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Inflation and Growth: A Non-Monotonic Relationship in an Innovation-Driven Economy

Zhijie Zheng (), Chien-Yu Huang () and Yibai Yang ()

MPRA Paper from University Library of Munich, Germany

Abstract: This paper investigates the effects of monetary policy on long-run economic growth via different cash-in-advance constraints on R&D in a Schumpeterian growth model with vertical and horizontal innovation. The relationship between inflation and growth is contingent on the relative extents of CIA constraints and diminishing returns to two types of innovation. The model can generate a mixed (monotonic or non-monotonic) relationship between inflation and growth, given that the relative strength of monetary effects on growth between different CIA constraints and that of R&D-labor-reallocation effects between different diminishing returns vary with the nominal interest rate. In the empirically relevant case where horizontal R&D suffers from greater diminishing returns than vertical R&D, inflation and growth can exhibit an inverted-U relationship when the CIA constraint on horizontal R&D is sufficiently larger than that on vertical R&D. Finally, the model is calibrated to the US economy, and we find that the growth-maximizing rate of inflation is around 2.8%, which is closely consistent with recent empirical estimates.

Keywords: Inflation; Endogenous growth; CIA constraint on R&D (search for similar items in EconPapers)
JEL-codes: E41 O30 O40 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-cse, nep-gro, nep-ino, nep-mac and nep-sbm
Date: 2018-02-21
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https://mpra.ub.uni-muenchen.de/84768/2/MPRA_paper_84768.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/87484/2/MPRA_paper_84768.pdf revised version (application/pdf)
https://mpra.ub.uni-muenchen.de/96302/2/MPRA_paper_84768.pdf revised version (application/pdf)

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