Using an innovative threshold estimation technique, this paper provides new evidence on the relationship between finance and inflation with distinct levels of finance.
The sample consisted of 10 high inflation countries using time series data for the period of 1992–2020. These 10 countries recorded the world's highest inflation rates in 2017.
The findings demonstrate that there is a threshold effect on the finance–inflation relationship. Whilst the effects of finance are consistently positive for below and above the threshold models, financial depth above the threshold tends to aggravate the inflation level.
These results disclose that financial depth could be the cause of high inflation in the top 10 countries and thus, is not necessarily welcome as too rapid of a price increase may in turn reverse the prospect of economic growth. Searching and strategizing for the optimal level of financing is crucial in facilitating price stability and economic growth.
The authors believe that the effect of financial depth on inflation is characterised by being desirable to certain extent and undesirable if over-financing is beyond the optimum level. Therefore, in this study, the authors have introduced the threshold modelling as the potential strategy to connect financial depth and inflation.
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