The Effect of Inflation on the Economic Growth of Nigeria

The Effect of Inflation on the Economic Growth of Nigeria

Abstract on The Effect of Inflation on the Economic Growth of Nigeria

The study examines the effect of inflation on economic growth in Nigeria from 1990-2017.

This study adopted secondary data. The research was carried out using Ex- post facto resarch design. The secondary data is a data compiled by other sources and obtained by the researcher. The data for the variables was sourced from the World Bank Development Indicators for the years 1990 -2017.

The study utilized unit root test through the application of Augmented Dickey-Fuller (ADF) to test for stationarity, Either of Ordinary Least Square estimation technique and Johansen Cointegration technique was employed in the analysis of the data. The outcome was deteermine by Vector Error Correction Model (VECM) to estimate the short run relationship between the variables while the Granger causality test is applied to examine the causality between inflation and economic growth in Nigeria.

The study revealed that: Real effective exchange rate has a negative but significant relationship with annual growth rate both in the short run and in the long run. Real interest rate has a positive but insignificant relationship with annual growth rate in the short run and also in the long run. Real effective exchange rate has a positive insignificant relationship with annual growth rate in Nigeria while real interest rate has a negative significant relationship with annual growth rate in Nigeria.

The study concluded that inflation has a significant effect on the economic growth of Nigeria, and the major determinants of inflation in Nigeria are interest rate and exchange rate. The study further recommends that: Government should make tight fiscal and monetary policies to reduce the inflation rate of the country and have the most advantageous interest rate, and so as to increase the gross domestic product of the country and thereby attract more foreign investors to the country. Government should increase the degree openness of the economy and this can be viable and thereby increase the percentage of foreign investors. Government should encourage the export promotion strategies in order to maintain a surplus balance of trade and also conducive environment, adequate security, as well as infrastructural facilities should be provided. 

Chapter One of The Effect of Inflation on the Economic Growth of Nigeria

INTRODUCTION

Background to the study

Inflation can be defined as an increase in the general price level of goods and services in an economy over a period of time. When there is an increase in price level, each unit of currency buys fewer goods and services. Therefore, inflation brings about a fall in the purchasing power of money and an increase in the cost of living of the people and it is usually measured by Consumer Price Index (CPI) which measures changes in the price level of market basket of consumer goods and services purchased by households (Naresh, 2014).

Economic growth is a key policy objective of any government. In addressing the pertinent issues in economic management, experts and economic planners have had to choose between or combine some of the macroeconomic variables. Economic growth, which is measured by Gross Domestic Product (GDP) confers many benefits which include raising the general standard of living of the population as measured by per capita national income, making income distribution easier to achieve, enhance time frame of accomplishing the basic needs of man to a substantial majority of the population. (Barnes, 2017)

The word inflation in the market economics of the world threatens both the developing and developed countries economy because of its undesirable effect. Among many variables that can be stated as the determinant of economic growth is inflation (Barro, 1995). Even though some studies suggest that moderate inflation helps in economic growth, the overall weight of evidence so far clearly indicated that inflation is inimical to growth. Inflation and economic growth are the main concern of most countries of the world. Thus, inflation and economic growth have gotten attention since the classical period of time. A large variety of factors can affect the rate of both. For example, investment in market production, infrastructure, education, and preventive health care can all grow an economy in greater amounts than the investment spending. Monetarists believe the most significant factor influencing inflation or deflation is how fast the money supply grows or shrinks. They consider fiscal policy, or government spending and taxation, as ineffective in controlling inflation.

Inflation is now one of the major problems facing the Nigeria economy and the reduction of its high pressure is considered one of the most critical macro-economic objectives in Nigeria. Nigeria started having double digits’ rates of inflation few years immediately after independence. The country experienced double digit within 1967-1970 and this was as a result of the civil war. The next period of high inflation was within 1974-1979, when the wage freeze was discontinued as recommended by Udoji salary review commission. To the policy makers, inflation endangers economic growth and development because it discourages investment and savings. These factors explain why policy makers put in lots of efforts to reduce inflation and why several researches have been conducted on this issue. The inflation pressure was further provoked by high demand for imports of both intermediate inputs and consumer’s goods due to over valuation of the naira which made imports relatively cheaper than locally manufactured goods in this case, the impediment to development may be referred to as cost. (Bayo, 2005)

Inflation has been the macroeconomic problem in Nigeria that seems to be difficult to manage over the years. It is generally accepted that inflation has a negative effect on medium and long-term growth. Most researches have claimed that inflation and economic growth have a negative relationship which means that that are inversely related (as inflation rises, GDP reduces and vice versa). During the period of inflation, the value of money falls which increases the earnings of business shareholders and others whose income are fixed in money terms but despite these, it also reduced the standard of living of the people whose income are fixed thus increasing their cost of education welfare and culture facilities available. The problem of inflation makes it difficult for the poor masses with fixed income to survive in the economy.

