Nonlinearities in Inflation and Growth Nexus: The Case of Tanzania



Abstract. Achieving high economic growth rate while maintaining low inflation rate, has become the main objective of monetary authorities all over the world. Indeed, empirical literature reflects that high inflation rates are detrimental to long run growth and entail welfare costs. To achieve this objective, central banks have availed different options from time to time which include inflation targeting. Monetary authorities in Tanzania have been targeting an inflation level of around 5 percent per annum for economic policy purposes. However, when high inflation is to be controlled, tight monetary policy is put in place which might in turn affect the economic activity. Also, the Tobin effect suggests that inflation causes individuals to substitute out of money and into interest earning assets, which leads to greater capital intensity which in turn promotes economic growth. Against these major points, this paper examines a non linear relationship between inflation and economic growth using both a quadratic and threshold endogenous models and attempts to identify the existence of threshold effects between these variables. The paper uses a data set spanning from 1967 to 2015. The most interesting finding of the estimations is that the estimated coefficient of the linear term of inflation is negative while the estimated coefficient of the square term of inflation is positive, suggesting a U-shaped effect as opposed to inverse or inverted U-shaped relationship found in other countries by previous studies. These results suggest that the Tobin effect may be valid for high inflation, in which people strongly realize the importance of substituting money for interest-bearing assets. This leads to an increase in capital investment, and in turn, an increase in economic growth even with high inflation rate. However, this U-shaped relationship between inflation and economic growth suggests that, the economy is better off at extremely low inflation episodes. The optimal inflation rate that ranges between 3.25 percent and 3.75 percent is obtained by minimizing the residual sum of squares and/or maximizing adjusted R-squared. These findings have some policy implications for the policymakers and development partners. The paper is consistent with policy suggestions by international agencies. Efforts to minimize inflation to a very low level are likely to have a positive effect on economic growth.

Keywords. Inflation; Economic growth; Threshold effects.

JEL. E31, C13, 040.


Inflation; Economic growth; Threshold effects

Full Text:


Ahmed, S., & Mortaza, M.G. (2005). Inflation and economic growth in Bangladesh: 1981-2005. Working Paper Series, No. 0604, Bangladesh Bank.

Aiken, L.S. & West, S.G. (1991). Multiple Regressions: Testing and Interpreting Interactions. Newbury Park, CA: Sage Publications.

Ambler, S. (2008). The cost of inflation in new Keynesian models. Bank of Canada, Winter, 5-14.

Ayyoub, M., Chaudhry, I.S., & Farooq, F. (2011). Does inflation affect economic growth? The case of Pakistan. Pakistan Journal of Social Sciences, 31(1), 51-64.

Ball, L., Mankiw, N.G., & Romer, D. (1988). The new Keynesian economics and the output-inflation trade-off. Brookings Paper on Economic Activity, 1, 1-90.

Bank of Tanzania, (2014). Annual Report, 2014.

Barro, R.J. (1995). Inflation and Economic Growth. NBER, Working Paper, No. 5326. doi. 10.3386/w5326

Barro, R.J. (1991). Economic growth in a cross-section of countries. Quarterly Journal of Economics, 106, 407-443. doi. 10.2307/2937943

Bassanini, A., & Scarpetta, S. (2001). The driving forces of economic growth: panel data evidence for the OECD countries. OECD Economic Studies, 33(2), 9-56. doi. 10.1787/eco_studies-v2001-art10-en

Becker, G.S., Glaeser, E.L.i & Murphy, K.M. (1999). Population and economic growth. The American Economic Review, 89(2), 145-149. doi. 10.1257/aer.89.2.145

Bhagwati, J., & Srinivasan, T.N. (2001). Outward-orientation and development: Are the revisionists right? In Trade, Development, and Political Economy: Essays in Honour of Anne O. Krueger., D. Lal & R.H. Snape (eds). Palgrave Macmillan, London, p.3-26.

