Inflation and Growth: A Nonlinear Relationship Analysis for Emerging Economies

Abstract

We investigate the nonlinear relationship between inflation and real economic growth in a large panel of emerging economies from 1990 to 2023. While moderate inflation can accompany rapid structural transformation, sustained high inflation is often associated with lower growth. Using multiple complementary nonlinear estimators—panel threshold regression (PTR), panel smooth transition regression (PSTR), panel quantile regression (PQR), and country-specific nonlinear ARDL (NARDL)—we identify (i) threshold effects whereby inflation above a critical level exerts increasingly negative growth effects; (ii) state dependence such that the marginal effect of inflation varies smoothly with the inflation regime; and (iii) heterogeneity across the growth distribution, with high-growth regimes relatively more inflation-tolerant. Identification concerns are addressed with internal instruments (system-GMM extensions), external cost-push shifters, and extensive robustness checks using alternative inflation measures (headline vs. core), alternative growth definitions (per-capita vs. aggregate; TFP), and crisis-exclusion windows. Our preferred specification indicates a growth-reducing threshold in the mid-single to low-double digits (≈7–11 percent), with stronger effects during terms-of-trade busts and in financially shallower economies. Policy results suggest that maintaining inflation firmly below the threshold—and reducing volatility—enhances medium-term growth, particularly in contexts where financial development and institutional quality are weaker. The paper reconciles conflicting linear estimates by showing that nonlinearity, asymmetry, and cross-country heterogeneity jointly explain the inflation–growth puzzle in emerging markets.