The Inflation–Finance–Growth Nexus: Where Does the Inflation Threshold Lie?
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This chapter explores the inflation thresholds beyond which inflation exerts negative effects on the growth–finance nexus. We use a number of econometric techniques to establish the inflation thresholds and test their robustness. The results from various techniques used in the chapter establish the inflation threshold that exerts negative effects in the finance–growth nexus to lie within a range of 4–5 per cent. When inflation is above this threshold range, it exerts a negative effect on the finance–growth nexus. The results are not only robust to the econometric technique used but are statistically significant across various specifications.
Furthermore, we establish that failure to take into account the effects of the inflation thresholds underestimates the effects of inflation on growth by 1.5 times. This means that failure to take into account the inflation non-linearities can seriously bias results towards finding a small inflation effect on GDP growth. Results that do not account for inflation thresholds can give a misleading impression that inflation must become quite high before its cumulative effects become important. The policy implication is that policy interventions should be directed at keeping the inflation rate within the target range, and preferably below 4 per cent, to support and enhance a sustainable financial deepening and economic growth.