On the nonlinear relationship between inflation and growth: A theoretical exposition

The relationship between inflation and growth is examined in an R&D-based model of endogenous growth in which the R&D abilities of agents are heterogeneous. We analytically demonstrate that if the distribution of ability has a fat and long tail, the relationship between inflation and growth becomes nonlinear; the negative relationship between inflation and growth is weaker in the heterogeneous ability economy than it is in the homogeneous ability economy for low inflation, whereas the opposite outcome holds for high inflation. Our numerical example shows that this nonlinear relationship between inflation and growth holds under plausible parameter values.