Inflation, R&D and growth in an open economy

This study explores the long-run effects of inflation in a two-country Schumpeterian growth model with cash-in-advance constraints on consumption and R&D investment. We find that increasing domestic inflation reduces domestic R&D investment and the growth rate of domestic technology. Given t...

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Bibliographic Details
Published in:Journal of international economics 2015-07, Vol.96 (2), p.360-374
Main Authors: Chu, Angus C., Cozzi, Guido, Lai, Ching-Chong, Liao, Chih-Hsing
Format: Article
Language:English
Subjects:
Bias
Consumption
Eastern Europe
Economic growth
Economic theory
Game theory
Growth models
Inflation
Inflation rate
Inflation rates
International economics
Monetary policy
Open economies
R&D
Research & development
Research and development
Studies
Trade in intermediate goods
U.S.A
Welfare economics
Western Europe
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Summary:This study explores the long-run effects of inflation in a two-country Schumpeterian growth model with cash-in-advance constraints on consumption and R&D investment. We find that increasing domestic inflation reduces domestic R&D investment and the growth rate of domestic technology. Given that economic growth in a country depends on both domestic and foreign technologies, increasing foreign inflation also affects the domestic economy. When each government conducts its monetary policy unilaterally to maximize the welfare of domestic households, the Nash-equilibrium inflation rates are generally higher than the optimal inflation rates chosen by cooperative governments who maximize the welfare of both domestic and foreign households. Under the CIA constraint on R&D (consumption), a larger market power of firms amplifies (mitigates) this inflationary bias. We use cross-country panel data to estimate the effects of inflation on R&D and also calibrate the two-country model to data in the Euro Area and the US to quantify the welfare effects of decreasing the inflation rates from the Nash equilibrium to the optimal level. •Research and Development (R&D) is a severely cash-constrained activity.•Inflation and the nominal interest rate influence R&D and growth.•In the open economy, the foreign nominal interest rate affects domestic growth.•Uncoordinated monetary policy equilibria yield too high inflation and interest rates.•US and EU monetary coordination can have significant welfare effects.
ISSN:0022-1996
1873-0353
DOI:10.1016/j.jinteco.2015.03.007