Impact Of Inflation On Investment And Economic Growth In Nigeria

Project and Seminar Material for Economics

Impact Of Inflation On Investment And Economic Growth In Nigeria


Abstract


This study investigated the impact of inflation on investment and economic growth in Nigeria. Since Nigerian financial sector liberalization is anchored on interest rate and exchange rate deregulation and the inflation targeting monetary policy, therefore exchange rate was incorporated in the study. The OLX technique was used in this study to estimate the two models specified in the study. Other tests such as unit root test and cointegration test were conducted to determine the stationarity and long term relationship among the variables.

The result of the investigation showed that both inflation has a negative effect on investment level and economic growth but exchange rate has positive effect on investment and economic growth. The study recommends that in order to curb inflation, government should create a conducive employment opportunity, transparency in the fiscal operations to bring about realistic fiscal deficits, exchange policy should be designed to bridge the savings investment gap, enhance government revenue and reduce the fiscal gap in order to ultimately enhance economic growth which will bring about development.


Chapter One


Introduction

1.1 Background of the Study

One of the greatest problems facing Nigerian economy today is inflation which is persistently a complex, economic and social problem of the economy. Inflation has become a leading topic of discussion in Nigerian families and other countries of the world. Government’s inability to provide a lasting solution to this aroused a universal conviction that inflation is inevitable and created pessimism that government has no power to bring rising price (inflation) trend to an end. Inflation is not only a serious problem but also has a disquieting effect on the economic life, political system and the society as a whole. A situation where the value of money continues to depreciate in terms of value, there is the tendency for rising prices for available goods and services generally and such situation is being referred to as inflation. Inflation can be defined as continuous rise in prices of goods and services. Inflation simply means too-much money chasing few goods. Inflation in the country has become a threat to the Nigerian economy particularly to investment and development.

Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. According to American College Dictionary, inflation is “Undue expansion or increase of the currency of a country.” Inflation can also be defined as the sustained increase in the general level of prices of goods and services overtime (Adebayo 1999). The term inflation is often used to describe upward movement in the general level of prices.

Inflation can also be seen as the persistent and appreciable rise in the general level of prices (Jhingan, 2006).Not every rise in the price level is termed inflation. Therefore, for a rise in the general price level to be considered inflation, such a rise must be constant, enduring and sustained.

When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase—or does not increase as much as the supply of money—then the prices of goods will go up.

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 .

The problem of how to reduce inflation has been a central issue among policy makers since the 1970s. Several authorities have attributed it to the expansion of public expenditure arising from the increase in oil revenue.

Existence of excess aggregate demand can cause inflation (demand pull inflation). Cost-push inflation arises from upward pressure of production costs, while structural inflation arises from constraints such as inefficient production, marketing and distribution systems in the productive sectors of the economy. Inflation has been apparent in Nigeria from the outset of our national life. This was propelled in the 1960s through the “cheap money policy” adopted by the government to stimulate development after independence.

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 development.

In Nigeria, one of the major problem facing the economy is inflation, the country registered low inflation in the years immediately after independence. 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.

It is in this light that this study is devoted to identify the impact of inflation on Investment and economic growth Nigeria.


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. There is almost a universal consensus that macroeconomic stability, specifically defined as low inflation is positively related to development. Indeed, the monetary policy framework adopted by Nigeria since 1993 has an overriding objective and that is the achievement of single digit inflation. Monetary and fiscal policies 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 in spite of these efforts; the achievement of price stability objective has been limited.

Inflation undermines the role of money as a store of value. It frustrates investments and growth. It also, hurts people who are retired and living on a fixed income.it is very difficult to determine how much to produce because business cannot predict the demand for their product at the higher prices they will have to charge in order to breakeven. Empirical studies on inflation, investment and development confirm the long-term inverse relationship between inflation and development. 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.


1.3 Research Questions

This study would be guided by the following research questions:

  1. What is the trend of Inflation in Nigeria?
  2. How does inflation impact on economic growth in Nigeria?
  3. What is the effect of Inflation on investment in Nigeria?