Bittencourt, M., van Eyden, R., & Seleteng, M. (2014). Inflation and economic growth: evidence from the Southern African Development Community. Economic Research Southern Africa (ERSA), Working Paper No. 405.

Blanchard, O., & Gali, J. (2005). Real wage rigidities and the new Keynesian model. NBER Working Paper, No. 11806. doi. 10.3386/w11806

Branson, W.H (1972). Macroeconomic theory and policy. Harper and Row.

Bruno, M., & Easterly, W. (1998). Inflation crises and long-run growth. Journal of Monetary Economics, 41(1), 3-26. doi. 10.1016/S0304-3932(97)00063-9

Busemeyer, J.R. & Jones, L.E. (1983). Analysis of multiplicative combination rules when the casual variables are measured with error. Psychological Bulletin, 93(3), 549-562. doi. 10.1037/0033-2909.93.3.549

Cass, D. (1965). Optimum growth in an aggregative model of capital accumulation. Review of Economic Studies, 32(3), 233-240. doi. 10.2307/2295827

Central Bank News (2016). Global Monetary Policy. [Retrieved from].

Chan, K.S. & Tsay, R.S. (1998). Limiting properties of the least squares estimator of a continuous threshold autoregressive model. Biometrika, 85(2), 413-426. doi. 10.1093/biomet/85.2.413

Chari, V., Jones, L.E., & Manuelli, L.E. (1996). Inflation, growth and financial intermediation. Federal Reserve Bank of St. Louis Review, 78, 41-58.

Clements, B., Bhattacharya, R., & Nguyen, T.Q. (2005). Can debt relief boost growth in poor countries? Economic Issues, 34, International Monetary Fund. [Retrieved from].

Cohen, J., Cohen, P., West, S.G., & Aiken, L.S. (2003). Applied multiple regression/correlation analysis for the behavioral sciences. Mahwah, NJ: Lawrence Erlbaum Associates.

Crafts, N., & Toniolo, G. (1996). Post-war growth: an overview, in N. Grafts and G. Toniolo (eds) economic growth since 1945. Cambridge University Press, 1-37.

De Gregorio, J. (1993). Inflation, taxation and long-run growth. Journal of Monetary Economics, 31(3), 271-298. doi. 10.1016/0304-3932(93)90049-L

Denton, F.T., & Spencer, B.G. (1998). Economic costs of population aging. Research Institute for Quantitative Studies in Economics and Population, McMaster University, ISEOP Research Paper No: 12. [Retrieved from].

Denton, F.T., & Spencer, B.G. (1997). Population, labour force and long-term economic growth. Hamilton, Ont.: Research Institute for Quantitative Studies in Economics and Population, McMaster University. IESOP Research Paper, No:25. [Retrieved from].

Devarajan, S., Swaroop, V., & Zou, H. (1996). The composition of public expenditure and economic growth. Journal of Monetary Economics, 37(2), 313-344. doi. 10.1016/S0304-3932(96)90039-2

Dimitruk, P., Schermelleh-Engel, K., Kelava, A., & Moosbrugger, H. (2001). Challenges in nonlinear structural equation modeling. Methodology, 3, 100-114. doi. 10.1027/1614-2241.3.3.100

Dollar, D. & Kraay, A. (2001). Trade, growth, and poverty. World Bank, Development Research Group. 38(3), [Retrieved from].

Dollar, D (1992). Outward-oriented developing economies really do grow more rapidly: Evidence from 95 LDCs, 1976-1985. Economic Development and Cultural Change, 40(3), 523-544. doi. 10.1086/451959

Dornbusch, R., & Fischer, S. (1990). Macroeconomics. Singapore, McGraw-Hill, 5th Ed.

Dotsey, M. & Sartre, P.D. (2000). Inflation, uncertainty and growth in a cash-in-advanced economy. Journal of Monetary Economies, 45(3), 631-655. doi. 10.1016/S0304-3932(00)00005-2

Drukker, D., Gomis-Porqueras, P., & Hernandez-Verme, P (2005). Threshold effects in the relationship between inflation and growth: a new panel-data approach. 11th International Conference on Panel Data.

