Threshold Effects of Inflation on Economic Growth: Is Africa Different?

Abstract

ABSTRACTThis study examines nonlinearities in the inflation-growth nexus in Africa. The study employs a novel dynamic panel threshold regression method developed by Kremer et al. [(2013). Inflation and growth: New evidence from a dynamic panel threshold analysis. Empirical Economics, 44, 861–878. doi:10.1007/s00181-012-0553-9] that extends Hansen’s [(1999). Threshold effects in non-dynamic panels: Estimation, testing, and inference. Journal of Econometrics, 93, 345–368. doi:10.1016/S0304-4076(99)00025-1] non-dynamic panel threshold model as well as Caner and Hansen [(2004). Instrumental variable estimation of a threshold model. Econometric Theory, 20, 813–843. doi:10.1017/S0266466604205011] cross-sectional threshold model to deal with potential endogeneity problems. The findings of this study confirm a non-linear relationship between inflation and economic growth in Africa. More specifically, the results show that the inflation threshold values are 6.7% for the whole sample, 9% for the sub-sample of low-income countries and 6.5% for middle-income countries. The regression results suggest that relatively lower level of inflation appears to be in favor of higher economic growth only in African middle-income countries. However, inflation rate beyond a certain threshold is more likely to be detrimental to economic growth for all the cases. These results are robust by considering additional control variables and using three-year averages of the data. The findings of this study may be useful to African monetary policymakers as they decide on inflation targets to adopt to avoid the detrimental effects of high inflation while reaping the growth benefits of low inflation.