other words, an increase in the exogenous growth rate of
money increases the nominal interest rate and velocity of money but decreases
the real interest rate.
Chowdhury (2001), they are among the supporters of positive relationships
between the two variables. To reach this conclusion they used co-integration
and error correction model to analyze data collected from four south Asian
countries (Bangladesh, India, Pakistan, Sri Lanka) and found a long-run
positive relationship between inflation and economic growth. They concluded
that moderate inflation is helpful to faster the economic growth.
Whether inflation and economic
growth benefits or impedes each other has long been paid much attention to. A
mixture of discussions has been put forward on both sides. There is an out numbered contribution of
literature that proves a negative link between inflation and growth.
has studied about the relationship between inflation and economic growth
entitled “Role of Macroeconomic Factors in Growth”. In the paper, the data set
consist of several macroeconomic variables including inflation for 93
countries. The complete data consists of several macroeconomic variables
including consumer price inflation, corresponding to 93 countries. Outside from
using simple panel regressions, Fischer also used a simple alternative to mixed
regressions, a production function based approach pioneered by Victor Elias in
1992. The approach is a regression analogue of growth accounting, which helps
identify the channels through which microeconomic variables affect growth.
significantly correlated with the growth rate. The simple panel regressions
confirm the relationships between inflation, inflation variability and growth.
The growth accounting framework made it possible to identify the main channels
through which inflation reduces growth. The result of the paper has shown that
the channel through which inflation affect economic growth and inflation
negatively affects growth by reducing investment and by reducing rate of
productivity growth. Fischer also argues that inflation distorts price
mechanism, and hence influence economic growth negatively.
Senhadji (2001) analyzed the inflation and growth relationship separately for
industrial and developing countries. They have used new econometric techniques
initially developed by Chan and Tsay in 1998 and Hansen in 1999 and 2000. The
paper specifically focused on the following questions:
there a statistically significant threshold level of inflation above which
inflation affects growth differently than at a lower rate?
the threshold effect similar across developing and industrialized country?
these thresholds values statistically different?
robust is the Bruno-Easterly finding that the negative relationship between
inflation and growth exists only for high-inflation observations and
The data set
included 140 countries (comprising both industrial and developing countries)
and generally covered the period 1960 – 1998. The authors stated that some data
for some developing countries had a shorter span, this is a limitation of the
study. As such, analysis had to be conducted by them using ‘unbalanced panels’.
The data came primarily from the World Economic Outlook (WEO) database, with
the growth rate in GDP recorded in local currencies at constant 1987 prices and
inflation measured by the percentage charge in the CPI index. The empirical
results presented in the paper, strongly suggest the existence of a threshold
beyond which inflation exerts a negative effect on growth. The result indicated
that inflation level below the threshold level of inflation have no effect on
growth. But inflation rates above the threshold level have a significant
negative effect on growth. Inflation levels below the threshold levels of
inflation have no effect on growth, while inflation rates above the threshold
have a significant negative effect on growth.
results find out that the threshold is lower for industrialized countries than
it is for developing countries (the estimates are 1-3 percent and 11-12 percent
for industrial and developing countries respectively, depending on the
estimation method used). The thresholds were statistically significant a 1
percent or less, implying that the threshold estimates are very precise. The
negative and significant relationship between inflation and growth above the
threshold level is argued to be robust with respect to type of estimation
method used. The authors suggest that while the results of the paper are
important, some caution should be borne in mind. The estimated relationship
between inflation which inflation affects growth, beyond the fact that, because
investment and unemployment are controlled for, the effect is primarily through