The relationship between inflation and growth: a panel smooth transition regression approach for developed and developing countries

Abstract

This paper studies the existence for a set of countries of an inflation threshold above which its effect on economic growth is negative, considering the speed of transition from one inflation regime to the other. Using a panel data set of above 120 countries for the period after the Second World War, we apply a panel smooth transition regression (PSTR) model with fixed effects. The estimated threshold of the inflation rate for industrialized countries is 4.1%, while for non-industrialized countries the threshold is 19.1%. The speed of transition is relatively smooth in the first group, but for developing economies inflation rapidly has negative effects on growth when it is near the threshold. In addition, we find that the inflation threshold falls to 7.9% by selecting a reduced group of developing countries, according to a measure associated with institutional quality.