1.4 Objective of the Study

The objective of this study is to examine the impact of inflation on investment and economic growth. The specific objectives of this study are to:

  1. Analyze the trend of inflation and economic growth in the country over the years.
  2. Investigate the relationship between inflation, investment and economic growth in Nigeria.
  3. Examine the effect of inflation on investment and economic growth in Nigeria.

1.5 Justification of the Study

The justification of the study is that it intends to answer certain questions such as, what are the causes of inflation in Nigeria, and how can it be related to investment and economic growth. This answer will form the basis upon which suggestions will be made as to how inflation can be reduced or eliminated totally or to the minimum level.


1.6 Scope of the Study

This study shall focus on the effect of inflation on investment and economic growth covering the period between 1980 and 2013. Therefore, this study examines not only the effect of inflation on investment and development, it will also investigate its effect on other macroeconomic variables.


1.7 Organization of the Study

This study shall be divided in five chapters.

Chapter one

Providing a background of the subject matter justifying the need for the study.

Chapter two

Present related literature concerning inflation, its causes and effects.

Chapter three

The research methodology

Chapter four

Data presentation and analyses

Chapter five

Findings and recommendations based on the findings


Chapter Five


Summary, Conclusion and Recommendations

5.1 Summary of Findings

This Thesis revealed that unemployment significantly and negatively affected economic growth in Nigeria for the period under study. The coefficients of unemployment rates and inflation rates were rightly signed, implying that they were consistent with the theoretical expectation of this Thesis. This was attributed to the dominant manifestation of inflation in Nigeria which was caused by the techniques of production adopted in the country (labour savings and cost push inflation). This Thesis found that the type of unemployment that characterized the Nigerian economy was structural and the type of inflation characterized the country was cost-push. Nigeria had been using capital intensive technique of production which is capable of increasing cost of production and hence inflation and unemployment; economic growth rates will deteriorate, making it difficult to achieving rapid and sustained economic growth rates. It was found in this Thesis that as inflation rates increased economic growth rates increased. However, as unemployment rates increases economic growth rates decreases. The f-statistics values in table 4.2, in models II, and III which measured the joint significance of the explanatory variables, was found statistically significant at 1 percent and 5percent level respectively as indicated by the corresponding probability values of 0.0083 and 0.0308. This implies that both inflation rates significantly affected economic growth rate in Nigeria.

The R2 values in table 4.2 are low and in all model implied that less than 50 per cent total variation in economic growth rate was explained by inflation rates. Coincidently, the goodness of fit of the regression remained weak after adjusting for the degree of freedom as indicated by the adjusted R2 values of less than 50 per cent. The
Durbin-Watson statistic values in table 4.2 and in all the models was observed to be higher than R2 values indicating that the model is non-spurious (meaningful). Durbin-Watson statistics values in model I and II were less than 2 (two) implied the presence of serial correlation among the error value, though there was a negligible serial correlation because their values were tending toward 2. This therefore, justified the need to conduct a unit root test. After taking the natural log of the data Durbin-Watson statistics value was found to be 2.4267 in model III implied the absence of serial correlation among the error values, thus making it possible to rely on the results of the model for policy guidance.

The results of unit root test were contained in table 4.4. The results revealed that all the variables of the model were found to be stationary at 1percent. The result further indicated that economic growth rate (ECGR), inflation rate (INF) were stationary at first difference 1(1). The ADF and PP statistics for all the variables are less than the critical values in negative direction.

The Johansen cointegration test results confirmed the existence of long-run relationship between economic growth rate, inflation rates as indicated by the TRACE-Statistic and also the Max- Eigen-statistics.

Table 4.1 shows that inflation rate was increasing in most of the years. There was no productivity, inflation and employment linkage. But literature reviewed shows that inflation is an economic woe that hinder not only investment but also economic growth in general. Nigeria has experienced high volatility in inflation rates. Since the early 1986‟s, there have been three major episodes of high inflation, in excess of 30percent. Literature reviews shows that there has been high rate of unemployment in the country spurred by the privatization programme of the government which was one of the core blueprints of the structural adjustment programme (SAP). The high unemployment negatively affected economic growth. The neglect of the agricultural sector, poor enabling environment, growth in money supply, disconnect between the institution providing the labour and industries employing them also affected economic growth. Inflation impacted negatively on the growth process of Nigeria.