Duval, R., Eris, M., & Furceri, D. (2010). Labour force participation hysteresis in industrial countries: evidence and causes. OECD Economics Department. [Retrieved from].

Edey, M. (1994). Costs and benefits from moving from low inflation to price stability. OECD Economic Studies, No. 23, [Retrieved from].

Espinoza, R., Leon, H., & Prasad, A. (2010). Estimating the inflation-growth nexus-a smooth transition model. IMF Working Paper, No.10/76. [Retrieved from].

Faria, J, R. & F, G. Carneiro (2001). Does high inflation affect growth in the long-run and short-run? Journal of Applied Economics, 4(1), 89-105.

Fischer, S. (1979). Capital accumulation on the transition path in a monetary optimizing model. Econometrica, 47(6), 1433-1439. doi. 10.2307/1914010

Fischer, S. (1983). Inflation and growth. NBER, Working Paper, No.1235. doi. 10.3386/w1235

Fisher, S. (1993). The role of macroeconomic factors in growth. Journal of Monetary Economics, 32(3), 485-512. doi. 10.1016/0304-3932(93)90027-D

Frankel, J. A. & Romer, D.H. (1976). Does trade cause growth? American Economic Review, 89(3), 379-399.

Friedman, M. (1976). Inflation and unemployment. Nobel Memorial Lecture, the University of Chicago, Illinois, USA.

Ganzach, Y. (1997). Misleading interaction and curvilinear terms. Psychological Methods, 2(3), 235-247. doi. 10.1037/1082-989X.2.3.235

Ghosh, A., & Phillips, S. (1998). Warning: inflation may be harmful to your growth. IMF Staff Papers, 45(4), 672-710.

Gillman, M., & Kejak, M. (2004). The demand for bank reserves and other monetary aggregates. Economic Inquiry, 42, 518-533. doi. 10.1093/ei/cbh078

Gillman, M., Harris, M. & Matyas, L. (2002). Inflation and growth: some theory and evidence. 10th International Conference on Panel Data, Berlin.

Gillman, M., Kejak, M. & Valentinyi, A. (1999). Inflation, growth and credit services. Transition Economies Series 13. Vienna: Institute of Advanced Studies.

Gokal, V., & Hanif, S. (2004). Relationship between inflation and growth. Economics Department, Reserve Bank of Fiji, Working Paper, 4, 1-24.

Gomme, P. (1993). Monetary and growth: revisited. Journal of Monetary Economics, 32(1), 51-77. doi. 10.1016/0304-3932(93)90035-E

Grossman, G. & Helpman, H. (1991). Innovation and growth in the global economy. Cambridge M. A: MIT Press.

Gultekin, N. (1983). Stock market returns and inflation: evidence from other countries. Journal of Finance, 38(1), 49-65. doi. 10.2307/2327637

Hansen, B. (2000). Sample splitting and threshold estimation. Econometrica, 68(3), 575-603. doi. 10.1111/1468-0262.00124

Hansen, B. (1999). Threshold effects in non-dynamic panels: estimation, testing and inference. Journal of Econometrics, 93(2), 345-368. doi. 10.1016/S0304-4076(99)00025-1

Haslag, J.H. (1998). Monetary policy, banking and growth. Economic Inquiry, 36(3), 489-500. doi. 10.1111/j.1465-7295.1998.tb01730.x

Hayat, Z. (2013). Optimal, desirable and threshold inflation-growth nexus: an empirical assessment of a typical discretionary monetary policy strategy. 54th Annual Conference of the New Zealand Association of Economists (NZAE), Wellington, New Zealand.

Hermes, N., & Lensink, R. (2001). Fiscal policy and private investment in less developed countries. UNU-WIDER, Discussion Paper, No.32.

Hineline, D. (2007). Examining the robustness of inflation and growth relationship. Southern Economic Journal, 73(4), 1020-1037.

