Inflation, Financial Development and Growth

It is generally thought that there is a negative long-term relationship between inflation and growth and a positive long-term relationship between financial development and growth. The existing empirical literature suggests that the finance-growth relationship is more robust than the inflation-growth relationship. In this paper we explore the triangle of relationships - finance-inflation-growth - with panel data from as many as 84 countries for 1960-95. Our results with standard growth equations indicate that inflation inhibits economic growth both directly and indirectly through its effect on financial development. However, the direct effects of inflation largely disappear when inflation is moderate. We also find that the strong and robust effect of financial sector depth on economic growth is largely unaffected by the presences of the inflation rate. However, the effect of financial depth tends to be much weaker in high inflation environments