Institutional quality and the relationship between inflation and economic growth

Abstract

While a bulk of literature in the last two decades confirms a nonlinear relationship between inflation and output growth, the inflation thresholds above which it reduces output growth remain high for developing countries compared to their developed counterparts. Cukierman et al. (Am Econ Rev 82(3):537–555, 1992) posit that the developing economies observe strong political instability and polarization, which makes inflation tax optimal choice for these countries. This study empirically supports these views by using an innovative threshold model and system GMM approaches for a large panel of 113 economies over the period 1981–2015. Moreover, our results show a minimum level of institutional quality above which the inflation–growth relationship is negative and below it is nonexistent.