Jha, R., & Dand, N. (2011). Inflation variability and the relationship between inflation and growth. Macroeconomics and Finance in Emerging Market Economies, 5(1), 1-15. doi. 10.1080/17520843.2011.608371

Judson, R., & Orphanides, A. (1996). Inflation, volatility and growth. Finance and Economics Discussion Series, No. 96-19, Washington, D.C.: Board of Governors of the Federal Reserve System, Division of Research and Statistics, May.

Kelava, A., Moosbrugger, H., Dimitruk, P., & Schermelleh-Engel, K. (2008). Multicollinearity and missing constraints: a comparison of three approaches for the analysis of latent nonlinear effects. Methodology, 4(2), 51-66. doi. 10.1027/1614-2241.4.2.51

Khan, M.S., & Senhadji, S.A. (2001). Threshold effects in the relationship between inflation and growth. IMF Staff Papers, 48(1). [Retrieved from].

Koopmans, T.C. (1965). On the concept of optimum economic growth. in the econometric approach to development planning. North-Holland, Amsterdam.

Kremer, S., Bick, A., & Nautz, d. (2009). Inflation and growth: new evidence from a dynamic panel threshold analysis. SFB 649 Discussion Paper, Humboldt University, Berlin, Germany.

Krugman, P. (1990). Increasing returns and economic geography. NBER Working Paper No. 3275. doi. 10.3386/w3275

Lee, C., & Wong, Y. (2005). Inflationary threshold effects in the relationship between financial development and economic growth: evidence from Taiwan and Japan. Journal of Economic Development, 30(1), 49-69.

Levine, R., & Renelt, D. (1992). A sensitivity analysis of cross-country growth regressions. American Economic Review, 82(4), 942-963.

Li, M. (2006). Inflation and economic growth: threshold effects and transmission mechanisms. University of Alberta Working Papers.

Lin, S., & Ye, H. (2009). Does Inflation targeting make a difference in developing countries? Journal of Development Economics, 89(1), 118-123. doi. 10.1016/j.jdeveco.2008.04.006

Lubinski, D., & Humphreys, L.G. (1990). Assessing spurious moderator effects: illustrated substantively with the hypothesized relation between spatial and mathematical ability. Psychological Bulletin, 107(3), 385-393. doi. 10.1037/0033-2909.107.3.385

Lucas, R.E. & Stokey, N.L. (1987). Money and interest in a cash-in-advance economy. Econometrica, 55(3), 491-513. doi. 10.2307/1913597

Lucas, R.E (1982). Interest rate and currency prices in two-country world. Journal of Monetary Economics, 10(3), 335-360. doi. 10.1016/0304-3932(82)90032-0

MacCallum, R.C., & Marr, C.M. (1995). Distinguishing between moderator and quadratic effects in multiple regressions. Psychological Bulletin, 118(3), 405-421. doi. 10.1037/0033-2909.118.3.405

Makuria, A.G. (2013). Relationship between inflation and economic growth in Ethiopia. South Africa. University of South Africa.

Malthus, T.R. (1798). An essay on the principle of population, as it affects the future improvement of society: with remarks on the speculations of Mr. Godwin, M. Condorset, and other writers. J. Johnson.

Mankiw, N.G. (2008). Principles of economics. Cengage Learning Publisher, 5th Edition.

McCallum, B.T. & Goodfriend, M.S. (1987). Demand for money: theoretical studies, in New Palgrave Money. J. Eatwell, M. Millgate and P. Newman, eds., Macmillan Press, New York.

Moosbrugger, H., Schermelleh-Engel, K., & Klein, A. (1997). Methodological problems of estimating latent interaction effects. Methods of Psychological Research, 2(2), 95-111.

Moshiri, S., & Sepehri, A. (2004). Inflation-growth profiles across countries: evidence from developing and developed countries. International Review of Applied Economics, 18(2), 191-207. doi. 10.1080/0269217042000186679

Motley, B. (1998). Growth and inflation: a cross-country study. Federal Reserve Bank of San Francisco Economic Review, 1, 15-28.

