Working Papers

May 1997, No. 97-5

Inflation Uncertainty and Growth in a Simple Monetary Model

Michael Dotsey and Pierre-Daniel G. Sarte

This paper analyzes the effects of inflation variability on economic growth in a model where money is introduced via a cash-in-advance constraint. In this setting, we find that inflation adversely affects long-run growth, even when the cash-in-advance constraint applies only to consumption. At the same time, we find that inflation and growth are positively related in the short-run. In addition, variability tends to increase average growth through a precautionary savings motive. Since inflation and inflation variability tend to be highly correlated, this latter effect attenuates the negative long-run relationship between inflation and real growth. It also provides a partial rational for the notorious lack of robustness in cross-country regressions of growth and inflation.

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