Abstract:
The negative relationship between growth and inflation is well-documented in the literature. However,
recent evidence tends to indicate the possibility of a growth-inflation trade-off. This paper attempts to
provide a theoretical explanation for this apparent empirical contradiction. To validate our point, we
develop a monetary endogenous growth model of a financially repressed small open economy in an overlapping
generations framework, characterized by curb markets, productive public expenditures, capital
mobility, transaction costs in domestic and foreign capital markets, and a flexible exchange rate system,
and analyze the impact of financial liberalization on growth and inflation. We show that including financial
repression in the model is necessary but not sufficient to produce a trade-off between growth and
inflation. Sufficiency requires high transaction cost in the domestic financial market.