This confirms the existing literature that inflation is macroeconomic threat to any nation. In summary, this study revealed that there was a positive relationship between economic growth rates and inflation rates. Finally the null hypothesis that inflation have no significant effect on economic growth was rejected; because this Thesis found that inflation significantly affected economic growth in Nigeria during the period under review.


5.2 Conclusion

The results of OLS revealed that increase in inflation rates raised economic growth rates; The coefficient inflation rates, though found consistent with theoretical expectations of this Thesis but was statistically insignificant in determining economic growth rates in Nigeria. The F-statistics values in all models of this Thesis indicated that inflation rates were jointly and significantly affected economic growth rates in the country at 1 percent and 5 per cent significant level. It can be concluded that there was the existence of long run relationship between economic growth, inflation. However, both structural rigidity and unstable monetary policy was been identified as the major causes of inflation and unemployment in Nigeria (Adamson, (2000). This Thesis concluded that the major cause of unemployment in Nigeria was the method of production adopted by the government in the country. The method of production adopted in this country was capital intensive (labour savings) which was capable of increasing unemployment rates thereby reducing economic growth rates. This Thesis further concluded that the nature of inflation in the country was cost-push attributed to the method of technology adopted and the level of poverty in the country. This will make it possible for inflation rates if regressed along to behave abnormally to growth rates of output in the country. A historical analysis of monetary policy in Nigeria within this framework suggests that monetary conditions might have been less accommodative and, hence, inflation in Nigeria might have been lower and less volatile than what was observed in the past had Nigeria followed prescriptions based on a rule consistent with price stability. In conclusion therefore, fight against inflation in Nigeria is not going to be easy or a short run affair, this was because what brought about high unemployment rates also brought about reduction in the growth rates of output in the country and what about high inflation rates brought about improvement in the growth rates of output in Nigeria. This Thesis concluded by saying that combating the challenges of the rising inflation and unemployment level in Nigeria is not a small task for policy makers and economic managers in Nigeria. The consequences of a growing inflation and unemployment phenomenon are so damning that Nigeria cannot afford them. Such implications are glaring in the economy of Nigeria where many negative developments were traceable to the non-availability of jobs for the teaming population of energetic youths coupled with a frequent rising in general price level. Therefore, the need to aptly address this ugly development becomes paramount.


5.3 Recommendations

Based on the findings made in the course of this study the following recommendations are made:

  1. Based on the coefficient of unemployment rate (-4.6727) in model III in Table 4.2, reduction in unemployment rate will increase economic growth rate. Precisely, 1 percent reduction in unemployment rates will increase economic growth by 4.6727 percent. This Thesis therefore, recommended that government and its relevant authorities should provide conducive investment environment by removing the structural rigidities that exist in the economy to create jobs. Government should endeavour to provide stable supply of power, good roads for transportation of goods and people, functional legal system, security of lives and property, infrastructural facilities etc. All these would boost employment by making goods and services readily available to meet the ever increasing demand in order to prevent inflation and subsequently lead to industrial expansion and improvement in growth rates of the economy which would provide employment opportunities for the people.
  2. Based on the coefficient of inflation rate (0.0246) in model III in Table 4.2; increase in inflation rate will increase economic growth rate. Precisely, 1 percent increase in inflation rates will increase economic growth by 0.0246 percent. This Thesis therefore, recommended the need to formulate policies to ensure relative price stability which may likely improve the welfare of Nigerians.
  3. The coefficients of elasticities in model III revealed the extent to which unemployment rates and inflation rates affects economic growth rates in Nigeria. It was found that economic growth rates was highly susceptible to change in unemployment given the elasticity coefficient of -4.6727 which is fairly elastic and less susceptible to inflation rates given the elasticity coefficient of 0.0246 which is fairly inelastic. This Thesis therefore, recommended that more effort should be channel toward reducing unemployment than stabilizing prices.
  4. This Thesis found that the type of inflation characterized the Nigerian economy was structural and cost-push respectively; hence the need by the government and relevant agencies to formulate policies to encourage self employment and reduce cost of doing business in the country so as to achieve a high, rapid and sustained economic growth.

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