Inflation and indivisible investment in developing economies

Maya Eden () and Ha Nguyen
Authors registered in the RePEc Author Service: Nguyen Phu Ha () and Ha Nguyen

No 6972, Policy Research Working Paper Series from The World Bank

Abstract: In countries with limited access to finance, firms accumulate retained earnings to finance indivisible investment projects. McKinnon (1973) illustrates that when cash is used as a primary store of value, inflation may discourage investment as it increases the cost of accumulating retained earnings. This paper formalizes this argument in a dynamic framework and provides a simple calibration of the model that suggests sizable effects of inflation on investment. The mechanism is particularly relevant for small firms, as firms with lower cash flows must accumulate retained earnings for longer periods of time to meet the price of indivisible investment goods. Consistent with the model, empirical evidence suggests that inflation disproportionately reduces investment in small firms.

Keywords: Investment and Investment Climate; Debt Markets; Economic Theory&Research; Access to Finance; Non Bank Financial Institutions (search for similar items in EconPapers)
Date: 2014-07-01
New Economics Papers: this item is included in nep-cba and nep-mac
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