Hostname: page-component-78c5997874-fbnjt Total loading time: 0 Render date: 2024-11-10T14:46:58.922Z Has data issue: false hasContentIssue false
  • English
  • Français

DYNAMIC RELATIONSHIP BETWEEN INFLATION AND FINANCIAL DEVELOPMENT

Published online by Cambridge University Press:  23 April 2010

Dong-Hyeon Kim  and
Shu-Chin Lin
Dong-Hyeon Kim
Affiliation:
Providence University and Dankook University
Shu-Chin Lin*
Affiliation:
Tamkang University and Kyung Hee University
*
Address correspondence to: Shu-Chin Lin, Department of Economics, Tamkang University, 151 Ying-Chun Road, Tamsui 25137, Taipei County, Taiwan; e-mail: econscl@mail.tku.edu.tw.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper studies the long- and short-run relationships between inflation and financial development. Applying the Pooled Mean Group estimator of Pesaran, Shin, and Smith (1999, Journal of the American Statistical Association 94, 621–634) to unbalanced panel data for 87 countries over the period 1960–2005, we find that a negative long-run relationship between inflation and financial development coexists with a positive short-run relationship. However, when the data are split into different income or inflation groups, these results can be observed only in low-income or low-inflation economies.

Keywords

InflationFinancial DevelopmentPooled Mean Group Estimator
Type
Articles
Information
Macroeconomic Dynamics , Volume 14 , Issue 3 , June 2010 , pp. 343 - 364
Copyright
Copyright © Cambridge University Press 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

