Skip to main content

May/June 1996, 
Vol. 78, No. 3
Posted 1996-05-01

Inflation, Financial Markets, and Capital Formation

by Sangmok Choi, Bruce D. Smith, and John H. Boyd

The authors find that higher rates of inflation tend to reduce the real rates of return received by savers in a variety of markets. When credit is rationed, this reduction in returns worsens informational frictions that interfere with the operation of the financial system. Once inflation exceeds a certain critical rate, a potential consequence is that the financial system provides less investment capital, resulting in reduced capital formation and long-run levels of real activity. Such forces need not operate at low rates of inflation, providing an explanation of why the consequences of higher inflation seem to be so much more severe once inflation exceeds some threshold level.