Threshold Effects of Inflation on Economic Growth: Evidence from Dynamic Panel Threshold Regression Analysis for 18 Developed Economies

Abstract

Inflation and growth nexus still a main focus in many studies as the existence of trade-off issue in inflation-growth relationship. The objective of this study is to estimate inflation threshold and its impact on inflation-growth relationship. This panel data study involves 18 developed countries over the period 1980-2016 with Consumer price index (CPI) and Gross domestic product (GDP) as variables associated with other determinants such as producer price, exchange rate, trade-openness, interest rate and population growth rate. Dynamic Panel Threshold Regression (DPTR) model that suggested by Kremer et al. (2013) is employed to estimate the threshold of inflation and its effects on economic growth. Our study extended the non-dynamic panel threshold model of Hansen (1999). Our results confirmed that the targeted inflation rate 2% by many central banks is a wise decision if compare to 4% as the impact of inflation on growth in lower inflation regimes is positive and statistically significant at the 5% level. For higher inflation regime, we estimate that inflation rates exceeding 1.44% are associated with lower economic growth, inflation and growth is negatively correlated and statistically significant at 1%. Trade-off relationship only exists at lower regime. By using GMM and Pooled OLS estimation, DPTR model results are proven robust where there is a U-shaped exist.