Inflation, Liquidity and Innovation
This paper presents a simple model with financial frictions where inflation increases the cost faced by firms holding liquid assets to hedge risky production against expenditure shocks. Inflation tilts firms' technology choice away from innova...
| Main Authors: | , , |
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| Format: | Working Paper |
| Language: | English |
| Published: |
World Bank, Washington, DC
2018
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/544711525968321874/Inflation-liquidity-and-innovation http://hdl.handle.net/10986/29842 |
| Summary: | This paper presents a simple model with
financial frictions where inflation increases the cost faced
by firms holding liquid assets to hedge risky production
against expenditure shocks. Inflation tilts firms'
technology choice away from innovative activities and toward
safer but return-dominated ones, and therefore reduces
long-run growth. The theory makes specific predictions about
how the severity of this adverse effect depends on industry
characteristics. These predictions are tested with novel
harmonized firm-level data from 139 developing countries,
overcoming small sample problems constraining previous work.
The analysis finds that inflation affects the composition
but not the overall quantity of investment. A one percentage
point increase in inflation reduces the establishment-level
probability of innovation by 4.3 percent but does not affect
total investment. Moreover, innovating firms display a
stronger dependence on liquid assets, which, in turn, are
negatively related to inflation. Generalized
difference-in-differences estimations corroborate the
sector-specific predictions of the theoretical model. |
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