Academic journal article Federal Reserve Bank of St. Louis Review

Inflation and Growth

Academic journal article Federal Reserve Bank of St. Louis Review

Inflation and Growth

Article excerpt

In recent years, many central banks have placed increased emphasis on price stability. Monetary policy -- whether expressed in terms of interest rates or growth of monetary aggregate -- has been increasingly geared toward the achievement of low and stable inflation. Central bankers and most other observers view price stability as a worthy objective because they think that inflation is costly. Some of these costs involve the average rate of inflation, and others relate to the variability and uncertainty of inflation. But the general idea is that businesses and households are thought to perform poorly when inflation is high and unpredictable.

The academic literature contains a lot of theoretical work on the costs of inflation, as reviewed recently by Briault (1995). This analysis provides a presumption that inflation is a bad idea, but the case is not decisive without supporting empirical findings. Although some empirical results (also surveyed by Briault) suggest that inflation is harmful, the evidence is not overwhelming. It is therefore important to carry out additional empirical research on the relation between inflation and economic performance. This article explores this relation in a large sample of countries over the last 30 years.


The data set covers over 100 countries from 1960 to 1990. Table 1 provides information about the behavior of inflation in this sample. Annual inflation rates were computed in most cases from consumer price indexes. (The deflator for the gross domestic product was used in a few instances, when the data on consumer prices were unavailable.) Table 1 shows the mean and median across the countries of the inflation rates in three decades: 1960-70, 1970-80, and 1980-90. The median inflation rate was 3.3 percent per year in the 1960s (117 countries), 10.1 percent in the 1970s (122 countries), and 8.9 percent in the 1980s (119 countries). The upper panel of Figure 1 provides a histogram for the inflation rates observed over the three decades. The bottom panel applies to the 44 observations for which the inflation rate exceeded 20 percent per year.(1)

The annual data were used for each country over each decade to compute a measure of inflation variability, the standard deviation of the inflation rate around its decadal mean. Table 1 shows the mean and median of these standard deviations for the three decades. The median was 2.4 percent per year in the 1960s, 5.4 percent in the 1970s, and 4.9 percent in the 1980s. Thus, a rise in inflation variability accompanied the increase in the average inflation rate since the 1960s.

Figure 2 confirms the well-known view that a higher variability of inflation tends to accompany a higher average rate of inflation.(2) These charts provide scatter plots of the standard deviation of inflation (measured for each country around its own decadal mean) against the average inflation rate (the mean of each country's inflation rate over the decade). The upper panel considers only inflation rates below 15 percent per year, the middle panel includes values above 15 percent per year, and the lower panel covers the entire range. The positive, but imperfect, relation between variability and mean is apparent throughout.

Table 1 also gives the means and medians of the growth rate of real per capita gross domestic product (GDP) and the ratio of investment to GDP for the three decades. The median growth rate fell from 3.1 percent in the 1960s (118 countries) to 2.5 percent in the 1970s (123 countries) and 0.4 percent in the 1980s (121 countries). The median investment ratio went from 16 percent in the 1960s to 19 percent in the 1970s and 17 percent in the 1980s. In contrast to inflation rates, the growth rates and investment ratios tend to be symmetrically distributed around the median. Table 1 Descriptive Statistics on Inflation, Growth, and investment(*)

     Variable                          Mean   Median   Number of

inflation rate                         . … 
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