The effects of inflation on economic growth in CIS countries: secondary research

For the last two or three decades, the principal target of economy has been the control of inflation (Delong, 2002). Both politicians and economists say that this is the first economic duty of any government. And they tend to assume that other economic goals such as economic growth and low unemployment will be achieved only if the inflation is held under control. According to Frank and Bernanke (2001), as economic growth and low unemployment is achieved through successful controlling of inflation, then there is a relationship between inflation and economic growth.

There were many researches and investigations to identify and analyse the relationship between inflation and economic growth which were carried out by Barro (1995) Li (2000), Gokal and Hanif (2004), and they all identified the relationship between two variables.

They all tend to conclude that a consistent economic growth can be achieved with low consistent inflation rates; however, higher inflation rates distort the economic growth consistency of any country.

Like many other developing and emerging groups, CIS countries also aim to achieve low sustainable inflation together with high economic growth which is of great importance for any country.

Malik, (2005), indicates that one of the determinants of macro-economic stability is inflation, and long term economic growth requires macroeconomic stability which will be achieved through low inflation along with sustainable budget deficits, realistic exchange rates and appropriate real interest rates. He points out that the stability of inflation rates has an enormous impact on the economic growth of the country.

Khan and Senhadji (2001) state that first researchers to study and detect the nonlinear inflation and economic growth relationship were Fischer (1993). Later, Sarel (1996) examined the data of 87 countries and covered the period of 1970-1990. He actually found structural break point of the relationship between inflation and economic growth.

One of the consequences of inflation stated by S. Sheffrin,(2003:.321), is that it leads to uncertainty about the future potential investment projects and ultimately results in lower levels of investments which in turn results in lower levels of economic growth.

Atkinson and Milward (1998:369) claim that inflation may also reduce country’s international competitiveness, by making its exports relatively more expensive which impacts on the balance of payments. Moreover, it also can impact the country’s tax system to distort borrowing and lending decisions.

As it was stated by Sheffrin (2003:310) according to the expectation of Philips curve, unemployment is one of the consequences of inflation as both variables are associated negatively to each other as lower unemployment is followed by high inflation.

Furthermore, Friedman, (1997:78), stated that high inflation is likely to lead to high unemployment. He also points out that the high inflation is associated with variable inflation which results in additional element of uncertainty. Due to this factor, there exists the increased risk on investment and in turn it means slower growth and fewer jobs.

As other economic growth determinants are also being employed to identify the relationship between inflation and economic growth, the Philips Curve also tends to be a useful tool to be applied to establish the relationship between inflation and unemployment as it is one of the determinants of economic growth.

In particular, according to other researchers, medium and high inflation adversely impacts on efficient distribution of resources (Fisher, 1993). However, many more, including Lucas (1973) mentioned that low levels of inflation promote economic growth.

As all those researches are country specific, we can not assume the same low rate of inflation to have positive impact on economy and same medium and high rates of inflation to have negative effect on economic growth and stability of CIS countries. Therefore, the goals and aims of this work are aimed at identifying the threshold levels of inflation in CIS countries.

According to Odling-Smee (2002, IMF) the macroeconomic performance in CIS countries has generally been good in 2003-04 and expected to remain so as all countries have experienced positive growth in those years and expected to do so in the following years.  He further states that as these countries tend to have more isolated trade relationships with other countries, the economic downturns in other countries seem to have less impact on CIS countries. Therefore, it is preferable to take and test CIS countries as one group.

The understanding and explanation of the correlation between inflation and economic growth will be established in CIS countries and the country specific threshold levels of inflation will be identified to the point where if the inflation falls below, the economic growth occurs and if rises above the threshold level, the economic growth is distorted and negative correlation takes place. To that end, the data for 10 years (2000-2009) in percentage changes of inflation and GDP is taken and applied to regression and correlation analysis together with other determinants of economic growth which are money supply, population growth, unemployment. The data is taken from International Monetary Fund (IMF), Asian Development Bank and World Bank resources for reliability and accuracy.

References

• Atkinson and Milward, 1998, “Applied Economics”, Macmillan Business,London, p.369
• Delong, “Macroeconomics”,McGraw Hill,New York, 2002
• Gokal and Hanif, 2004, “Relationship between inflation and economic growth, Reserve Bank of Fiji press”, Vol. No. 2004/04
• Khan and Senhadji, 2001, “Threshold effects in the relationship between inflation and growth”, International Monetary Fund, Vol. No. 48,1
• Lucas, R. 1973 “Some International evidence on Output-Inflation Tradeoffs”. American Economic Review, v.63,
• Makin, 2000, “Global Finance and the Macroeconomics”, Macmillan, Houndmills, p.107
• Malik,(2005) “Inflation and Economic growth” Available: <http://www.dawn.com/2005/05/16/ebr11.htm> retrieved on: 25.05.2010
• Robert J. Barro, 1996, “Determinants of economic growth”, National Bureau of Economic research, NBER, Vol. No. 5698
• Sarel, 1995, “Nonlinear effects of inflation on economic growth”, International Monetary Fund, working paper No. 95/96
• Sheffrin, 2003, “Macroeconomics, Principles and Tools”, Third edition, Prentice Hall,London, p. 321
• R Frank and B Bernanke (2001), “Principles of Economics”,McGraw Hill,New York
• J. Odling-Smee, 2002, “Press Briefing on Developments in Baltic and CIS countries”, IMF, Washington