REFERENCES

Ades, A. and Di Tella, R. (1999) Rents, competition, and corruption. American Economic Review 89, 982–993.CrossRefGoogle Scholar
Aghion, P. and Bolton, P. (1997) A trickle-down theory of growth and development with debt overhang. Review of Economic Studies 64, 151–172.CrossRefGoogle Scholar
Albanesi, S. (2007) Inflation and inequality. Journal of Monetary Economics 54, 1088–1114.CrossRefGoogle Scholar
Asteriou, D. and Price, S. (2005) Uncertainty, investment and economic growth: Evidence from a dynamic panel. Review of Development Economics 9 (2), 277–288.CrossRefGoogle Scholar
Azariadis, C. and Smith, B.D. (1996) Private information, money and growth: Indeterminacies, fluctuations, and the Mundell–Tobin effect. Journal of Economic Growth 1, 309–322.CrossRefGoogle Scholar
Banerjee, A.V. and Newman, A. (1993) Occupational choice and the process of development. Journal of Political Economy 101, 274–298.CrossRefGoogle Scholar
Barro, R.J. (1995) Inflation and economic growth. Bank of England Quarterly Bulletin 35 (May)166–176.Google Scholar
Beck, T., Demirgüç-Kunt, A., and Levine, R. (2007) Finance, inequality and the poor. Journal of Economic Growth 12, 27–49.CrossRefGoogle Scholar
Bernanke, B.S. (1983) Nonmonetary effects of the financial crisis in propagation of the Great Depression. American Economic Review 73, 257–276.Google Scholar
Bernanke, B.S. and Gertler, M. (1989) Agency costs, net worth, and business fluctuations. American Economic Review 79, 14–31.Google Scholar
Bernanke, B.S. and Gertler, M. (1990) Financial fragility and economic performance. Quarterly Journal of Economics 105, 87–114.CrossRefGoogle Scholar
Bernanke, B.S. and Gertler, M. (1995) Inside the black box: The credit channel of monetary policy transmission. Journal of Economic Perspectives 9, 27–48.CrossRefGoogle Scholar
Bernanke, B.S., Gertler, M., and Gilchrist, S. (1999) The financial accelerator in a quantitative business cycle framework. In Taylor, J.B. and Woodford, M. (eds.), Handbook of Macroeconomics, Vol. 1, pp. 1341–1393. Amsterdam: Elsevier.CrossRefGoogle Scholar
Bose, N. (2002) Inflation, the credit market, and economic growth. Oxford Economic Papers 54, 412–434.CrossRefGoogle Scholar
Bose, N. and Murshid, A.P. (2008) Mitigating the growth-effects of inflation through financial development. The B.E. Journal of Macroeconomics 8 (1), Article 8.CrossRefGoogle Scholar
Boyd, J.H. and Champ, B. (2003) Inflation and Financial Market Performance: What Have We Learned in the Last Ten Years? Federal Reserve Bank of Cleveland Working Paper 03-17.CrossRefGoogle Scholar
Boyd, J.H., Levine, R., and Smith, B.D. (2001) The impact of inflation on financial sector performance. Journal of Monetary Economics 47, 221–248.CrossRefGoogle Scholar
Braun, M. and Larrain, B. (2005) Finance and the business cycle: International, inter-industry evidence. Journal of Finance 60, 1097–1128.CrossRefGoogle Scholar
Bruno, M. and Easterly, W. (1998) Inflation crises and long-run growth. Journal of Monetary Economics 41, 3–26.CrossRefGoogle Scholar
Bullard, J.B. and Keating, J.W. (1995) The long-run relationship between inflation and output in postwar economies. Journal of Monetary Economics 36, 477–496.CrossRefGoogle Scholar
Byrne, J.P. and Davis, E.P. (2005a) The impact of short- and long-run exchange rate uncertainty on investment: A panel study of industrial countries. Oxford Bulletin of Economics and Statistics 67, 307–329.CrossRefGoogle Scholar
Byrne, J.P. and Davis, E.P. (2005b) Investment and uncertainty in the G7. Review of World Economics 141, 1–32.CrossRefGoogle Scholar
Calderon, C. and Liu, L. (2003) The direction of causality between financial development and economic growth. Journal of Development Economics 72, 321–334.CrossRefGoogle Scholar
Catao, L.A.V. and Solomou, S.N. (2005) Effective exchange rates and the classical gold standard adjustment. American Economic Review 95, 1259–1275.CrossRefGoogle Scholar
Catao, L.A.V. and Terrones, M.E. (2005) Fiscal deficits and inflation. Journal of Monetary Economics 52, 529–554.CrossRefGoogle Scholar
Clarke, G., Xu, L.C., and Zou, H., (2006) Finance and income inequality: Test of alternative theories. Southern Economic Journal 72, 578–596.Google Scholar
Cysne, R.P., Maldonado, W.L., and Monteiro, P.K. (2005) Inflation and income inequality: A shopping-time approach. Journal of Development Economics 78, 516–528.CrossRefGoogle Scholar
