Inflation and Economic Growth with Cross-Section Dependency: an Empirical Analysis in Terms of Relative Price Variability across Canadian Provinces
Komlan Fiodendji, Ph.D

This paper empirically provides new evidence on the relation between inflation, relative price variability and economic performance or living standards to a panel of Canadian provinces over the period 1981-2010. We use the Bick and Nautz (2008) modified version of Hansen's (1999) Panel Threshold Model. The evidence strongly supports the view that the relationship between inflation and economic growth is nonlinear. Further investigation suggests that relative price variability is one of the important channels through which inflation affects economic performance in Canadian provinces. When we control cross-section dependency and use the appropriate method, we find the critical threshold value slightly changes. Our findings are consistent with the claims of Blanchard et al. (2010) who suggest that an inflation target of 4 percent might be more appropriate because it leaves more room for expansionary monetary policy in the case of adverse shocks. These findings provide some policy implications. It is desirable to keep inflation in the moderate inflation regime and therefore the Bank of Canada should concentrate on those policies which keep the inflation rate between 1.82 percent and 4.16 percent because it may be helpful for the achievement of sustainable economic growth and to improve the living standards of Canadian provinces. The results seem to indicate that inflation that is too high or too low may have detrimental effects on economic growth. This information gives a very important signal for Canadian policymakers to impose new policies to provide economic stabilization through Canadian provinces.

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