The Impact Of Inflation On Cost Of Living In Nigeria

Project and Seminar Material for Economics

Abstract

This study investigates the impact of inflation on cost of living in Nigeria. The Nigerian economy had faced with inflationary trends over the years and the various government policies to deal with it eluded long- term solution needed to bring about increased living standard of the Nigerian citizenry. Hence, the need for an investigation into the multi-dimensional and dynamic factors that affect inflation with the view to make appropriate recommendations to curbing it. From the study, it was revealed that all explanatory variables (fiscal deficits, money supply, interest and exchange rates) significantly and positively impacted on the rate of inflation in Nigeria during the period under review. The explanatory variables accounted for 72% of the variation in inflation during the period with the error terms capturing 28% of the variation. This research contributes to the idea that the causes and effects of inflation in Nigeria are multi-dimensional and dynamic, requiring full knowledge at any point in time to be able to proffer solutions to the inflationary trends in the country to lead to high productivity and increased living standard of the citizenry.

Table Of Content

Preliminary Page(s)

Title page i
Certification page ii
Dedication iii
Acknowledgement iv
Abstract v
Table of content

Chapter One

1.0 Introduction

1.1 Background To The Study
1.2 Statement Of The Problem
1.3 Objectives Of The Study
1.4 Research Questions
1.5 Research Hypotheses
1.6 Significance Of The Study
1.7 Scope And Limitation Of The Study
1.8 Definition Of Terms

Chapter Two

2.0 Literature Review

2.1 Conceptual Framework
2.2 Effects Of Inflation And Deflation
2.3 Theoretical Framework

Chapter Three

3.0 Research Methodology

3.1 Model Specification Estimation Technique
3.2 Parameters For Estimation/A Priori Expectation

Chapter Four

4.0 Results And Discussion

4.1 Results
4.2 Discussion Of Findings

Chapter Five

5.0 Conclusion And Recommendation

5.1 Conclusion
5.2 Recommendations
References

Chapter One

Introduction

1.1 Background Of The Study

Inflation is an inevitable property of any economy in the world. It influences every country, negatively as well as positively, whether it is developed or developing country as well. Anyanwu Â (2011) stated that inflation is an important factor leading to social and economic instability and disorder. It is one of the most largely observed and tested economic variables both theoretically and empirically. Its causes, impacts on other economic variables, and cost to the overall economy are well known and understood. Nigeria, being a developing country, could not overcome the continuously year to year climbing up inflation, and also its causes and consequences.

After remaining relatively low for quite a long time, the inflation rate in Nigeria started to accelerate in late 2003 . The role of money supply appears significant in influencing food price inflation in Nigeria (Anyanwu, 2011).which disturbed family budget as well as consumerâ€™s purchasing power. People struggled in order to maintain their living standard but it slumped down gradually. Many authors have written on the impacts of inflation and cost of living on the Nigerian economy, but the authors have different views, nevertheless, one common thing is that all the authors agree that inflation and cost of living have various impacts on the economy of Nigeria.

The problem created by the rising prices of goods and services leading to higer cost of living has become too difficult for the government to solve. During inflationary period, fixed amounts of money buy less quantity of goods and services. The real value of money is drastically reduced i.e the purchasing power of consumers are reduced.

To attain sustainable economic growth coupled with price stability continues to be the central objective of macroeconomic policies for most countries in the world today. Among others the emphasis given to price stability in conduct of monetary policy is with a view to promoting sustainable economic growth as well as strengthening the purchasing power of the domestic currency (Umaru and Zubairu, 2012).

The question on whether or not inflation is harmful to economic growth has recently been a subject of intense debate to policy makers and macro economists. Several studies have estimated a negative relationship between inflation and economic growth. Specifically the bone of contention is that whether inflation is necessary for economic growth or it is detrimental to growth. Basically the rate of economic growth depends primarily on the rate of capital formation and the rate of capital formation depends on the rate of savings and investment (Datta and Kumar, 2011).

World economic growth and inflation rates have been fluctuating. Likewise, inflation rates have been dominating to compare with growth rates in virtually many years (Madhukar and Nagarjuna, 2011) and relationship between inflation and the economic growth continued to be one of the most macroeconomic problems. Similarly, Ahmed (2010) maintains that this relationship has been argued in various economic literatures and these arguments shown differences in relation with the condition of world economy order. In accordance with these policies, increases in the total demand caused increases in production and inflation too. However, inflation was not regarded as a problem in that period rather considered as a positive impact on the economic growth which was widely accepted. Amid these views, Phillips first introduced hypothesizes that high inflation positively affects the economic growth by lowering unemployment rates.

