Inflation as a Selector for Radical vs. Incremental Innovation

Radonjić and Veselinović (2020) find inflation depresses R&D in CEECs, while Chekwa et al. (2023) report that, in Nigeria, inflation can be positively associated with FDI inflows in the long run. Reconciling these, this project theorizes inflation as a selection mechanism operating differently on incumbents and entrants. In a Schumpeterian model with Grüning’s (2017) heterogeneity, incumbents rely on internal funds with monopoly rents vulnerable to inflation, while entrants rely on external finance (often FDI) that may chase nominal returns in mild inflation regimes. Combine this with a beliefs channel (Tavani & Petach, 2019/2020): inflation volatility amplifies coordination frictions and depresses utilization, dampening all innovation. The resulting testable predictions are non-monotonic: mild, stable inflation can raise the radical/pioneering share of patents (entrants gain relative to incumbents), but higher or volatile inflation reduces both total and radical innovation. Empirically, exploit inflation-targeting adoptions, VAT reforms, and commodity price shocks as instruments; measure innovation composition using patent novelty metrics, applicant age, and funding sources. This reframes inflation as not just an “innovation tax,” but a selector of innovation type, offering a fresh lens on the inflation-growth-innovation nexus.

References:

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2. Patterns of Interrelationships between Inflation, R&D, Innovation, and Economic Growth: Evidence from Central and Eastern European Countries. Ljubivoje Radonjić, Nevena Veselinović (2020). Croatian Economic Survey.
3. Firm beliefs and long-run demand effects in a labor-constrained model of growth and distribution. Daniele Tavani, Luke Petach (2020). Journal of evolutionary economics.
4. Firm beliefs and long-run demand effects in a labor-constrained model of growth and distribution. Daniele Tavani, Luke Petach (2019). Journal of evolutionary economics.
5. Macroeconomic Drivers of Foreign Direct Investment Inflows to Nigeria: Analysis of Shocks and Long-Run Causation. Charles Chekwa, C. Ezirim, Samuel Adeyinka, Chinonye Onwuchekwa (2023). Journal of Applied Business and Economics.