Inflationary Pressures And Price Fluctuations Influence On The Nigeria Economy From 1981- 2020

Inflationary Pressures And Price Fluctuations Influence On The Nigeria Economy From 1981- 2020
Abstract
Overtime, Nigeria has experienced persistent price fluctuation, with inflation increasing at opposite direction, despite government’s exchange rate policies to stabilize prices. Exchange rate is key in foreign trade, as no country can satisfy demands of its population by operating close economy due to nations are endowed with varying natural resources. Thus, exchange rate and inflation constitute key determinants of economic performance of any economy. This paper therefore investigates the relationship between exchange rate and inflationary rate and Nigeria Economy for the period 1970-2018, by applying Co-integration test, Vector Error Correction Model and Partial Correlation Coefficient analysis. Variables used in the study include inflation rate (INFR), exchange rate (EXCR), money supply (M2) and real gross domestic product (RGDP). The study conducted stationarity test, and found stationarity of the variables at second difference. The results of co-integration test revealed that long run relationship exist among the variables. Thus, since negative weak correlation value of -0.143 exist between inflation and exchange rate; the study recommends that government should consider both official and parallel exchange rate markets in its exchange rate policies, as over reliance on official market alone in tackling inflation problem would be frustrated, if parallel exchange market remained unchecked.
Chapter One
Introduction
1.1 Background to the Study
The ability and capacity to increase the level of production of quality service and tangible goods, is pertinent to the growth of any economy. Economic growth can therefore be viewed as an increase in the Gross Domestic Product (GDP) of a particular country. Inflation and exchange rate are essential macroeconomic variables capable of changing, transforming and redirecting the growth pattern of a country’s economy. One of the major macroeconomic objectives of any country (Nigeria inclusive) is to have a sustained level of economic growth combined with low levels of Inflation and a reasonable level of exchange rate . Hence the behaviors’ of both Inflation and exchange rate to a large extent affect the economic growth of a country (Okpe, 1998).
According to Jayathileke and Rathnayake (2013), most developing countries (like Nigeria), are easily affected by supply shocks which leads to high variability in inflation hence disturbing the consumption, investment and production behaviour . However, due to government intervention in the financial and goods markets, macroeconomic reactions may cause economic instability and market failure. Although mild inflation is a healthy and natural phenomenon of any developing economy, no matter how strong and stable it may be (Aurangzeb and Haq, 2012). Thus it could be said that a slight inflation is “greasing the wheels of commerce.” The risk attached to this is that stable prices and zero inflation rates might trigger deflation, economic depression, general recession, technical insolvency and even bankruptcy.
Economists have diverse views about the concept of inflation. The monetarists opined that inflation is harmful to economic growth while the structuralists argue otherwise. Therefore existing literature opined that relationship of economic growth with inflation can either be positive or negative as the case maybe (Mortaza, 2005). However, exchange rate is another macroeconomic growth factors (as earlier identified), it’s up and down volatility is closely related with inflation rates. Its high or low rates also impact the economic prosperity and extending to influence economic growth rate. In business fields, it is very important to accurately predict exchange rate trends. Unfortunately therefore, previous studies have assumed that the time series data is stationary and they ignored that non stationary could exist in the variables.
Tamunonimim & Reginald (2013) explained exchange rate as a ratio between one unit of currency and the amount of another currency for which that unit is exchanged at a given period. Exchange rate plays important role in a country’s level of trade. It is very critical for every free market economy. In real economy, exchange rate is the most watched, analyzed and government most manipulated macroeconomic indicator. Some countries try to control fluctuations in their currencies through imposition of restrictions on exchange rate movements. Exchange rate is classified into nominal exchange rate and real exchange rate. While nominal exchange rate involves monetary concept which measures relative prices of two currencies of two countries, real exchange rate on the other hand, measures relative prices of two goods involving tradable goods in relation to non-tradable goods. These two concepts are interrelated; in that, a change in nominal exchange rate will result in short run changes in real exchange rate. Therefore, as one of the most important prices in economy, domestic prices of traded goods, as well as exports and imports are seriously affected by exchange rate (Obadan, 2006). Appreciation or depreciation of exchange rate of a domestic currency has serious implication on economic activities of a nation. In a small open economy that does not have influence on the world prices of traded goods, an appreciation in the country’s exchange rate would lead to low domestic prices of traded goods; while depreciation of the exchange rate value increases price of domestic traded goods.