1.2 Statement Of The Problem

As far as Nigeria concerns regarding inflationary effects it has been experienced worst consequences reflected by poverty, food crises, price hike etc. Mahmood, Hafeez and Rasheed (2009) concluded that inflation causes poverty. Day to day increase in prices of commodities especially of non-food items like oil and gas snatch money from savings of consumers and uncertainty of prices, both food and non-food items, generate enthusiasm among people toward earn more and more therefore, people prefer to work over recreation underestimating theirÂ Health.

Over work and lack of recreation make them vulnerable particularly of middle class people and they almost fall into lower class. Although, over time work bless money but it causes exertion and lethargic body that charge more expense on health instead upper class people hardly encounter any problem to inflation.

Muoghalu, et.al. (2010) found that the inflation brings negative impact while exports and investment brings positive impact on Nigeria economy and suggested that we should encourage a larger scale of export promotion activities to enhance the economic growth. It will create numerous job opportunities which increase the per-capita earnings and standard of living.

1.3 Objectives Of The Study

The main aim of the study is to analyze the effects of inflation of cost of living in Nigeria while examining the various monetary and fiscal policies that will help sustain the economy of Nigeria with much emphasis on how to reduce inflation and achieve lower cost of living for her citizenry.

Specific objectives of the study will be aimed at:

To determine the impact of inflation on the cost of living in Nigeria.
To examine the impact of inflation and cost of living on economic growth in Nigeria.
To examine what constitutes cost of living, and how it negatively affects economic growth.
To recommend to monetary authorities and the government on how inflation and cost of living can be reduced to an acceptable level.

1.4 Research Questions

In-order to achieve the stated objectives of the study, the researcher developed the following research questions:

Why have all the policies used been unable to reduce inflation and cost of living to an acceptable level?
How can the economy of Nigeria be sustainable into the foreseeable future?
What are the economic implications of high inflation and higher cost of living on the economy of Nigeria?

1.5 Research Hypotheses

To carry out the study effectively, the following proposed hypotheses have been formulated and will be tested in the course of carrying out the study:

Hypothesis I

Ho: Inflation has no significant impact on cost of living in Nigeria economy.
H1: Inflation has significant impact on cost of living in Nigeria economy.

Hypothesis II

Ho: Cost of living has no significant impact on economic growth in Nigeria.
H1: Cost of living has no significant impact on economic growth in Nigeria.

1.6 Significance Of The Study

The study will be useful to policy makers especially in formulating policies that will reduce inflation growth rate and ensure lower cost of living.

The study will also be useful to monetary houses like central and commercial banks in Nigeria. Findings and recommendations from this study will be of great benefits to financial institutions in Nigeria, as the recommendations if implemented will go a long way in guaranteeing a sustainable and sound economy.

The study when carried out will also be of great benefit to student researchers who have interest in researching more into inflation and cost of living. It will act like a guide to student researchers who may find the recommendations and findings of the study when completed useful.

1.7 Scope And Limitation Of The Study

The research work will be centered on the beginning structure, operations and effect of inflation on cost of living in Nigeria economy.

Finance is one of the elements that assist a good research. Financial constraint created difficulties in the process of this research work, however, it did not hinder the research. The study will be for a period of thirty one years data point which is between 1982 to 2012.

The main limitation of this study is time constraint. The time allowed for the completion of this research is not adequate based on recent and contemporary happenings with respect to the impact of inflation on cost of living in Nigeria economy.

1.8 Definition Of Terms

Cost of living:

Is the cost of maintaining a certain standard of living. Changes in the cost of living over time are often operational zed in a cost of living index. Cost of living calculations are also used to compare the cost of maintaining a certain standard of living in different geographic areas. Differences in cost of living between locations can also be measured in terms of purchasing power parity rates.

Inflation:

Is a persistent increase in the general price level of goods and services in an economy over a period of time.[1] When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy

Economic growth:

Refers to the increased every time of an economy’s capacity to produce those goods and services needed to improve the well-being of the citizen in increasing number and diversity. It is the study process by which productive capacity of the economy is increased every time to bring about rising level in national income.

Economic development:

Economic development is a multidimensional process involving the provision of basic needs, acceleration of economic growth reduction of inequality and unemployment, eradication of poverty as well as changes in attitude institution and structure in the economy.

