Dissecting Inflation: The effects of inflation volatility on economic growth

Abstract: Price stability has become an increasingly important target of policy makers. However, the debate on the effects of inflation and economic growth is by no means settled. It is generally agreed that inflation uncertainty harms growth, however, a common challenge in inflation-growth studies lies in the difficulty to separate the effects of inflation rates from inflation volatility. Using inflation rate volatility as a measure of inflation uncertainty, the study aims to untangle the inflation-growth relationship. We hypothesise that the inflation volatility, rather than a given inflation rate itself, has a significant effect on economic growth. Using a system GMM regression on panel data of 162 countries, ranging from 1990 to 2019, this study finds that it is the volatility of the inflation rate, rather than the inflation rate, itself which affects growth. Further, the results hold when transforming the data into five-year averages, suggesting results are significant for longer time horizons. These results are robust when including relevant growth control variables and when changing the sample to include only non-OECD countries. These results imply that price stability is a sound policy, but the focus should be shifted from targeting a specific rate, to ensuring inflation is kept at a steady and predictable rate.