BCP Business & Management ECRM 2022

Volume 40 (2023)

Relationship Between GDP and Inflation Rate

Meixi Xiong*
University of Toronto, Toronto, Canada
* Corresponding author: [Link]@[Link]
Abstract. In history, inflation has appeared many times. For example, the Recession. Also, GDP
inflation and deflation occur from time to time. However, there is little research about the relationship
between inflation and GDP. Therefore, this paper wants to investigate how inflation is associated
with GDP. However, there is no linear relationship between these two factors. Investment managers
must discover a degree of awareness that aids their decision-making without overwhelming them
with superfluous information. Discover the implications of inflation and GDP on the marketplace, the
business, and the investment. Innovative banking variations across nations, or within a nation and
over time, influence how inflation impacts economic growth. Smaller intermediaries costs mean that
inflation has a negative production less than in higher-cost nations, and comparable effects apply
within the same nation when intermediation prices shift over time. Inflation's impacts on growth have
long been debated, both conceptually and experimentally. In contrast to several financial concerns,
where the issue is frequently whether a particular impact or no impact exists, there are consistent
theories that indicate inflation can have a favorable, unfavorable, or no influence on economic growth.
As a result, it appears to be a perfect condition for testing different ideas against evidence.
Keywords: Relationship; GDP; Inflation rate.

1. Introduction
During the COVID-19 pandemic, gross domestic product (GDP) decreases drastically and
inflation is very severe. Therefore, it is very significant to discover the relationship between inflation
and GDP in order to promote GDP growth and lighten inflation, and in turn, help economics recover
from the pandemic. From early 1990, a reappearance of effort in the problem of inflation and
economic expansion emerged. The majority of the present research has employed cross-country
information, either aggregated in development regression models or evaluated independently in time-
series analysis, and one of the findings is that there are significant disparities between nations.
Aside from inflation, the researchers included employment levels as a variable in the equation
since economic expansion and jobs are associated. It is the relationship between an increased
country's economic production and lower national jobless. This is because, in order to improve a
country's economic production, individuals must return to work, decreasing unemployment. Most
nations around the globe are concerned about inflation and economic development. As a result,
economic expansion and inflation have garnered praise since the classical era. All mainstream
economists, politicians, and central financial institutions have to understand whether inflation is good
or destructive to development.
It is widely agreed in macroeconomics that a moderate level of inflation will boost the growth of
GDP. However, the problem of what level of inflation is ‘good’ for economics is remain open.
Structuralists believe that a moderate level of inflation could benefit economic expansion, while from
the monetarists’ perspective, inflation imposed a detrimental effect on economic growth. Earlier
empirical work generally supports the argument that inflation impairs economic development. Even
so, it is quite hard to deny the possibility of a natural link between GDP and inflation.
Many powerful mathematics and statistics tools were utilized by economists to elucidate the causal
relationship between two variables. The unit root test is one of the most widely used techniques in
casual relationship analysis. For cases where time series data are stationary, the causal relationship
could be unveiled by ordinary least squares (OLS). If there are unit roots and nonintegrated, the Error
Correction Model may be needed to transform the model. This method has been used to check the
integration order of the variables [1]. To study the long-term relationship between variables,

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cointegration analysis could also be employed [2]. Other methods like nonlinear least squares (NNLS)
estimation [3], Granger Causality Test [4], Series Autocorrelation [5], and GDP-CPINLDS [6] have
also been used to find the causal relationship.
Recent research tends to believe that there is a ‘threshold’ inflation rate (i.e. a country is more
likely to recess if its inflation rate is above the threshold inflation rate; on the contrary, it will grow if
its inflation is lower than the threshold inflation rate.) In 2005, Yasir Ali Mubarik used four variables
model to find the threshold inflation rate for Pakistan [7]. According to annual data from the
Economic Survey of Pakistan, he claimed that the threshold value of inflation is 9% for Pakistan. On
the contrary, in the research conducted by Sweidan in 2006, Sweidan reported a positive structural
effect at a 2% inflation rate, while rates bigger than 2% would lead to destructive effects [8]. In
addition to the research focusing on developing economies, there is also some research conducted in
some developed economies. In 2005, Lee and Wong used the unit root test to determine the nonlinear
relationship between inflation and GDP growth. After reviewing the data from 1965 to 2002 in
Taiwan and Japan, they found the threshold inflation rate is 7.25%, while this rate is 2.52% for Japan
[9]. In this article, research methodology is applied to ascertain the relationship between gross
domestic product and inflation rate in the USA.

