The Impact Of Inflation On Economic Growth In Nigeria

Project and Seminar Material for Economics

The Impact Of Inflation On Economic Growth In Nigeria


Abstract


The study seeks to present an empirical analysis of the impact of inflation on economic growth in Nigeria, using annual time-series dataset for the period 1979-2008. It has been argued that inflation is an unavoidable phenomenon in the face of economic growth. That is why, over the years there had been a long standing conventional wisdom that inflation impedes economic growth.

The stationarity and co-integration techniques were adopted to examine the data in order to determine if there exists a long-run relationship among the variables. Also, using OLS regression technique, our empirical findings revealed an inverse significance relationship between inflation and economic growth in Nigeria. These findings revealed an inverse significant relationship between inflation and economic growth in Nigeria. These findings recommend among others, inflation targeting in controlling inflation in Nigeria.


Chapter One


Introduction

1.1 Background of the Study

Inflation has become a leading topic of discussion in Nigerian families and other countries of the world. The press as its effect penetrates more deeply into the nation’s life. It has become something of a platitude to say that sharp, continuous increase in price is among the serious economic problems of our time. Indeed, the problem is so great that unless it is brought under control, inflation will destroy the very fabric of our societies.

Inflation is generally used to describe a situation of high and sustained increase in the general price level of an economy. It is a social malady as well as a pervasive economic phenomenon. Besides, distorting prices, it erodes savings, discourages investment, stimulates capital flight, inhibits growth, and makes economic planning a nightmare and political unrest (Guy, Debelle et al, 1998). Governments consequently regard inflation as a plague and try to squelch it, by adopting sustained and consistent fiscal and monetary policies.

Today, we commonly hear about different kinds of inflation. Indeed, the word inflation is often used synonymously with “price increase”. But there is also a different, more specific definition of inflation – a rise in the general price level caused by an imbalance between the quantity of money and trade needs. This “inflation” has but one origin, the central bank and one solution – a less expansive money growth rate. But as a condition of the price level, which may have originated from a variety of things (including a depreciating dollar, rising labor costs, bad weather, or a number of factors other than “too much money”), the solution to- and the prudence of eliminating inflation is much less clear.

Inflation can have positive and negative impact on the economic performance of an economy. Positively, inflation can lead to a higher sustained growth due to the effect it has on capital accumulation. Also, through its negative impact on productivity in an economy, inflation results in adverse effects on economic growth.

Some researchers advocated that, inflation can lead to uncertainty about the future profitability of investment project. Hence this lead to more conservative investment strategies than would otherwise by the case, ultimately leading to lower levels of investment and economic growth. Khan (2002), concurs that inflation may also reduce a country’s international competitiveness, by making its exports relatively more expensive, thus impacting negatively on the balance of payments. In addition, budget deficits also reduce both capital accumulation and productivity growth. On the contrary, some theories advocated that there is a positive relationship between inflation and economic growth.

One of macro-economic goals in a society is economic growth as defined by Kuznet (1973) as a long term rise in the capacity to supply increasingly diverse economic goals to its population and this growing capacity is based on advanced technology, industry and the institutional and ideological adjustments, that is demands. It therefore, implies the increase in the value of goods and services produced by an economy. Economic growth is conveniently measured as the percentage rate of increase in real Gross Domestic Product and it is usually calculated in real terms, i.e. inflation adjusted terms in order to net out the effect of inflation on price of goods and services produced.

Barro and Grilli (1994), posit that, mainstream economists believe that high rates of inflation are caused by high rates of growth of the money supply. They are of the view that changes in inflation are sometimes attributed to fluctuations in real demand for goods and services or in available supplies (i.e changes in scarcity), and sometimes to change in the supply and demand for money.

In Nigeria, one of the major problem facing the economy is inflation, the country registered low inflation in the years immediately after independence. However, the country experienced double digit inflation rate in the 1970s. This was mainly as a result of civil war. Other era of high inflation was 1984, 1988, 1992 and 1995.

Various macro-economic policies notably fiscal, monetary and exchange rate had from time to time been adopted to address this problem of inflation. Unfortunately, these measures have met with little or no success and this has hindered the achievement of other macro-economic objectives such as economic growth, increase in employment, satisfactory balance of payments and equitable income distribution.

It is in this light that this study is devoted to identify the impact and the rate of inflation that is acceptable to achieve economic growth in Nigeria in order to attain a more balanced economic growth.


1.2 Statement of the Problem

Since the attainment of independence of 1960, economic policies have been concerned basically with anti-inflationary measures aimed at achieving price stability. Indeed, the monetary policy framework adopted by Nigeria since 1993 has an overriding objective and that is the achievement of single digit inflation (Essien and Eziocha 2002). Monetary and fiscal polices as well as wage freeze, price control, exchange rate and other measures have been employed from time to time to stem the tide of sustained increase in the general price level. In retrospect, it appears that inspite of these efforts; the achievement of price stability objective has been limited.

