Threshold effects of inflation on economic growth: Evidence from a static threshold analysis for 18 developed economies

Abstract

Many studies have been conducted in studying the inflation-growth relationship. However, the relationship remains a contentious issue if there exists a trade-off between inflation and growth. We extend the study by considering the threshold relationship on inflation-growth by applying the static panel threshold regression (SPTR). The panel data study involves 18 developed countries over the period 1980–2016. Testing with inflation rate as threshold variable, our results capture the existence of threshold relationship between inflation and growth due to influences of inflation, producer price, trade openness, interest rate and population growth. In the first regime where the inflation rate is below or equal to threshold value, higher inflation is associated with higher output growth, implying a trade-off relationship exists. The higher threshold level of inflation is compensated with higher growth. Other determinants of growth include producer price, trade-openness, exchange rate, interest rate and population growth. Among these determinants, exchange rate and trade-openness have significant direct effect on growth. Although higher inflation may boost the economic growth, the policymaker should control the level of inflation in order to balance the objective of high growth and stable/ lower inflation rate. Our result proven that higher inflation rate may lead to higher growth up to a certain threshold value, when exceed the threshold value, higher inflation may harm the economy. This is important for stable and sustainable economic growth in a longer term.