1 Mitigating the growth-effects of inflation through financial development By Niloy Bose a,♣ and Antu Panini Murshid a a University of Wisconsin-Milwaukee, Department of Economics, 3210 North Maryland Avenue, Bolton Hall 868, Milwaukee, WI 53211, USA January 31, 2006 Abstract This paper examines the growth-effects of inflation at alternative stages of financial development. We propose an endogenous growth model with money where intermediated savings generate capital. Informational problems cause banks to ration credit and hold cash. Inflation therefore acts like a tax on capital accumulation. However financial development lessens credit-rationing, which reduces the reliance on cash and softens the incidence of the inflation tax. Sizeable and statistically significant interactions between inflation and measures of financial development in cross-country and panel regressions provide empirical support for our model. JEL classification: E31, E44, G14, O42 Key words: Credit-rationing, financial intermediary development, inflation, information, monetary growth models. ♣ Corresponding author: Tel.: +1-414-229-6132; fax: +1-414-229-3860. E-mail addresses: nbose@uwm.edu (Niloy Bose), amurshid@uwm.edu (Antu Panini Murshid)