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 in...
| Main Authors: | , |
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank Group, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2014/07/19877601/inflation-indivisible-investment-developing-economies http://hdl.handle.net/10986/19353 |
| Summary: | 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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