Inflation, complexity and endogenous growth

What is it about?

In this article, we argue that inflation increases complexity pertaining to knowledge production (or R&D). In fact, in low-inflation economies, R&D activities are easily performed since prices of inputs are well known and expectations of future input and prototype prices are easy to anticipate. However, in high-inflation countries, R&D activities have additional costs linked to tighter planning and studying different price scenarios both for the future potential products that arise from the knowledge production process and also for the respective inputs in the production phase of the projects. In face of those inflation-caused costs, some of the projects may be abandoned due to higher returns of shorter-term alternatives. To highlight this new transmission channel of inflation, we expand a recently developed complexity index based on entropy to include the effect of inflation. As a result of this new mechanism in an endogenous growth model, inflation is no longer superneutral. In the model, inflation can decrease economic growth in a non-linear way, a sudden upward shock on inflation can severely hurt economic growth and an inflation cut can be responsible for a take-off. These effects are illustrated quantitatively.

Featured Image