Mubarik, A. (2005). Inflation and growth: an estimate of the threshold level of inflation in Pakistan. State Bank of Pakistan-Research Bulletin, 1(1), 35-44.

Muganda, A. (2004). Tanzania’s economic reforms and lessons learned: a case study from reducing poverty, sustaining growth-what works, what doesn’t, and why. A Global Learning Process and Conference Shanghai, May 25-27.

Mundell, R.A (1963). Inflation and real interest. Journal of Political Economy, 71(3), 280-283. doi. 10.1086/258771

Nicas, Y. & Kessy, N.J. (2015). Appropriate threshold level of inflation for economic growth: evidence from the three founding EAC countries. Applied Economics and Finance, 2(3), 127-144. doi. 10.11114/aef.v2i3.966

Odhiambo, N.M (2012). Inflation dynamics and economic growth in Tanzania: a multivariate time series model. The Journal of Applied Business Research, 28(3), 317-324. doi. 10.19030/jabr.v28i3.6951

Patillo, C., Poirson, H., & Ricci, L. (2002). External debt and growth, IMF Working Paper, No. 02/69. [Retrieved from].

Paul, P.B. (2012). Inflation-growth nexus: some bivariate EGARCH evidence for Bangladesh. Macroeconomics and Finance in Emerging Market Economies, 6(1), 66-76. doi. 10.1080/17520843.2012.695385

Paul, S., Kearney, C. & Chowdhury, K. (1997). Inflation and economic growth: a multi-country empirical analysis. Applied Economics, 29(10), 1387-1401. doi. 10.1080/00036849700000029

Pentecost, E.J. (2000). Macroeconomics: an open economy approach, 1st Ed., Macmillan Press Ltd., 2000, New York.

Phillips, A. W. H. (1958). The relation between unemployment and the rate of change of Money wage rates in the United Kingdom, 1861-1957. Economica, 25(2), 283-299. doi. 10.2307/2550759

Pollin, R., & Zhu, A. (2006). Inflation and economic growth: a cross-country non-linear analysis. Journal of Post Keynesian Economics, 28(4), 593-614.

Quartey, P. (2010). Price stability and the growth maximizing rate of inflation for Ghana. Modern Economy, 1(3), 180-194. doi. 10.4236/me.2010.13021

Reinhart, C. & Mohsin, K. (1989). Private investment and economic growth in developing countries. World Development, 18(1), 243-258. doi. 10.1016/0305-750X(90)90100-C

Risso, W.A. & Carrera, E.J. (2009). Inflation and mexican economic growth: long-run relationand threshold effects. Journal of Financial Economic Policy, 1(3), 246-263. doi. 10.1108/17576380911041728

Rodríguez, F., & Dani, R. (1999). Trade policy and economic growth: a sceptic’s guide to the cross-national evidence. CEPR Discussion Papers No.2143,

Rodrik, D. (1998). Why do more open economies have bigger governments? Journal of Political Economy, 106(5), 997-1032. doi. 10.1086/250038

Romer, P.M. (1990). Endogenous technological change. Journal of Political Economy, 98(5), 71-102. doi. 10.1086/261725

Romer, P.M. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94(5), 1002-1037. doi. 10.1086/261420

Rutasitara, L. (2004). Exchange rate regimes and inflation in Tanzania. African Economics Consortium (AERC), Paper No. 138.

Rutayasire, M. (2013). Threshold effects in the relationship between inflation and economic growth: evidence from Rwanda. Research Paper Submitted to African Economic Research Consortium (AERC), April 2013.

Rutayisire, L.W.(1986). Measurement of government budget deficit and fiscal stance in less developed economy: the case of Tanzania, 1966-84. The University of Dar es Salaam, Eastern Africa Economic Review, 2(2). 35-45.