2. Methodology
2.1 Source of data
A dataset from the US Bureau of Economic Analysis and US Bureau Labor of Statistics is used to
predict the relationship between GDP growth and inflation rate. The data consists of 10 quarters’ data
of GDP and inflation. The inflation is taken from CPI.
In this dataset, the independent variable is inflation (CPI). Inflation represents a price rise for
commodities and services. If a country’s inflation is increasing, then the general price level in this
country will also increase. Conversely, if a country’s inflation is decreasing, the general price level
in this country will also decrease. The dependent variable in this dataset is GDP growth, which is
used to measure how quickly an economy is growing or shrinking.
2.2 Machine learning models
Linear regression to examine the relationship is used in this work. Linear regression is a common
technique to model the relationship between interpretation variables and scalar responses, i.e.,
independent and dependent variables. If there is only one explanatory variable, the regression is called
simple linear regression. Regression of more than one explanatory variable is called multiple linear
regression. An analogous concept is multivariate linear regression, which predicts multiple
independent variables rather than single scalar variables [9]. Linear regression model relationships
based on linear predictive functions and their unknown model specifications are calculated from
collected data. In general, assumptions that the average value of the response condition yielding the
value of interpretation variables is considered to be an affine function of these values. Not too
common is to use the median and other digits of the condition. As with all forms of regression analysis,
linear regression places much emphasis on the condition.

3. Results
3.1 Data Visualization
Consider using descriptive statistics tables for variables (showing means, etc. in tabular form),
GDP growth, and Inflation rate are shown in Table 1.

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Table 1. GDP growth and Inflation rate

Variables Obs Mean Std. Dev. Min Max
GDP growth 40 3.51% 4.47 -1.8% 7.2%
Inflation rate 40 4.47% 9.84 0.7% 13.3%

So far, the government has initiated a monetary policy in order to promote GDP growth and
decrease the inflation rate. For example, the government would borrow money and send it to citizens
in order to increase government spending and promote costs.
The two major goals of this article are to identify and investigate the link between economic
expansion and prices. A questionnaire survey is used to accomplish the goal of this work. The sample
size is used because it makes use of both response variables and cross-sectional knowledge and
provides a high quantity of observations, enhancing the amount of freedom and decreasing colinearity
between explanatory factors. Data series enhances econometric evaluation in ways that cross-section
or time series information alone cannot. It provides far greater modeling freedom for cross-sectional
unit behavior than forced air time series analysis does. The data is organized into panels. The very
first quadrant is composed of five factors: real GDP per capita percentage growth, deflation, capital,
demographic, and beginning real GDP per capita. The second section is made up of two factors: real
GDP growth rate and inflation. The first part is designed to examine the link between economic
expansion and inflation. The second part is made up of economists who are attempting to determine
the connection between economic expansion and inflation.
The USA is the largest economy in the world. This country's GDP was around $15 trillion in 2011.
When compared to other countries, the United States ranks eighth, after countries like Norway. This
is based on her 76,450 per capita income. The United States has a huge economy with a continuous
and stable GDP. There was a modest reduction in the rate of unemployment. This was accompanied
by an increase in the parity of purchasing power. All of these factors combine to make the United
States economy one of the largest on the planet.
The next regression coefficient is the expenditure rate. The majority of research found that
investment had a favorable influence on economic growth. For example, the United States discovered
that investment had a favorable influence on economic growth. The information was obtained from
the Penn World Tables website. INVT denotes the rate of investment in this study.
Although higher inflation rates are detrimental to economic growth, the administration must also
manage the inflationary pressures. These original study findings confirm the Monetary-Lead Theory
and imply that the government ought to concentrate not just on the growth of the financial industry,
but also on other macroeconomic policies that favor a stable currency exchange rate. A low high ratio
of inflation implies that policymakers rethink the current Macroeconomic Policy [10].
The helps influence component is the demographic. It is the geometrically expanding pace of the
midseason populace. The understanding of the link between population expansion and industrial
progress is mixed. According to some, rapid population increase places a strain on limited natural
resources, thereby restricting personal and government wealth production and economic success.
Others contended that increasing population was helpful to productivity expansion. GPOP denotes
the effect of population expansion. The World Bank information was used to create this collection.
The last regression coefficient in this analysis is the initial per capita GDP. Various studies produce
conflicting results about the impact of beginning per capita GDP on growth in the economy. Barro
(1997) discovered an inverse link between beginning GDP and wealth creation. Blomstrom (1996),
on the other hand, discovered a positive link between beginning GDP and wealth creation. For this
analysis, the real GDP per capita of 1969 is used as the starting point. GDP0 represents it.
3.2 Test-Hypotheses:
A threshold inflation rate for the US is presumed. When the inflation rate is higher than this level,
economic growth will shrink. Otherwise, it will increase.