High inflation is known to have many adverse impact, it imposes welfare cost of the society, impedes efficient resources allocation by obscuring the significant role of relative price change, discourages savings and investment by creating uncertainly about further price, inhabit financial development by making intermediate on more costly, hits the poor excessively, because they do not hold financial asset that provide a hedge against inflation and reduces a country international competitiveness by making its exports relatively more expensive, this impacting negatively on the balance of payments and perhaps more importantly reduces long-term economic growth (Dumka, 2018).

The government has been geared towards trying to make inflation rate in Nigeria a single digit but all efforts have been to no avail. The government has put all efforts into making the inflation rate a single digit instead of a double digit but alas the inflation rate in 2017 was 16.30. However most previous studies on inflation have focused on the effect it brings about on the economic growth of developed countries, therefore this research is going to focus on the effect it has on the economic growth of developing countries with particular focus on Nigeria. Over the years we have noticed that the highest rate of inflation was in 1995 with 72.8% which according to Mordi et al (2007) was due to excess money supply, scarce foreign exchange and severe shortages in commodity supply, as well as continual labor and political unrest following the annulment of the June 1993 elections and the lowest was in 2007 with 5.40%.

According to Piano (2007), businesses and house-holds are likely to perform poorly in period of high unpredictable inflation. Even though some studies suggest that moderate inflation helps in economic growth, the general weight of evidence so far clearly indicate that inflation is distress to growth, it is therefore imperious to conduct a research work on the impact of inflation on Nigeria economic growth which is the main objective of this research work.

The monetary authorities strive to achieve the government overall inflation objective through impassive monetary management, which entails setting intermediate and operating targets in the assumed targets for gross domestic product (GDP) growth inflation rate and balance of payment, Adamson (2001). Maintenance of price stability continues to be the paramount objective of monetary policy for most countries in the world today. The propensity of a fall in the value of money is known as inflation. The emphasis given to price stability in conduct of monetary policy is with a view to promoting sustainable growth and development as well as strength thinning amongst others (Essien, 2005). The central Bank of Nigeria (CBN) employs the monetary targeting frame work in the conduct of its policy. This is based on the assumption of a stable and predictable relationship between money supply and inflation. Although several people, producers, consumer’s professional non-professionals trade union lists, workers and the likes, talks frequently about inflation particularly if the issues are becoming stressing.

Having a view on the effect of inflation on Nigerian economy and realizing that the problems caused by the effects of the growth of inflation is becoming unbearable to the citizens and the entire economy and it becomes necessary to analyze the effect of inflation on economic growth.

Significance of the Study

This study helped to unveil those factors and challenges acting as a restraint to reducing inflation. The knowledge gained from this work will help to improve strategies put in place to curb the problem of inflation in Nigeria. The importance of this study was to find the solution to inflation and the major causes and investigate the impact of inflation on macroeconomics variables such as productivity, investment and consumption in a country like Nigeria. It will also be of importance to students of economics and other related fields for a basic understanding of the subject matter and when further studies want to be conducted. It will be useful to the general public because it will provide an explanation for Nigeria’s stunted growth. This study is very important to macroeconomists, financial analyst, academicians, policy makers such as Central bank of Nigeria and Minister of Finance in understanding the responsiveness of gross domestic product (GDP) to the change in general price level and thus come up with the relevant policies so as to keep prices at the reasonable rate that stimulate production. This study is also of importance to the Nigeria government to help know that inadequate supply of locally produced and imported commodities, the high price of imported commodities, the high price of imported goods arising from increases in foreign prices as a result of instability in foreign exchange, thereby effecting our economy and its growth. It must be noted that this study is of relevant not only to Nigeria but it relevant to almost all the countries that experience inflation especially as a result of various common features.