In Nigeria, the analysis of exchange rate movements is very pertinent, knowing fully well that the economy has ever depended heavily on importation of goods and services. Therefore, any attempt by government to float exchange rate without corresponding economic diversification of the economy would result to exchange rate depreciation, which will in turn lead to increases in domestic prices of goods and services, and as well affects other macroeconomic indicators. Exchange rate depreciation appears to predict changes in other macroeconomic variables such as inflation, gross domestic product (GDP) growth, and fiscal deficit/GDP ratio etc. For instance, when Structural Adjustment Program (SAP) was adopted in Nigeria in 1986, procedures in foreign exchange allocation and import licensing were scrapped. Foreign exchange transactions were allowed to be determined by market forces under an auction system (Imimole & Enoma, 2011). This policy helped to remove the problem of overvaluation of the domestic currency; in that, naira was undervalued. Since then, the economy has persistently experienced exchange rate depreciation and increases in the imports’ prices of goods and services of the country. For example, with the commencement of the structural adjustment program (SAP), exchange rate depreciated from N2.02 for a dollar to N4.02, N8.04 and N9.91 per dollar in 1987, 1990 and 1991 respectively. Inflation rates within these periods were 10.2%, 7.5% and 12.7% in 1987, 1990 and 1991, respectively (Honoland & Lane, 2003).
Similarly, the exchange rate further depreciated to N17.30 and N22.05 per dollar in 1992 and 1993 respectively, while the inflation rates rose to 44.8% and 57.2% in 1992 and 1993 respectively. Following the persistent depreciation of exchange rate in the economy, it then become necessary to completely reverse exchange rate floating policy in 1994 and reintroduce fixed exchange rate regime, with exchange rate of naira being pegged at N21.886 a dollar. However, the dismal performance of the economy at the end of that year, also led to reintroduction of floating exchange rate regime under autonomous foreign exchange market (AFEM), and this lasted for the period between 1995 and 1999. Consequently, exchange rate in return depreciated from the fixed rate of N21.89 a dollar in 1994 to all height of N81.00 a dollar in 1995. Barely one year after it was fixed, exchange rate further depreciated to N84.38 and N92.65 to a dollar in 1998 and 1999 respectively. It further depreciated to N128.75, N148.90, N150.298 and N164.02 in 2002, 2005, 2009 and 2010, respectively. The corresponding inflation rates were 76.8%, 51.6% in 1994 and 1995 respectively; by 1998, it declined to 11.9% and roseto 13.9% and 12.1% in 1999 and 2009, respectively; and again declined to 11.8% in 2010(CBN, 2009, 2010).
Today, one of the central issues in Nigeria’s economic policies is how to put inflation under effective control, using monetary and fiscal policies, as demonstrated in the various budgets and policy statements of the country. The continuous fall in the country’s domestic currency was in line with the period of inflationary growth of the economy, which has resulted in continually falling in the standard of living of the average Nigerians (Rasaq, 2013). The period of the oil boom of 1970s automatically allowed for fiscal dominance by the government, coupled with series of macroeconomic imbalances that surfaced within the period, which has witnessed an upward trend in government revenue in terms of foreign exchange earnings from the sale of crude oil product. The massive oil revenue generated from the oil boom coincided with the post war era that led federal government to embark on massive spending on program such as reconstruction, rehabilitation and resettlement of the areas that were badly affected during the civil war. The above measures increased the currency in circulation and as a result, the annual growth rate of money supply further escalated from 56.6% to 91.3% in 1975 (CBN, 1982).
