Finance & Development, September 1995


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Working Papers & Publications

Antonis Adam. Eric Mr.

Studying the evidence

Nallari Raj; Griffith Breda. Taxation in Modern China. Donald J. Benedict Mr. Growth and Policy in Developing Countries. Codrina Rada.

Financial development can actually hinder growth at a certain point | World Economic Forum

Louis Mr. International Monetary Fund. African Dept. Overcoming Developing Country Debt Crises.

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Barry Herman. Promoting Fiscal Discipline. Manmohan Mr. Reforming China's Public Finances. Vito Mr. Research Dept. International Public Policy Analysis. George M. Asia and Pacific Dept. Responding to Financial Crisis. Changyong Rhee. Chorng-Huey Mr. Alfred Mr. Andrew Mr. Global Financial Contagion. Shalendra D. From Great Depression to Great Recession. Atish R. Money, Markets, and Government. James A.

Maximizing Finance for Development

R 59, Inflation and Growth in China. Robert Mr. Sanjeev Mr.


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Sergei Mr. Ruogu Li. Joshua Mr. R 75, Globalization and the Asia Pacific Economy. Kyung Tae Lee. Owen Mr. Finance and Development, June External Relations Dept. R 60, Finance and Development, September How to write a great review. The transition from high inflation to relative price stability, while not yet universal, has been widespread and dramatic.

Why is it that the prevailing view in the s and s, that the growth costs of inflation are not serious and, indeed, that some inflation is good for growth, has today been discarded? It could be simply that after two decades of rampant and often persistent inflation and growth crises, and the painful lessons of stabilization, we are much wiser than before. Or, it may be that the growth costs of inflation and the importance of keeping it in check only become significant beyond a certain inflation threshold. If so, it may be that the underlying mechanism for low inflation is inherently different from that for much higher inflation.

Why worry about low or moderate inflation if the growth costs seem to be less pronounced at those rates? The answer lies in the dynamics of inflation itself.

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If not held in check, a little inflation can lead to higher inflation, and eventually also to the inevitable costs of low growth. A recent World Bank study of inflation and growth in countries, from to shows a close association between rising inflation and diminishing growth rates across a variety of inflation ranges see Chart 1. Over this period, average growth rates seem to fall only slightly as inflation rates move up to percent.

But growth rates decline more steeply as inflation rates approach percent, and growth rates become increasingly negative at higher rates of inflation. The picture changes when we look at different subperiods. During , per capita growth on average increased as inflation rose from negative or low rates to the percent range, suggesting that, at inflation rates below 20 percent, inflation and growth may even have been positively related Chart 2.

In the s and s, low-to-moderate inflation went hand in hand with very rapid growth because of investment demand pressures in an expanding economy. There were, however, few cases of inflation in excess of 25 percent per annum. In contrast, the s and s were marked by supply shocks. Inflation and growth were negatively related during the subperiod, at least in part because supply shocks affected both variables simultaneously.

But for higher inflation frequencies, causality also ran from inflation to lower growth. A striking picture emerges when we look at the transition from the s into the s Chart 3. The industrial countries that had maximum inflation rates below the 20 percent range during the s all stayed below that level during the s. In contrast, those countries with inflation rates in the percent range during the s experienced higher inflation in the s, although they still did not go into extreme inflation.

The 40 percent inflation rate appears to be a threshold: those countries that crossed it in the s were almost certainly on their way to extreme inflation rates in the s. This experience suggests that relatively low-to-moderate inflation percent may not lead to immediate growth reductions, but it is very likely to lead to much higher inflation.

The truly dangerous inflations occur at 40 percent and above. Does high inflation cause low growth, or low growth cause high inflation—or is most of what we observe due to other factors budget deficits, debt rescheduling, and supply shocks that affect inflation and growth simultaneously? One relevant bit of evidence is that there is a significant effect from past inflation to current growth but no evidence for a feedback from past growth to current inflation. Once the supply shocks of the s set in, the negative relationship between inflation and growth was at least partly a simultaneous response to these shocks.

But at higher rates of inflation certainly at those experienced by many non-industrial countries in the s , the evidence is consistent with causality also running from high inflation to low growth. The World Bank study examined what happened to per capita growth compared with the world average before, during, and after a high-inflation crisis. That is, there is no evidence that countries that have inflation crises are those that have subnormal growth beforehand.

Brief History

The magnitudes of the growth depressions during the crisis were large. In some countries with repeated inflation crises, like Brazil, Somalia, and Zaire, the growth crises matched the inflation crises exactly. By contrast, when all inflation crises above 40 percent were excluded from the international data set, there was no evidence of a growth-inflation relationship. The study found surprising uniformity in the response of growth after the crisis for those countries that had brought inflation down by the end of the s. The post-crisis growth rate was also above the pre-crisis growth rate and above the world average in most cases.

This growth acceleration suggests a strong return to trend after the collapse of output during the crisis; it could indicate a change for the better in long-run growth after the crisis. The experience of countries that suffered the great hyperinflations in the period after World Wars I and II is also illustrative. All of the European countries that experienced hyperinflation in the s Austria, Germany, Hungary, Poland, and Russia had higher-than-average growth from the ends of their inflation crises to , the last year before World War II broke out.

Likewise, the recovery from the post-World War II inflation crises is extremely strong for the affected countries, which include the East Asian tigers Japan, Korea, and Taiwan Province of China , the fastest-growing industrial countries Greece and Italy , and three of the fastest-growing socialist economies China, Hungary, and Romania.

For the period , as well as the sub-period , all of these countries had an average per capita growth rate that was higher than any of a comparator group of 26 countries that did not have serious inflation after World War II. Finally, the dramatic output collapse in Eastern Europe and the Baltic countries, Russia, and the other countries of the former Soviet Union BRO has occurred simultaneously with high rates of inflation in many countries.

There is a correlation between the two. Output has been recovering mainly in those economies that have stabilized inflation, while output continues to drop in economies where inflation remains high. Also, the most recent successful Latin American stabilizations, in Argentina and Peru, have been accompanied by vigorous and immediate output recoveries.

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Finance & Development, September 1995 Finance & Development, September 1995
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