INFLATION AND GROWTH IN THE LONG RUN: A NEW KEYNESIAN THEORY AND FURTHER SEMIPARAMETRIC EVIDENCE

Andrea Vaona

Macroeconomic Dynamics, 2012, vol. 16, issue 1, 94-132

Abstract: This paper explores the influence of inflation on economic growth both theoretically and empirically. We propose to merge an endogenous growth model of learning by doing with a New Keynesian one with sticky wages. We show that the intertemporal elasticity of substitution of working time is a key parameter for the shape of the inflation–growth nexus. When it is set equal to zero, the inflation–growth nexus is weak and hump-shaped. When it is greater than zero, inflation has a sizable and negative effect on growth. Endogenizing the length of wage contracts does not lead to inflation superneutrality in the presence of a fixed cost of wage resetting. Adopting various semiparametric and instrumental-variable estimation approaches on a cross-country/time-series data set, we show that increasing inflation reduces real economic growth, consistent with our theoretical model with a positive intertemporal elasticity of substitution of working time.

Date: 2012
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