Inflation-Growth Nexus: Evidence from Panel Smooth Threshold Model Analysis in Different Geographical Region Countries

Abstract

The relationship between inflation-growth has long been debated and it is inconclusive if there is a trade-off between inflation and growth. The main objective of this study is to model the threshold effect of inflation on growth, in addition to testing on the existence of the trade-off relationship. For this purpose, the Panel Smooth Transition Regression (PSTR) model analysis is
conducted. The results are compared among three panel groups, namely the EU, ASEAN and African countries. These three different geographical regions have different inflation experiences and country-specific characteristics separately over the period 1980–2017. Inflation is treated as the threshold variable and other variables as treated as control variables (exchange rate,
trade-openness, government final consumption and population growth rate). The results reveal a nonlinear relationship between growth and inflation in all three different geographical regions. The trade-off relationship is detected in the first regime in all three panel groups. The PSTR model has detected the optimal threshold of inflation rate to be 4.17%, 6.02% and 0.94% to 14.51% respectively. Africa has a higher inflation tolerance range, 0.94 to 14.52 % compared to the EU and ASEAN groups. Overall, the inflation-growth relationship is positive (trade-off) below the reported threshold levels and the relationship is negative once the inflation rate exceeds the threshold levels. These imply that our results reveal that the relationship between inflation-growth is non-linear in the company of an existence of a threshold level of inflation.