Mestre

economics leff;er
ELSEVIER

Economics Letters 53 (1996) 61-65

Growth, inflation and the exchange rate regime
Javier Andr6s a'b'*, Ignacio Hernando b, Malte Kriiger c
"Dpto. Andlisis Econ6mico, University of Valencia, Avda. Blasco Ibd~iez, 32, 46010 Valencia, Spain ~'Estudios Econ6micos, Bank of Spain, Alcald, 50, 28014 Madrid, Spain "University of Cologne, Cologne, Germany
Received 6 April 1996; accepted 11 July 1990

Abstract According to the Balassa-Samuelson effect, growth and inflation are positively correlated in economies with pegged currencies. This paper shows that the costs of inflation on long-term growth are underestimated in samples that include countries and periods with fixed exchange rate regimes.

Keywords: Inflation; Growth; Exchange rate
JEL classification: F43; 049

1. Introduction In spite of the existence of several theoretical models that predict negative effects of inflation on long-term growth, ~ the econometric evidence is far from conclusive) Even among those who find significant negative coefficients of inflation in growth equations, the estimated effects are fairly small. As an example, in a recent study, Barro (1995) concludes that " . . . an increase in average inflation of 10 percentage points per year reduces the growth rate of real per capita GDP by 0.2-0.3 percentage points per year". 3 In this paper we argue that many of these empirical studies are likely to underestimate the costs of inflation if they do not control for the influence of different exchange rate regimes opei'ating during the sample period. The argument for this downward bias runs as follows. Suppose that there is a genuine negative effect of inflation on growth and that we try to estimate it with a panel of countries
* Corresponding author: J. Andr6s, Dpto. Anfilisis Econ6mico, University of Valencia, Avda. Blasco Ibdfiez, 32, 46010 Valencia, Spain. E-mail: [e-mail]. See, inter alia, De Gregorio (1993) and Roubini and