By Professor Robert J Barro.
In this article, Robert Barro uses data for around 100 countries from 1960 to 1990 to assess the effect of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that an increase in average inflation of ten percentage points per year reduces the growth rate of real per capita GDP by 0.2–0.3 percentage points per year and lowers the ratio of investment to GDP by 0.4–0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment.
Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by ten percentage points per year is estimated to lower the level of real GDP after 30 years by 4%–7%, more than enough to justify a strong interest in price stability.
Professor Barro is at present a Houblon-Norman fellow at the Bank. The views expressed in this article are his, rather than those of the Bank.