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3.3 Test result and analysis:

The total of all factors in the study is shown in Table 2. Stata is used to compute it. It includes the
average, standard deviation, and highest and lowest values of the data that may be seen. It is used to
see the data's general perspective.

Table 2. The test result of all factors

Variable Number of observations Mean Std. Devation Minimum Maximum
GGDP 476 2.9299 5.7923 16.0492 19.48
INVT 478 19.1833 9.2088 0.9 21.37
GPOP 476 0.0158 0.7639 0.3871 4.8644
InINF 476 2.7673 1.4789 6.7196 7.0168
InGDPO 476 3.4908 1.0147 2.202 4.9267

Markets are geographically fragmented, with the cost of intermediaries proportionate to demand
and rising with distance from the main market. Using cash, on the other hand, is expensive but
proportionate to the real rates of interest, which is the same in all marketplaces. As can be shown,
there is a cutoff point at which credit is employed in that site and all of those nearer to the domestic
market, while cash is utilized in all markets farther away. This cutoff will be determined by the actual
interest rate as well as inflation as calculated by the Fisher equation. Since credit is expensive, there
will be an implicit financial sector, the size of which will be determined by the real rate of interest
and inflation.
This section will discuss how to investigate the connection between economic development and
inflation. To reach the objective of this study, I developed a model that incorporates inflation and
beginning GDP into the Solow growth model. I replace labor and capital in the Solow growth model
with population and investment. As a result, the model includes five variables: real GDP per capita,
inflation, population, starting per capita GDP, and cash flow. Control factors include population,
beginning per capita GDP, and investments. Every parameter and the method for measuring each
variable is outlined below:

4. Discussion
The primary objective was to clarify the relation between foreign direct investment and economic
progress, and the relation between business and pricing. The connection between foreign direct
investment and the economy was also inspected, and a developmental model was constructed that
contained three additional components in addition to inflation. Because the model requires a temporal
impact, the explanation is based on the model. The study showed that inflation is statistically
meaningful, but with a minus number, suggesting that inflation seems to imply a detrimental influence
on economic growth. The estimate was done using three distinct models, but the results are all the
same. This finding is similar to the findings of Fisher and Gregorio. They conducted extensive
research on the subject and determined that inflation is adversely and strongly connected to growth
in the economy [10].
In contrast to inflation, the findings suggest that beginning GDP has a detrimental impact on the
economy's growth. This conclusion suggests converging, which indicates that the nations with greater
per capita GDP originally have negative growth. The figure's coefficients of expenditure parameter
have a good thing and are statistically meaningful. This outcome is consistent with Keynes' General
Theory and the Sala-Martin investigation (1997). They demonstrated that investing was critical in
supporting productivity expansion. Finally, the estimated results show a slightly negative correlation
between population and economic growth. The multivariate cointegration test revealed that inflation
stimulates economic expansion and that income growth creates inflation. For the 13 nations in the
sample, the previous causation mechanism may be described as homogeneous. The latter process is
diverse, occurring in Congo, the Democratic Republic of the Congo, and the United States but not in

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other nations. As a result, it may be claimed that previous inflation rates help anticipate present-day
economic growth (GDP) and vice versa.

5. Conclusion
Macroeconomic policy is associated with the realization of significant so-called economic
objectives. Such goals involve raising real GDP levels, reaching high levels of production and
domestic and international competitiveness, in addition to product creation, obtaining economic
growth (and levels of unemployment), and, last but not less, attaining and preserving monetary and
economic stabilization. By investigating trends in inflationary expectations for industrial
development in the United States, we confirmed the concept that stagnant productivity is essential
but is not sufficient for sustainable productivity expansion. A paradigm with multiple output
responses was devised. A regression analysis was used for estimation. The connection between
economic progress and pricing is proposed and the correlation test was applied. The projected result
demonstrated that monetary policy was significantly and negatively related to economic growth. This
demonstrates how inflation is a drag on productivity expansion. Inflation and per capita real GDP are
moving in opposite ways.

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