Inflation and Growth in the Long Run: A New Keynesian Theory and Further Semiparametric Evidence. WP Series University of Verona Department of Economics (ISSN 2036-2919), 09/2010

This paper explores the influence of inflation on economic growth both theoretically and empirically. We propose to merge an endogenous growth model of learning by doing with a New Keynesian one with sticky wages. We show that the intertemporal elasticity of substitution of working time is a key parameter for the shape of the inflation-growth nexus. When it is set equal to zero, the inflation-growth nexus is weak and hump-shaped. When it is greater than zero, inflation has a sizeable and negative effect on growth. Endogenizing the length of wage contracts does not lead to inflation superneutrality in presence of a fixed cost to wage resetting. Once adopting various semiparametric and instrumental variable estimation approaches on a cross-country/time-series dataset, we show that increasing inflation reduces real economic growth, consistently with our theoretical model with a positive intertemporal elasticity of substitution of working time.