Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 606: Output Gain From Economic Stabilization

Thorvaldur Gylfasson
Additional contact information
Thorvaldur Gylfasson: Department of Economics, University of Iceland, Postal: Department of Economics, University of Iceland, IS-101 Reykjavik, Iceland

Abstract: By driving a wedge between the marginal returns to real and financial capital, inflation distorts production. The elimination of this distortion increases both the level and rate of growth of output. First, increased price stability improves the utilization of capital and thus increases the full-employment level of output in the long run, even though output decreases initially. Second, the static output gain from stabilization is captured in a simple formula in which the gain is approximately proportional to the square of the original inflation distortion. Third, successful stabilization increases the rate of growth of output per head, and not only its level, in the presence of constant returns to capital in a broad sense. Fourth, substitution of plausible parameter estimates into the simple formulae reflecting the gains from stabilization indicate that the static and dynamic output gains can be substantial.

Keywords: inflation distorted production

JEL-codes: E23; E31; P21

23 pages, October 31, 1997

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