Inflation, endogenous quality increment, and economic growth

This study explores the effects of monetary policy in a Schumpeterian growth model with endogenous quality increment and distinct cash-in-advance (CIA) constraints on consumption, manufacturing and R&D investment. Our results are summarized as follows. When the CIA constraint is solely on consumption expenditure, an increase in the nominal interest rate may stifle economic growth by lowering the arrival rate of innovation and stimulate it at the same time by raising the size of quality increment. An additional CIA constraint on manufacturing weakens the growth-retarding effect and enhances the growth-promoting effect, whereas an additional CIA constraint on R&D investment strengthens only the negative growth effect. The quantitative analysis finds that the relationship between inflation and growth can be either monotonically decreasing or hump-shaped, but the welfare effect of inflation is always negative.