Inflation, Liquidity and Innovation
- Michael Evers, Stefan, Niemann Marc, Schiffbauer
- May 2018
- The World Bank Group (WBG)
- International
Inflation tilts firms’ technology choice away from innovative activities and toward safer but return-dominated ones, and therefore reduces long-run growth. In theory, specific predictions are made about how the severity of this adverse effect depends on industry characteristics. These predictions are tested with 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.
