Inflation thresholds and the finance-growth nexus

The robustness of the cross-sectional relationship between the size of a country's financial sector and its rate of economic growth is by now well established. In this article, we examine whether the strength of this relationship varies with the inflation rate. Using five-year averages of standard measures of financial development, inflation, and growth for 84 countries from 1960 to 1995, a series of rolling panel regressions show that there is an inflation threshold for the finance-growth relationship that lies between 13 and 25 percent. When inflation exceeds the threshold, finance ceases to increase economic growth. We also find that the level of financial depth varies inversely with inflation in low-inflation environments and that disinflation is associated with a positive effect of financial depth on growth. (C) 2002 Elsevier Science Ltd. All rights reserved.