Socio-political instability and growth dynamics

Abstract

We develop an overlapping generations (OLG) monetary endogenous growth model characterized by socio-political instability, with the latter being specified as a fraction of output lost due to strikes, riots and protests. We show that growth dynamics arise in this model when socio-political instability is a function of inflation. In particular, two distinct growth dynamics emerge, one convergent and the other divergent contingent on the strength of the response of socio-political instability to inflation. Since our theoretical results hinge on socio-political instability being a function of inflation, we test the prediction that inflation affects socio-political instability positively by using a panel of 156 countries for the 1980–2012 period, and allowing for country and time fixed effects. The results indicate that inflation relates positively with socio-political instability. Policy makers should be cognisant that it is crucial to maintain long-run price stability, as failure to do so may result in high inflation emanating from excessive money supply growth, leading to high (er) socio-political instability, and ultimately, the economy being on a divergent balanced growth path.