Revisiting the role of inflation in financial development : unveiling non-linear and moderating effects

Purpose: This paper aims to examine the non-linear impact of inflation on financial development, and the moderating role of GDP in the relationship between inflation and financial development in a panel of 125 countries. Design/methodology/approach: It employs the dynamic common correlated effects (CCE) that can control for heterogeneity and cross-sectional dependence. This technique enables us to conduct both panel and country-specific analyses. Findings: Though there is no significant evidence that inflation has a non-linear impact on financial development in the panel, the country-specific estimations reveal that inflation has a non-linear impact on financial development in 66 countries. The results also show that GDP mitigates the detrimental effect of inflation on financial development in 45 countries. An insight into the non-linear relationship between inflation and financial development is crucial for policy decision-making. Besides, knowledge of the moderating role of GDP in the relationship between financial development and inflation is fundamental for policy formulations. Originality/value: Although the extant literature has shown that the inflation rate plays a negative role in financial development, the literature overlooked the non-linear relationship between the two variables. Besides, the studies have not considered the role of GDP in moderating the impact of the inflation rate on financial development. This study fills these gaps in the existing body of finance literature.