De Gregorio, J. and Guidotti, P.E. (1995) Financial development and economic growth. World Development 23, 433–448.CrossRefGoogle Scholar
Deidda, L. and Fattouh, B. (2002) Non-linearity between finance and growth. Economics Letters 74, 339–345.CrossRefGoogle Scholar
Denizer, C.A., Iyigun, M.F., and Owen, A.L. (2002) Finance and macroeconomic volatility. Contributions to Macroeconomics 2, Article 7.Google Scholar
Desai, R.M., Olofsgard, A., and Yousef, T.M. (2005) Inflation and inequality: Does political structure matter? Economics Letters 87, 41–46.CrossRefGoogle Scholar
Djankov, S., McLiesh, C., and Shleifer, A. (2007) Private credit in 129 countries. Journal of Financial Economics 84, 299–329.CrossRefGoogle Scholar
Doepke, M. and Schneider, M. (2006) Inflation and the redistribution of nominal wealth. Journal of Political Economy 114, 1069–1097.CrossRefGoogle Scholar
Dotsey, M. and Sarte, P.D. (2000) Inflation uncertainty and growth in a cash-in-advance economy. Journal of Monetary Economics 45, 631–655.CrossRefGoogle Scholar
Engle, R.F. and Lee, G.J. (1999) A long run and short run component model of stock return volatility. In Engle, R.F. and White, H. (eds.), Cointegration, Causality and Forecasting: A Festschrift in Honour of Clive W. J. Granger, pp. 475–497. Oxford, UK: Oxford University Press.CrossRefGoogle Scholar
English, W.B. (1999) Inflation and financial sector size. Journal of Monetary Economics 44, 379–400.CrossRefGoogle Scholar
Fackler, J.S. and Parker, R.E. (2005) Was debt deflation operative during the Great Depression? Economic Inquiry 43, 67–78.CrossRefGoogle Scholar
Fisher, I. (1933) The debt-deflation theory of great depressions. Econometrica 1, 337–357.CrossRefGoogle Scholar
Frank, M.W. (2008) Inequality and growth in the United States: Evidence from a new state-level panel of income inequality measures. Economic Inquiry 47, 55–68.CrossRefGoogle Scholar
Fuerst, S. (1992) Liquidity, loanable funds, and real activity. Journal of Monetary Economics 29, 3–24.CrossRefGoogle Scholar
Galor, O. and Zeira, J. (1993) Income distribution and macroeconomics. Review of Economic Studies 60, 35–52.CrossRefGoogle Scholar
Gillman, M. (2005) Contrasting models of the effect of inflation on growth. Journal of Economic Surveys 19, 113–136.CrossRefGoogle Scholar
Gourinchas, P. and Jeanne, O. (2006) The elusive gains from international financial integration. Review of Economic Studies 73, 715–745.CrossRefGoogle Scholar
Haslag, J. and Koo, J. (1999) Financial Repression, Financial Development and Economic Growth. Federal Reserve Bank of Dallas Working Paper 99-02.Google Scholar
Honohan, P. (2004) Financial Development, Growth and Poverty: How Close Are the Links? World Bank Policy Research Working Paper Series 3203.CrossRefGoogle Scholar
Hung, F.-S. (2003) Inflation, financial development, and economic growth. International Review of Economics and Finance 12, 45–67.CrossRefGoogle Scholar
Huybens, E. and Smith, B.D. (1998) Financial market frictions, monetary policy, and capital accumulation in a small open economy. Journal of Economic Theory 81, 353–400.CrossRefGoogle Scholar
Huybens, E. and Smith, B.D. (1999) Inflation, financial markets and long-run real activity. Journal of Monetary Economics 43, 283–315.CrossRefGoogle Scholar
Khan, M.S. and Senhadji, A.S. (2001) Threshold effects in the relationship between inflation and growth. IMF Staff Papers 48, 1–21.CrossRefGoogle Scholar
Khan, M.S., Senhadji, A.S., and Smith, B.D. (2006) Inflation and financial development. Macroeconomic Dynamics 10, 165–182.CrossRefGoogle Scholar
King, M. (1994) Debt deflation: Theory and evidence. European Economic Review 38, 419–445.CrossRefGoogle Scholar
Kiyotaki, N. and Moore, J. (1997) Credit cycles. Journal of Political Economy 105, 211–248.CrossRefGoogle Scholar
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., and Vishny, R.W. (1997) Legal determinants of external finance. Journal of Finance 52, 1131–1150.CrossRefGoogle Scholar
La Porta, R., Lopez-de-Silanes, F., Shleifer, A., and Vishny, R.W. (1998), Law and finance. Journal of Political Economy 106, 1113–1155.CrossRefGoogle Scholar
Levine, R. (1997) Financial development and economic growth: Views and agenda. Journal of Economic Literature 35, 688–726.Google Scholar
Levine, R. (2002) Bank-based or market-based financial systems: Which is better? Journal of Financial Intermediation 11, 398–428.CrossRefGoogle Scholar
