Modeling the Inflation Growth Effect

This paper adds a credit services sector into a monetary endogenous growth economy in order to investigate the inflation-growth effect. We compare this economy to more standard models with respect to the effect of the money / credit exchange technology. We find a markedly negative effect of inflation on economic growth using very standard calibration parameters. Resulting estimates are within or close to the range reported in the literature, depending on the credit technology. Analytically the model employs a general equilibrium version of the Tobin-type substitution in the face of higher inflation that manifests as an increase in the effective capital to effective labor ratios across each of the sectors. An realistic large fall in growth results because of the combination of Lucas (1988) endogenous growth, in which more leisure time implies directly lower growth, and a capital intensive credit technology that induces resource reallocation across sectors so as to avoid the inflation tax