Chapter Five

5.0 Conclusion And Recommendation

5.1 Conclusion

Inflation is one of the major macroeconomic problems that confront the Nigerian economy today with direct effects on the cost of welfare and living standards. Attempts by the government to control this menace using the traditional monetary and fiscal policies have not provided a long lasting solution. Therefore, the knowledge of the determinants of inflation in Nigeria is the necessary prerequisite to evolving a long term solution.

In this research, the macroeconomic uncertainties that are associated with inflation rate in Nigeria are fiscal deficits, money supply, interest rate, and exchange rate among others. These explanatory variables combined to significantly influence the rate of inflation in Nigeria as much as 72% while the stochastic error term (U1) capture 28%. At five (5) percent level of significance, they all impacted on the rate of inflation during the period. Thus, revealing some important facts about the general determinants of inflation in the Nigerian economy. These determinants are multi dimensional and dynamic.

Therefore, the government should pursue with vigour, policies that will enhance the reduction of the general price level but enhance increased productivity of goods and services. Such policies may include wage control/freeze, monetary policy (reduction in money supply), fiscal policy (increase in personal income tax and reduction in government in government expenditure), total ban on importation of some goods, increase in output of goods and services, over hauling distribution system, government/CBN intervention in FEM/SFEM to check excessive bidding or depreciation of the Naira among others. These will asset in controlling inflation, which if allowed to go out of control, would lead to macroeconomic instability and further reduce the already unacceptably low rate of economic growth. The research work revealed some important facts about the general determinants of inflation in Nigeria between 1981 and 2003. Based on the findings, it was established that inflation in Nigeria was caused by such dynamic factors as increased deficits, money supply (M1), interest rate, real exchange rate and other factors like population growth rate, activities of the middlemen and monopolistic activities, distribution, bottlenecks, high production costs etc. captured by the stochastic error term.

5.2 Recommendations

Following the analysis and the findings of this research work, these recommendations are made to curb inflation in the Nigerian economy.

Spurred by the urge to jump start the economy and thus create employment and alleviate poverty, fiscal operations of the three tiers of government were always expansionary as evidenced by their borrowing from the money and capital markets. Since government direct instrument and the moral suasion by the Central Bank of Nigeria never persuaded them to adhere to the fiscal prudence, there should be a policy or an act of parliament empowering the banks granting loans to government to make exceptional prudential provision for such loans. The problem of poor economic infrastructure (water supply, transport system, telecommunication, and energy) is solved by the use of either massive public expenditure or massive private investment. These have inflationary effect on the economy. But such inflationary effect would be minimized/minimal if these investments were spread out over a long time period.
The government should display a high sense of transparency in the fiscal operations to bring about realistic fiscal deficits. Fiscal deficits, where recorded should be channeled to productive investments like road constructions, electricity provision, and other overheads that will serve as incentives to increased productivity and high Gross Domestic Product (GDP). Therefore, deficit financing should only be applied in a situation of true economic recession to reduce the incidence of inflation. Fiscal deficits can also be reduced by the government reducing her participation in the economic activities by the government reducing her participation in the economic activities as evidenced in her ongoing privatization and commercialization policies. However, government must continue to exercise caution and be systematic in the implementation to check the monopolistic tendencies of private investors.
On the determining power of money supply (M1) on inflation, the policy of selective credit control should be pursued with the vigour it deserves. Greater efforts should be made to make available, short, medium and long term loans to productive investments like small scale industries/businesses as they constitute an integral part of the growth and transformation process of an agro based economy like that of Nigeria.
Exchange policy should be designed to bridge the savings investment gap, enhance government revenue and reduce the fiscal gap through the curtailment of deficits and guarantee of external balance in the long run. This implies that domestic productivity and exports should be enhanced in the medium to long term while aggregate demand should be curtailed in the short run. To reduce exchange rate, the foreign exchange market should be policed to ensure that only those who have the aim to add value to the real sector get attention. This among other steps would at least value of the naira against major world currencies, and leave us with only the prices increases occasioned by increase in local money supply.
To checking the influence off other explanatory variables captured by the stochastic error term (ui), government should adopt and pursue with vigour policies such as encouragement of family planning to further reduced population growth rate. this will reduce excess demand for goods over their supply. Hoarding of any kind should be prohibited with necessary sanctions on defaulters. Again, a good distribution network should be set up to eliminate dubious distributors who increase prices of their goods at each distribution stage for profits.

From the research work, it was revealed that the effects of inflation in Nigeria are multi dimensional and dynamic. Therefore, the multi-dimensional and dynamic nature of the determinants of inflation in Nigeria pose a problem for future/further researchers to continuously make recommendations to curbing inflationary tendencies in Nigeria and improving living costs.