Levine, R. (2005) Finance and growth: Theory and evidence. In Aghion, P. and Durlauf, S.N. (eds.), Handbook of Economic Growth. Amsterdam: Elsevier.Google Scholar
Li, H., Squire, L., and Zou, H.F. (2001) Explaining international and intertemporal variations in income inequality? Economic Journal 108, 26–43.CrossRefGoogle Scholar
Lin, S.-C. (in press) Inflation and real stock returns revisited. Economic Inquiry.Google Scholar
Loayza, N. and Ranciere, R. (2006) Financial development, financial fragility, and growth. Journal of Money, Credit and Banking 38, 1051–1076.CrossRefGoogle Scholar
Lucas, R.E. (1990) Liquidity and interest rates. Journal of Economic Theory 50, 234–264.CrossRefGoogle Scholar
Lucas, R.E. and Stokey, N.L. (1987) Money and interest in a cash-in-advance economy. Econometrica 55, 491–513.CrossRefGoogle Scholar
Mankiw, N.G. (1989) Real business cycles: A New Keynesian perspective. Journal of Economic Perspectives 3, 79–90.CrossRefGoogle Scholar
Martin, E. and Wachtel, P. (1993) Were price changes during the Great Depression anticipated? Journal of Monetary Economics 32, 3–34.Google Scholar
Masten, A.B., Coricelli, F., and Masten, I. (2008) Non-linear growth effects of financial development: Does financial integration matter? Journal of International Money and Finance 27, 295–313.CrossRefGoogle Scholar
Mendoza, E.G. and Smith, K.A. (2006) Quantitative implications of a debt-deflation theory of sudden stops and asset prices. Journal of International Economics 70, 82–114.CrossRefGoogle Scholar
Mishkin, F.S. (1999) International Capital Movements, Financial Volatility and Financial Instability. NBER Working Paper 6390.CrossRefGoogle Scholar
Mishkin, F.S. (2007) Is financial globalization beneficial? Journal of Money, Credit and Banking 39, 259–294.CrossRefGoogle Scholar
Mishkin, F.S. (2009) Globalization and financial development. Journal of Development Economics 89, 164–169.CrossRefGoogle Scholar
Mundell, R. (1963) Inflation and real interest. Journal of Political Economics 71, 280–283.CrossRefGoogle Scholar
Nelson, D.B. (1991) Conditional heteroskedasticity in asset returns: A new approach. Econometrica 59, 347–370.CrossRefGoogle Scholar
Obstfeld, M. (1998) The global capital market: Benefactor or menace? Journal of Economic Perspective 12, 9–30.CrossRefGoogle Scholar
Pesaran, M.H., Shin, Y., and Smith, R.P. (1999) Pooled mean group estimation of dynamic heterogeneous panels. Journal of the American Statistical Association 94, 621–634.CrossRefGoogle Scholar
Pesaran, M.H. and Smith, R.P. (1995) Estimating long-run relationships from dynamic heterogeneous panels. Journal of Econometrics 68, 79–113.CrossRefGoogle Scholar
Raddatz, C. (2006) Liquidity needs and vulnerability to financial underdevelopment. Journal of Financial Economics 80, 677–722.CrossRefGoogle Scholar
Rajan, R. and Zingales, L. (2003) The great reversals: The politics of financial development in the 20th century. Journal of Financial Economics 69 (1), 5–50.CrossRefGoogle Scholar
Rajan, R. and Zingales, L. (2004) Saving Capitalism from the Capitalists. Princeton, NJ: Princeton University Press.Google Scholar
Rioja, F. and Valev, N. (2004) Finance and the sources of growth at various stages of economic development. Economic Inquiry 42, 27–40.CrossRefGoogle Scholar
Rousseau, P.L. and Wachtel, P. (2002) Inflation thresholds and the finance-growth nexus. Journal of International Money and Finance 21, 777–793.CrossRefGoogle Scholar
Sachs, J.D. and Warner, A. (1995) Economic reform and the process of global integration. Brookings Papers on Economic Activity 1, 1–118.CrossRefGoogle Scholar
Schreft, S.L. and Smith, B.D. (1997) Money, banking, and capital formation. Journal of Economic Theory 73, 157–182.CrossRefGoogle Scholar
Smith, B.D. (2003) Taking intermediation seriously. Journal of Money, Credit, and Banking 35, 1319–1357.CrossRefGoogle Scholar
Stiglitz, J. (2000) Capital market liberalization, economic growth, and instability. World Development 28, 1075–1086.CrossRefGoogle Scholar
Tobin, J. (1965) Money and economic growth. Econometrica 33, 71–684.CrossRefGoogle Scholar
Tytell, I. and Wei, S.J. (2004) Does Financial Globalization Induce Better Macroeconomic Policies? IMF Working Paper WP/04/84.CrossRefGoogle Scholar
Wachtel, P. (2003) How much do we really know about growth and finance? Federal Reserve Bank of Atlanta Economic Review 88, 33–47.Google Scholar
Winters, L.A. (2004) Trade liberalization and economic performance: An overview. Economic Journal 114, 4–21.CrossRefGoogle Scholar