The relationship between inflation and economic growth (GDP): an empirical analysis
Inflation impacts the costs of every facet of the economy. Inflation can be both beneficial to economic recovery and, in some cases, negative. Economic growth is measured in gross domestic product (GDP), or the total value of all when rates of return on loans are low, which decreases profit margins. Gross domestic product in the United States represents the total The relationship between inflation and economic output (GDP) plays out like a very delicate dance. economy can safely maintain without causing negative side effects. In a theoretical world, a 2% wage increase during a year with 4%. The possible justification for the inverse effect of inflation on terms of lower output thereby leading to lower income and well-being of the citizens (Raheem, establishment of National Directorate of Employment (NDE).
For example, between andthe UK experienced low inflationary growth. This is partly due to economic growth being sustainable i. Low inflation causes long-term economic growth It is also argued that low inflation can contribute to a higher rate of economic growth in the long term. This is because low inflation helps promote stability, confidence, security and therefore encourages investment.
This investment helps promote long-term economic growth.
Conflict between economic growth and inflation | Economics Help
If an economy has periods of high and volatile inflation rates, then rates of economic growth tend to be lower. The cost-push inflation of rising oil prices led to recession because the higher prices lead to declining disposable income.
High Inflation and Low Growth It is possible that an economy can experience low growth and high inflation e. Cost-push inflation could be caused by rising oil prices.
It increases costs for firms and reduces disposable income. Therefore, there is lower growth, whilst high inflation. This is sometimes known as stagflation. Inthe UK is experienced a fall in the rate of economic growth and relatively high inflation.
Rising taxes Therefore, despite low growth, inflation was high. Conclusion There can be a conflict between economic growth and inflation. In periods of rapid economic growth, inflation is likely to rise. Their results are robust after controlling for other factors such as external shocks. Ghosh and Phillips studied the relationship between inflation and GDP for a large set of IMF countries for the period from to They found that, generally, the coefficient, with respect to inflation, was negative.
The findings were statistically significant. The relationship between these appeared to be negative for very low inflation rates around two to three per cent.
They also found a negative correlation for higher values but the relationship was convex, meaning that a decline in growth related to an increase of from ten to 20 per cent inflation was larger than that related to an increase in inflation of from 40 to 50 per cent. GDP, in real terms, is measured in levels and seasonally adjusted with being the base period.
Conflict between economic growth and inflation
Inflation is measured as the logarithm of the CPI rate, also being seasonally adjusted. Having the variables in logarithms reduces the variance and heteroskedasticity and makes their relationship linear. Figure 1 shows the trend of inflation and LGDP.
Inhowever, when another recession began, there was an enduring drop in LGDP, starting from Finally, the UK economy started improving in On the other hand, there is no apparent trend in inflation and thus we might infer that inflation is either stationary around the mean or, at most, a drift-less unit root process. However, these will be checked later by doing the unit root test.
Table 1 below illustrates the descriptive statistics of these variables. We see that inflation is more spread out than LGDP, because its standard deviation is higher 0.
Moreover, LGDP has a left-skewed distribution Both variables have a platykyrtic distribution, flatter than a normal with a wider peak LGDP: In this section we will estimate empirically the impact of inflation on GDP using the following ad-hoc relationship: First, we have to check the order of integration of our variables.
We want them to be stationary, because non-stationarity leads to spurious results, since test statistics t and F are not following their usual distributions and thus standard critical values are almost always incorrect.
Using the augmented Dickey-Fuller ADF test, we can distinguish between non-stationary processes and stationary processes with the null hypothesis as there is a unit root H0: The test shows that both variables are non-stationary and integrated of order 1 I 1 . In order to make our variables stationary we have to de-trend the variables.
In order for our variables to be de-trended, we generate their first differences. Therefore, when we do the test for the de-trended variables we use only the intercept choice.
Now the variables are stationary and integrated of order 0 I 0 .