Sala-i-Martin, X. (1997). I just ran two million regressions. American Economic Review, 87(2), 178-183.

Salami, D., & Kelikume, I. (2010). An estimate of inflation threshold for Nigeria, 1970-2008. International Review of Business Research Papers, 6(5), 375-385.

Sarel, M. (1996). Nonlinear effects of inflation on economic growth. IMF Staff Papers, No.43, 199-215.

Schiavo, S., & Vaona, A. (2007). Nonparametric and semi-parametric evidence on the long-run effects of inflation on growth. Economics Letters, 94(3), 452-458. doi. 10.1016/j.econlet.2006.09.004

Seleteng, M. (2012). Inflation and economic growth nexus in the Southern African Development Community: a panel data investigation. PhD Thesis, Faculty of Economic and Management Sciences, University of Pretoria.

Seleteng, M., Bittencourt, M., & Van Eyden, R. (2010). Nonlinearities in inflation-growth nexus in the SADC region: a panel smooth transition regression approach. Economic Modelling, 30(1), 149-156. doi. 10.1016/j.econmod.2012.09.028

Singh, P. (2010). Searching threshold inflation for India. Economics Bulletin, 30(4), 3209-3220.

Snowdon, B. & Vane, H.R. (2005). Modern macroeconomics: Its Origins, Development and Current State. E. Elgar,

Solomon, M., & de Wet, W.A. (2004). The effect of a budget deficit on inflation: the case of Tanzania. South African Journal of Economic and Management Sciences, 7(1), 100-116.

Solow, R.M. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70(1), 65-94. doi. 10.2307/1884513

Stein, J.L. (1968). Rational choice and patterns of growth in a monetary economy. American Economic Review, 58(4), 534-544.

Stockman, A.C. (1981). Anticipated inflation and the capital stock in a cash-in-advance economy. Journal of Monetary Economics, 8(3), 387-393. doi. 10.1016/0304-3932(81)90018-0

Svensson, L.E.O. (1985). Money and asset prices in a cash-in-advance Economy. Journal of Political Economy, 93(5), 919-944. doi. 10.1086/261342

Tawiri, N. (2010). Domestic investment as a drive of economic growth in Libya. International Conference on Applied Economics, ICOAE, 759-767.

Temple, J. (2000). Inflation and growth: stories short and tall. Journal of Economic Surveys, 14(4), 395-426. doi. 10.1111/1467-6419.00116

Thirlwall, A.P. (1994). Growth and development. 5th ed. London: Macmillan.

Tobin, J. (1965). Money and economic growth. Econometrica, 33(4), 671-684. doi. 10.2307/1910352

Tsen, W.H. & Furuoka, F. (2005). The relationship between population and economic growth in Asian economies. ASEAN Economic Bulletin, 22(3), 314-330.

United Republic of Tanzania, (2015). The economic survey. Ministry of Finance and Economic Affairs, United Republic of Tanzania.

Wacziarg, R. (1998). Measuring the dynamic gains from trade. World Bank, Development Economics, Development Prospects Group, Policy Research Working Paper, Washington, D.C.

World Bank (2015). World Development Indicators (WDI).

World Bank (2016). World Development Indicators (WDI)

Xiao, J. (2009). The relationship between inflation and economic growth of China: empirical study from 1978 to 2007. Lund University, School of Economics and Management.

Yabu, N., & Kessy, N.J. (2015). Appropriate Threshold Level of Inflation for Economic Growth: Evidence from the Three Founding EAC Countries. Applied Economics and Finance, 2(3), 127-144. doi. 10.11114/aef.v2i3.966

Younus, S. (2012). Estimating growth-inflation trade-off threshold in Bangladesh. Policy Analysis Unit, Research Department, Bangladesh Bank, Working Paper 2012.



  • There are currently no refbacks.


Journal of Economics and Political Economy - J. Econ. Pol. Econ. - JEPE -

ISSN: 2148-8347

Editor:   Secretarial:   Istanbul - Turkey.

Copyright © KSP Library