Inflation, Investment and Growth: a Banking Approach

Output growth, investment and the real interest rate are all found empirically to be negatively affected by inflation. But a seeming puzzle arises of opposite Tobin-like inflation effects because theory indicates a negative Tobin effect when investment falls and a positive Tobin effect when the real interest rate rises. We define inflation's Tobin effect more specifically in terms of the effect on the capital to effective labor ratio and resolve the puzzle by showing the simultaneous occurrence of all three negative inflation effects, on growth, investment and real interest rates, in a model calibrated to postwar US data. Here, investment along with consumption are exchanged for within a monetary endogenous growth economy with human capital and a decentralized credit-producing sector.