Inflation and Indivisible Investment in Developing Economies [electronic resource] / Eden, Maya
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TextPublication details: Washington, D.C., The World Bank, 2014Description: 1 online resource (35 p.)Subject(s): Access to Finance | Debt Markets | Developing Economies | Economic Theory & Research | Finance and Financial Sector Development | Indivisible Investment | Inflation | Investment & Investment Climate | Investment Decisions | Macroeconomics and Economic Growth | Money-Intensive Investment | Non Bank Financial InstitutionsAdditional physical formats: Eden, Maya: Inflation and Indivisible Investment in Developing Economies.Online resources: Click here to access online Abstract: In countries with limited access to finance, firms accumulate retained earnings to finance indivisible investment projects. McKinnon (1973) illustrates that when cash is used as a primary store of value, inflation may discourage investment as it increases the cost of accumulating retained earnings. This paper formalizes this argument in a dynamic framework and provides a simple calibration of the model that suggests sizable effects of inflation on investment. The mechanism is particularly relevant for small firms, as firms with lower cash flows must accumulate retained earnings for longer periods of time to meet the price of indivisible investment goods. Consistent with the model, empirical evidence suggests that inflation disproportionately reduces investment in small firms.
In countries with limited access to finance, firms accumulate retained earnings to finance indivisible investment projects. McKinnon (1973) illustrates that when cash is used as a primary store of value, inflation may discourage investment as it increases the cost of accumulating retained earnings. This paper formalizes this argument in a dynamic framework and provides a simple calibration of the model that suggests sizable effects of inflation on investment. The mechanism is particularly relevant for small firms, as firms with lower cash flows must accumulate retained earnings for longer periods of time to meet the price of indivisible investment goods. Consistent with the model, empirical evidence suggests that inflation disproportionately reduces investment in small firms.
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