Inflation undermines the role of money as a store of value. It also, frustrates investments and growth. Empirical studies (Ajayi and Ojo, 1981; Fisher 1993), on inflation, growth and productivity confirm the long-term inverse relationship between inflation and growth. The negative relationship between inflation and growth has been attributed to the strong negative association between inflation, capital accumulation and productivity growth. Consequently, high inflation is said to be harmful to both investment and hence, real output.

Though most countries aim at keeping inflation low, it has been volatile in Nigeria in-spite of the consistent effort of the central bank of Nigeria through its monetary policy that is geared towards achieving a single-digit inflation rate. For instance, within the last thirty years (1970 – 2000), inflation rate has fluctuated widely. It assumed single-digit only in seven years and double in twenty-three years reaching a peak of 72.8% in 1994 from 57.2% in 1993. Consequently, some economic analysts (Adeyeye and Fakiyesi 1980, Osakwe 1993 and Asogu 1991), in recent time have sought explanation for this worrisome trend that has evidently been impeding economic growth in the country.

Against this background, this policy is poised to investigate and identify the extent of the effect of inflation on economic growth with a view to proffering suggestion on ways for its control.


1.3 Objective of the Study

This study focuses attention on the effect of inflation on economic growth in Nigeria over the years. The study has the subsequent objectives:

  1. To examine the effect of inflation on the economic growth of Nigeria.
  2. To find out whether inflation targeting would achieve a better economic growth of Nigeria.
  3. To investigate the relationship between inflation and economic growth in Nigeria.
  4. To analyze the trend of inflation and economic growth in the country over the years.
  5. Suggest, on the basis of the findings, policy recommendation for effective control of inflation in Nigeria.

1.4 Significance of the Study

This study is of significance in three respects, namely;

  1. It would assist monetary authorities to appreciate variables that impact on Nigeria inflation, with a view to managing such variables appropriately and effective;
  2. The recommendations, based on the finds are expected to assist the government in finding a lasting solution to the problem of inflation in Nigeria.
  3. It would provide guide and a reference material for other researchers who might be interested in conducting research similar or related area of study.

1.5 Research Hypothesis

The hypothesis which arises from our research question shall be tested.

Ho: There is no significance relationship between inflation and economic growth in Nigeria.


1.6 Scope and Limitation of the Study

This study covers a period of 30 years, that is, from 1979-2008. It seeks to discuss theories on inflation and economic growth. In taking an over-view of inflation, the study will critically examine the effect of inflation on economic growth.

More so, it will take an extensive review of the history of economic growth and review empirical works on inflation and economic growth using obtained data from Nigeria.

However, this work, like any other work especially in the social sciences, has its own limitation. In the first instance, this study will be constrained by the amount of relevant research materials and data that are available to the researcher at the time of conducting this study. More so, the paucity of official data, their reliability whenever available as well as the inconsistencies in the data published by different sources on the same item, all pose a serious challenge in the conduct of this study.

Therefore, in-spite of these constraints, attempt shall be made to ensure that these draw backs do not in anyway, significantly affect the findings of this study.


1.8 Organization of the Study

This study will be divided into five chapters. The research shall commence by providing a background to the study in chapter one. Chapter two shall present related literatures concerning inflation, its causes and effects. The research methodology shall be outlined in chapter three while the data presentation and analyse shall be presented in chapter four as well as highlights of the implications of the findings. Concluding comments in chapter five shall reflect on the findings of the study and recommendations based on the findings.


Chapter Five


Conclusions and Recommendations

This study used ARDL as the variables are I(1) and I(0). The bound test shows that there is a long relationship among GDP, inflation and foreign exchange rates. The result shows that inflation has a positive and statistical insignificant impact on economic growth in Nigeria both in the short run and long run. This is in line with Philip’s curve that with the expansion of money supply, it leads to an increase in price and output given that labour does not demand for an increase in wages. But this finding is contrary to monetarist view that inflation is harmful to economic growth. The result of a positive impact of inflation on economic growth in Nigeria is in line with the other studies, such as Olu and Idih (2015) and Aminu and Anono (2012). Another finding also shows that foreign exchange has a significant positive impact on economic growth in the long run unlike in the short run. The impact of foreign exchange turns negative at lag 1 and 2 in the short run. The ECT coefficient is -0.085115 and significant at the 5% level of significant. This indicates that at 8.5% of the dis-equilibrium due to the shock in the previous years is adjusted back to the long run equilibrium in the current year. The paper therefore, recommends that monetary authority should embark on inflationary targeting based on a single digit inflation rate.


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