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Inflation, Unemployment and Economic Growth in a Schumpeterian Economy

Chu, Angus C. and Cozzi, Guido and Fan, Haichao and Furukawa, Yuichi (2013): Inflation, Unemployment and Economic Growth in a Schumpeterian Economy.

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Abstract

This study explores the long-run relationship between inflation and unemployment in a monetary Schumpeterian growth model with matching frictions in the labor market and cash-in-advance (CIA) constraints on consumption and R&D investment. Under the CIA constraint on R&D, higher inflation that raises the opportunity cost of cash holdings leads to a decrease in innovation and economic growth, which in turn decreases labor-market tightness and increases unemployment. Under the CIA constraint on consumption, higher inflation instead decreases unemployment in addition to stifling innovation and economic growth. Therefore, the two CIA constraints have drastically different implications on the long-run relationship between inflation and unemployment. This theoretical result is consistent with our empirical finding and provides a plausible explanation (via the relative magnitude of the two CIA constraints) for the mixed empirical results on the relationship between inflation and unemployment in the literature. Finally, we also calibrate our model to aggregate data in the US and Eurozone to explore quantitative implications on the relationship between inflation and unemployment.

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