Meanwhile, monetary authorities, economists, as well as policy analyst have overtime worried over the adverse effects of inflationary pressure that emanate from exchange rate depreciation, having known that exchange rate and inflation rate are the major determinants of economic performance of any economy (Philip & Oseni, 2012). In Nigeria, persistent increase in price of goods and services dated back to mid-1970s, when fixed exchange rate policy was first adopted in the country. The situation worsened with the adoption of exchange rate deregulation regime in mid 1980s. Therefore, high inflation was according to civil war, salary awards (Udoji award) and excess public spending, as huge revenue was generated from oil boom era, which encouraged increase in public spending.
1.2 Statement of the Problem
The effect of Inflation and price fluctuation on economic growth in Nigeria is a serious malady. There is a general consensus that high Inflation rates and exchange rate cause problems for aggregate economic performance, although there is much less agreement about the relationship between Inflation, exchange rate and economic growth and how it affects economic activities at the macroeconomic level. This has generated a significant debate both theoretically and empirically. The level of the country’s inflation is no longer the problem, but the fact that inflation has reached a crisis stage. Since the mid-1960’s, Inflation has become so contentious in Nigeria and the recent rate of Inflation has been a cause of great concern to many. The change in exchange rate determines the rate of Inflation, as the Nominal exchange rate is a function of the Real exchange rate and the Inflationary expectations (Fisher 1993). Nominal exchange rate adjusts to change in rate of Inflation; the higher the rate of Inflation, the higher will be the Nominal exchange rate . The historical experience shows that Nominal exchange rate and Inflation are closely associated, bringing to light how economic activities are affected by this relationship.
Since independence, Nigeria has been suffering from high Inflation and exchange rate even after the several interventions by the Central Bank of Nigeria (CBN). Measuring real economic growth in Nigeria, aims to access whether growth can cope with the growing demands of the society including population and how to maintain growth and development in the face of Inflation and exchange rate . This study is designed to investigate the effect of the basic economic factors such as exchange rate , inflation rate, and GDP on Nigeria’s economic growth. This situation turn, triggered off high demand and high inflation in the economy. However, Elbadawi (1990) argued that exchange rate does not have any significant effect on inflation pressure in an economy, while Greene & Canetti (1991), Moser (1994) and Festus et al. (1994) argued that exchange rate movements is the major factor that explains inflationary change in an economy. It is against this background that this study will aim to investigate the inflationary pressures and price fluctuations influence on the nigeria economy from 1981- 2020.
1.3 Objective of the Study
The Objective of this study is to examine the inflationary pressures and price fluctuations influence on the nigeria economy from 1981- 2020; it will examine if exchange rate changes significantly affect the total national output and whether this influences the development of Nigeria’s economy.
Specifically the study to:
- Empirically examine the relationship between price fluctuation and inflation
- Determine the effect of price fluctuation on inflation in Nigeria
- Examine the effect of price fluctuation and inflation in Nigeria on Nigeria Economy
1.4 Research Hypothesis
Considering the goals of this study, the following hypothesis will be generated and tested:
- Ho: price fluctuation has no direct influence on Nigeria’s economic growth.
Hi: price fluctuation fluctuation has a direct influence on Nigeria’s economic growth. - Ho: inflationary rate has no direct influence on Economic Growth in Nigeria
Hi: inflationary rate has a direct influence on Economic Growth in Nigeria
1.5 Significance of the Study
There could be no better time to investigate this subject matter given the prolonged decline of the naira in the foreign exchange market, and the continuous rising cost of living.
The importance of this research work is the fact that it will provide better insight into the factors responsible for the continuous exchange rate fluctuations and the best measures to manage them effectively and stabilize the exchange rate. Significantly, this investigation would help the administration and the national bank of Nigeria (CBN) to call attention to the advantages and disadvantages of each conversion scale system and thus develop an effective exchange regime conditioned to the specific nature of the Nigerian economy, both in the short term and long term.
This will contribute to a sustainable economic growth.
The study will also set out as a reference to researchers in the coming years on this subject.
