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Money and the Welfare Cost of Inflation in an R&D Growth Model

Authors

  • ANGUS C. CHU,

    1. Angus C. Chu is with the Durham University Business School, Durham University and School of Economics, Shanghai University of Finance and Economics (E-mail: angusccc@gmail.com). Ching-Chong Lai is with the Institute of Economics, Academia Sinica, Department of Economics, National Cheng Chi University, and Department of Economics, Feng Chia University (E-mail: cclai@econ.sinica.edu.tw).
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  • CHING-CHONG LAI

    1. Angus C. Chu is with the Durham University Business School, Durham University and School of Economics, Shanghai University of Finance and Economics (E-mail: angusccc@gmail.com). Ching-Chong Lai is with the Institute of Economics, Academia Sinica, Department of Economics, National Cheng Chi University, and Department of Economics, Feng Chia University (E-mail: cclai@econ.sinica.edu.tw).
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  • The authors would like to thank Ming-Jen Chang, Been-Lon Chen, Le-Yu Chen, Chang-Ching Lin, Ping Wang, and two anonymous referees for their insightful comments and helpful suggestions. We are especially grateful to Wen-Jen Tsay for his collaboration in the early part of this study. The usual disclaimer applies.

Abstract

This study analyzes the effects of inflation on R&D and innovation-driven growth. In the theoretical section, we incorporate money demand into a quality-ladder model with elastic labor supply and derive the following result. If the elasticity of substitution between consumption and the real money balance is less (greater) than unity, then R&D and the growth rate of output would be decreasing (increasing) in the growth rate of money supply. Quantitatively, decreasing inflation in the U.S. to achieve price stability improves social welfare, and the welfare gain is equivalent to at least 0.5% of annual consumption. In the empirical section, we use cross-country data to establish a negative and statistically significant relationship between inflation and R&D.

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