Growth -Inflation Nexus in USA:A Threshold Regression Approach

MBA department of Vidyasagar University organized two days International Seminar during 25-26 January,2017 on the theme “Recent Innovations in Management,Accounting ,Business and Entrepreneurship”.Honourable V.C. Prof. Ranjan Banerjee inaugurated the seminar. Prof.V.G.Venkatesh ,Waikato University,NewZealand addressed as chief guest  on “Changing dynamics in supply chain in International perspectives”and Prof.Ankit Katrodia of South Africa addressed as Special guest on “Scope of entrepreneurship:A comparison between India and South Africa”.Prof.R.P.Banerjee,Formerly IIM and now Director of EIILM,Kolkata addressed on Emerging Issues of Management in India and Overseas” and Prof.T.P.Ghosh from IMT,Dubai addressed on Oil Dependency of G.C.C. market.More than 40 renouned scholars presented their research papers.

Prof Debasish Biswas of Vidyasagar University,MBA Deparment and I(Dr.Debesh Bhowmik,-Former Principal) also have presented a paper jointly on “Growth-Inflation nexus in USA:A Threshold Regression Approach”

The details of the paper is given below.

Growth-Inflation nexus in USA:A Threshold Regression Approach

Dr.Debesh Bhowmik

(Retired Principal and Associated in International Institute for Development Studies,Kolkata. debeshbhowmik@rediffmail.com)

Dr.Debasish Biswas

(Assistant Professor,MBA Department,Vidyasagar University,debasish762010@yahoo.com)

Abstract

The paper endeavours to find out the nature of inflation of USA during 1961-2015 and

to find out the nexus between inflation and growth using Granger causality, Johansen cointegration and vector error correction models.It also showed threshold limit of inflation of 1.75-3.0 per cent in USA using GDP deflator as inflation and taking World Bank Data. It finds one structural break at 1992 and no random walk with drift. Growth inflation nexus is negative. They are cointegrated and showed unidirectional causality. Error correction process is very fast and significant but vector error correction model is stable but divergent. Federal Reserve Bank is in favour of fiscal and monetary policy reforms to curb inflation.

Key words: Inflation,Economic growth, Granger Causality,Vector Error Correction, Threshold,Monetary policy

JEL:C13,E22,E31,E37,E52,O40,O49

I.Introduction

The relationship between inflation and economic growth plays an important role in the economy.

High and stable output growth and low inflation are the two main goals of macroeconomic policy. In the economic literature, there has been considerable debate on the nature of inflation and growth relationship. Mundel (1965) and Tobin (1965) predict a positive relationship between the rate of inflation and the rate of capital accumulation, which in turn, implies a positive relationship to the rate of economic growth. Fischer and Modigliani (1978) suggest a negative and nonlinear relationship between the rate of inflation and economic growth through the new growth theory mechanism. They mention that inflation restricts economic growth largely by reducing the efficiency of investment rather than its level. Both the views of the structuralists and the monetarists up to a certain extent, that is, low inflation is helpful for economic growth but once the economy achieves faster growth then inflation is detrimental for the sustainability of such growth. High inflation can cause companies or investors to shift resources away from high to low inflation countries as a hedge against losses that might be generated from rising costs of inflation. However, low inflation levels promote economic growth by making prices and wages more flexible. If high inflation is detrimental for the economy and low inflation is beneficial, then it is natural to ask what the optimal level of inflation for an economy is.  For each country or group of countries there exists a certain level or a range of inflation (threshold inflation) which is conducive for growth. If inflation is indeed harmful for economic growth when it reaches a particular threshold level, then knowing this level as well as potential losses of output growth in the short run and in the long run is crucial for formulating macroeconomic policies. Hence it is important to investigate the existence and nature of the link between these two variables.

VIII.Conclusion

The paper concludes that inflation of USA has been declining at the rate of 1.58% per year during 1961-2015.It has no random walk with drift but it showed a structural break in 1992 at 2.27% .One percent increase in inflation rate per year led to 0.88% decrease in growth rate per year in USA at the specified time. Growth inflation causality is unidirectional and they are cointegrated in the order one. Error correction is speedy and significant which was found in VECM which is stable but divergent. The threshold level of inflation rate or target rate is a limit of 1.75-3.00 per cent beyond which growth will be more adverse for the economy.