Statement of the Problem

The problem of inflation in Nigeria was brought about by the oil glut in 1981, which resulted into balance of payment deficits leading to foreign exchange crisis that necessitated various measures of import restrictions. The resultant shortage of goods and services for local consumption spurred the inflation rate to rise from 20% in 1981 to 39.1 % in 1984. With the adoption of the structural adjustment programme (SAP) in September 29, 1986, there was a temporal reduction in fiscal deficit as government removed subsides and reduce her investment in the economy but as structural adjustment programme (SAP) policies gathered momentum, there was a fall in growth rate of gross domestic product (GDP) in 1990 from 8.3%to 1.2% in 1994 with inflation rising from 7.5% in 1990 to 57% in 1994 .In 1995, inflation rate rose to 72.8% due to increased lending rate, the policy of guided deregulation and lagged impact of fiscal indiscipline. Inflation is unfavorable to economic growth but some researches that have been conducted have stated it is sustainable for economic growth if it is stable and maintained at a low rate. The problem of inflation is not new to Nigeria because it has been a major problem for the past few years. The relationship between inflation and economic growth has shown that it brings about a positive effect on some countries while some countries experience negative effects. Macroeconomists, policy makers and central monetary authorities of all the nations need to know whether inflation is beneficial to growth or detrimental to growth. We can see the complexity of the relationship between inflation and economic growth from the result of research conducted by different researchers. Theories also have different views on issue of inflation and economic growth. The direction of causal relationship between inflation and economic growth is also debatable. Some have shown bidirectional causality, unidirectional causality and no causality relationship between inflation and economic growth. Although, the relationship between the inflation rate and economic growth has been studied extensively, the exact relationship is not well defined and the empirical results and policy recommendations from the studies vary and sometimes are in conflict. Although many recent studies have insisted that inflation affects economic growth negatively or that inflation promotes growth. Empirical results from different researches that have been conducted on this subject in the existing literature fall into four categories;

i.         Inflation does not have any influence on economic growth (Inyiama, 2013; Shuaib, Ekeria & Ogedengbe, 2015)

ii.         Inflation has a positive impact on economic growth (Mallik & Chowdhury, 2001; Rapach ,2003; Benhabib & Spiegel, 2009; Olu & Odih, 2015; Osuala, Osuala & Onyeike, 2013)

iii.         Inflation has a negative influence on economic growth (Valdovinos ,2003; Ezeanyeji & Ejefobihi, 2015)

iv.         Inflation impacts economic growth in terms of specific thresholds (Dogwa, 2015; Khan, & Senhadji,2001; Kremer, Bick & Nautz, 2009; Vinayagathasan, 2013).

Due to the inconclusiveness of the results of scholars on this subject area, there is therefore need to examine the effect of inflation on economic growth in Nigeria with the use of appropriate econometric tools.

Research Questions

i.         How has inflation affected the growth of the Nigerian economy?

ii.         What are the major determinants of inflation in Nigeria?

iii.         Is there a short run or long run relationship between inflation and economic growth?

 Research Objectives

The main objective of this research is to determine the effect of inflation on the economic growth of Nigeria. The specific objectives are to;

i.         determine the effect of inflation on economic growth.

ii.         identify the major determinants of inflation in Nigeria.

Research Hypothesis

H₀: Inflation rate has no significant effect on economic growth in Nigeria

H₁: Inflation rate has a significant effect on economic growth in Nigeria

Justification of the Study

This research was to reveal the challenges brought about by inflation in the economy. It was important to carry out a research on this area in order to suggest possible ways of battling these challenges as well as to offer solutions to the problems faced by the economic sector. The Nigerian government will also see the clearer picture of major constraints and the viable solutions to be adopted in future for positive results. The motivation for this study was the present economic situation in Nigeria which has suffered due to a decrease in the rate of economic growth due to the fluctuations in the rate of inflation. This study employed the most recent data and information in determining if inflation has a significant impact on economic growth of Nigeria and to what extent in comparison to previous studies that exist in Nigeria and other countries.

Scope of the Study

The study examined the prospects and challenges that inflation has brought upon the economic growth of Nigeria between 1990 and 2017. The data used for this research is secondary data and it was gotten from World Development Indicators (2017). The data used is annual data. This study only focused on Nigeria. However, additional information about events that occurred in other years was added.