1.6 Limitations of the Study
The study is created to assess the Nigerian price fluctuation and the inflationary rate as the drivers of economic sustenance. The examination will be accordingly restricted to the Nigerian growth rate of the economy and not associated with the socio-political components of the unfamiliar conversion standard.
1.7 Scope of the Study
This work of research will intend to review the time frame of 1970-2018, a time frame of 48 years. The degree comprises of the administrative and self-regulating exchange period for example the fixed swapping scale and the skimming conversion standard period. The examination will depends on center full scale monetary execution of Nigeria somewhere in the range of 1981 and 2020.
Chapter Five
Conclusion and Recommendations
The primary objective of the study is to examine the inflationary pressures and price fluctuations influence on the Nigeria economy from 1981- 2020, through the applications of Co-integration test, Vector Error Correction Model (VECM) and Correlation Coefficient analysis. The study employed ex-post facto research design by employing Nigeria’s data obtained from the Central Bank of Nigeria (CBN) statistical bulletin from 1980 to 2020. The variables used for the investigation include inflation rate (INFR) as the dependent variable, whereas the independent variables involves exchange rate (EXCR), money supply (MS) and real gross domestic product (RGDP). Unit root test was conducted, and the result indicated that all the data series were integrated of the same order at second difference at 5% and 10% level of significance.
More so, the result of the Johansen co-integration test demonstrated that long run equilibrium relationship exists between inflation rate and the independent variables such as exchange rate (EXCR), money supply (MS) and real gross domestic product (RGDP). The result of the Vector Error Correction Model (VECM) revealed that exchange rate (EXCR) does not have significant effect on inflation rate (INFR) in Nigeria. On the average, it was estimated that 1% increase in exchange rate, decreases inflation in Nigeria by 24.9%. ECT result indicates that it will take 59.9% annually to correct temporary deviation within long run equilibrium relationship in the economy. Furthermore, the results of the partial correlation coefficient test illustrated that weak and negative correlation exists between the dependent variable (inflation rate) and the independent variables (exchange rate, money supply and real gross domestic product). This implies that a change in each of the independent variable(s) does not significantly lead to changes in the dependent variable.
In view of the findings above, the study therefore recommends as follows: that government should consider the activities of the parallel exchange rate market in its exchange rate policies while tackling inflation problem in the economy, as effort to stabilize prices would always be altered by unofficial exchange rate activities. The study also recommended that government should expand the scope of monetary authorities in order to strengthen them to control the activities of parallel exchange market in order to avoid continuous hike in exchange rate as seen in the corridors of foreign exchange market today, as depending solely on official exchange rate would not capture the reality of the exchange market. Similarly, government should look inward to encourage production of export goods, rather than continuing to devalue or depreciate the country’s currency without tradable goods to export and reap the gain accrue to such devaluation policy.
The researchers appreciate that no work is all encompassing. We therefore suggest that further study should include other macroeconomic variables in the model and also expand the scope of the data, if data are available, to capture larger sample size.
Policy Recommendations
In line with the findings of this study, the following policy recommendations are suggested to develop a more stable exchange rate as follows.
- Incentives should be provided for small scale manufacturing industries, to ease cost of production and enable them increase output level in terms of both quality and volume.
- The government should develop effective export promotion strategies in order to encourage domestic industries to produce and export more. This would strengthen the country’s export base against its import base resulting in a surplus balance of trade.
- The government should stimulate export diversification in agriculture, agro- investments, and agro-allied industries. These will improve foreign exchange earnings and strengthen the real GDP.
- The government should invest more in infrastructural development, in both rural and urban centres, to attract foreign investments into the economy. Such infrastructure will foster job creation, increase income, and improve the standard of living of the people.
- The government should focus its attention on developing policies that will impact the country’s balance of payment, thus creating a favorable balance between the domestic and foreign sectors.
- Stricter import tariffs should be put in place to discourage importers from bringing foreign goods into the country.
- Finally, the government should influence the foreign exchange rate, by positive economic reforms that will reduce the adverse effect of unstable foreign exchange rate on the Nigerian economy with respect to trade flow.


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