Inflation and Indivisible Investment in Developing Economies

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.

Bibliographic Details

Main Authors:	Eden, Maya, Nguyen, Ha
Language:	English en_US
Published:	World Bank Group, Washington, DC 2014-07
Subjects:	ACCESS TO CREDIT, ACCESS TO SAVING, AFFILIATED ORGANIZATIONS, ANNUAL SALES, CAPITAL INVESTMENT, CAPITAL STOCK, CAPITAL STOCKS, CASH FLOW, CASH RESERVES, CASH SURPLUS, CENTRAL BANK, COST OF CAPITAL, CREDIT LINE, CREDIT MARKET, DECISION MAKING, DECLINE IN INVESTMENT, DEVELOPING COUNTRIES, DEVELOPMENT POLICY, DISCOUNT RATE, DIVIDENDS, DUMMY VARIABLE, DUMMY VARIABLES, ECONOMIC ACTIVITIES, ECONOMIC DEVELOPMENT, ECONOMIC GROWTH, ECONOMIC PERFORMANCE, EQUIPMENT, EXTERNAL FINANCE, FINANCIAL INSTITUTION, FORMAL ANALYSIS, FUTURE CASH FLOWS, GDP, GDP DEFLATOR, HOLDING, HOUSEHOLDS, HUMAN CAPITAL, ID, INEQUALITY, INFLATION, INFLATION RATE, INFLATION RATES, INTEREST RATE, INTERNAL FINANCING, INTERNATIONAL BANK, INVESTING, INVESTMENT ACTIVITIES, INVESTMENT CHOICE, INVESTMENT DECISION, INVESTMENT DECISIONS, INVESTMENT OPPORTUNITIES, INVESTMENT PROJECTS, INVESTMENT RATES, LACK OF ACCESS, LEVEL OF INFLATION, LIMITED ACCESS, LIMITED ACCESS TO FINANCE, LOCAL CURRENCY, MACROECONOMIC CONDITION, MACROECONOMIC CONDITIONS, MACROECONOMICS, MARGINAL PRODUCT, MICRO DATA, NOMINAL VALUE, POLITICAL ECONOMY, PRODUCTION FUNCTION, RATE OF RETURN, RATES OF INFLATION, RATES OF RETURN, REAL INTEREST, REAL INTEREST RATE, RETAINED EARNINGS, RETURN ON INVESTMENT, RETURNS, SAVINGS, SAVINGS ACCOUNTS, SELF-FINANCING, TAX, TOTAL OUTPUT, WEALTH,
Online Access:	http://documents.worldbank.org/curated/en/2014/07/19877601/inflation-indivisible-investment-developing-economies https://hdl.handle.net/10986/19353
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