Inflation, Growth, and Credit Services

research in the social sciences. The publication of working papers does not imply a transfer of copyright. The authors are fully responsible for the content. The empirical evidence suggests that there is a significant, negative relationship between inflation and economic growth. Conventional monetary growth models, however, predict a significantly smaller growth effect. This paper proposes a monetary growth model with an explicit credit service sector to explain the observed magnitude. Since credit services are assumed costly to produce, the consumers equate the opportunity cost of holding money with the marginal cost of credit. Therefore the technology of the financial sector influences the velocity of money, and consequently, how inflation affects leisure, the time spent accumulat-ing human capital, and the growth rate of output. The calibration shows that the model generates an inflation-growth effect whose magnitude falls in the range found by the empiri-cal studies. Moreover, in contrast to previous works, we are also able to explain an inflation-growth effect that becomes increasingly weak as the inflation rate rises, as the evidenc