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PROJECT TOPIC: AN ECONOMETRIC ANALYSIS ON THE IMPACT OF INFLATION ON ECONOMIC GROWTH IN NIGERIA (1980-2015)

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CHAPTER ONE

INTRODUCTION

  • Background to the Study

Maintaining price stability and growth together in an economy is one of the central macroeconomic policy objectives of most developing countries in the world today. Also the central objective of macro-economic policies is to foster economic growth and keep inflation on a low level.  In order to promote economic growth and strengthen the purchasing power of the domestic currency for the Nigerian economy, emphasis has been laid by the Central Bank of Nigeria on maintaining stability in prices through the use of expansionary or contractionary monetary policy, (Umaru  & Zubairu 2012). Inflation according to Hamilton (2015) can be defined as the rise in the level of prices maintained over a given period in an economy. It can also be seen as a situation where “too much money is chasing too few goods”    In other words, it refers to the general rise in the price of various goods or services thus leading to a fall in the purchasing power of a countries currency, (Lipsey & Chrystal 1995). Inflation is an economic situation and it occurs where an increase in the supply of money is greater than the amount of goods and services produced in a country, (Piana 2002). Inflation is categorized into various degrees and they are as follows: hyperinflation (3 digits % points), extremely high inflation (50 % to 100%), chronic inflation (15% to 30%), high inflation (30% to 50%), moderate inflation (5% to 25%-30%) and low inflation (1%-2% to 5%), (Umaru & Zubairu 2012).

Consequently, the need to understand the relationship between inflation and economic growth of the Nigerian economy become imperative and the dynamics of inflation became central to the success of monetary policy to ensure the achievement of price stability. An economy where the purchasing power of money is expected to retain acceptable value, low level of Inflation is beneficial for consumers and businesses to make long term plans. An economy where inflation is low, “households” will be encouraged to purchase more goods that are durable and increase the rate at which they invest. This will lead to an increase in productivity and mass production of goods and services thus boosting economic growth. . A situation whereby inflation is on a high level is harmful to the economy because a high inflation rate has negative effects on the economic performance of general activities. Inflation in Nigeria can be traced to the “Cheap Money Policy” which started in 1960. It was a monetary policy used by the government to encourage development of key sectors in the economy after the country got her independence. It was characterized by reductions in interest rate which was targeted towards certain sectors in the Nigerian economy. This policy was implemented to aid the execution of the first national development plan and later the prosecution of the civil war. This led to increased monetary expansion with the narrow and broad measures of money stock increasing at annual rates of 29.7% in 1961 and 44% in 1969. Consequently, inflation rose from 6.4% in 1961 to 12.1% in 1969, (Bayo, 2005). There was a boom in oil revenue of the country in 1970, this led to a rise in government expenditure and aggregate demand without accompanying increase in the amount of goods and services produced domestically, thus leading to an increase in the amount of money in circulation. Monetization of oil revenue is also a factor that expanded money supply which also resulted in a rise in the general level of prices in Nigeria, (Oriavwote & Samuel 2012).

Currently, the rate inflation as of October 2016 is 18.5%. These high rates have catapulted the price of goods and services to a level which is very difficult for masses of the country to attain. Therefore, there is no clear decision on the relationship between economic growth and inflation. Different studies have been carried out on inflation and economic growth and results generated from conducted research states different views and opinions to the relationship existing between inflation and growth.

 

The key macro-economic development between October 2016 to March 2017 is that inflation has declined markedly in many economies over the past two years and this disinflation is broad base across countries, measures and sectors larger for tradable goods than for services. The main drivers of recent disinflation are persistent economic slack and softening commodity prices. Most of the available measures of medium term inflation expectations have not declined substantially so far. However, the sensitivity of expectation to inflation surprises an indicator of the degree of anchoring of inflation expectation has increased in countries where policy rate have approach their effective lower bounds. While the magnitude of this change in sensitivity is modest, it does suggest that the perceived ability of monetary policy to combat persistent disinflation may be diminish in these economies.

1.2 Statement of the Problem

The Nigerian economy has remained underdeveloped for a long period despite being blessed richly with huge human and natural resources. This is a result of various factors such as corruption, unemployment, inflation etc. During the period under review (1960-2017), there has been an increase in the rate of inflation which has led to various economic distortions, a situation whereby the government of a country interferes in the economy using policies such as fiscal and monetary policies, examples of some policies that led to distortions in the economy are minimum wage, lump sum tax, taxation, and government subsidies. Also the over valuation of the Nigerian Currency (Naira) in 1980 after the fall of the oil boom contributed significantly to economic distortions in production and consumption thus leading to a high rate of dependence of the Nigerian economy on goods imported from other countries, that is more import less export. This led to a deficit in the balance of payment of the economy, (Bayo, 2005). Since the economy had a balance of payment deficit, in order to correct this various trade restrictions such as high import quotas, tariffs and export licenses were placed on the importation of various goods and services into the country. This led to a shortage in the availability of raw materials necessary for production thus leading to a decrease in the amount of goods and services available for purchase. This situation spurred inflation rate to rise from 20% in 1981 to 39.1% in 1984, (Itua , 2000).

Previous records showed that inflation in the Nigerian economy has gross effect on savings, investment, productivity and balance of payment thus leading to a fall in growth rate from 26.8% in 1991 to 5.4% in 2000 and 3.5% in 2002. In Nigeria, inflation discourages investment in financial assets and led to low growth of cash value, (Obafemi & Epetimehin  2011). Accordingly this research aims to investigate the effects of inflation on the economic growth of the Nigerian economy.

. During inflation, money losses value and people are discouraged from savings which ultimately affect the volume of money in the money market as well as investment which in turns lead to economic growth at large. Various governments had introduced list of policy measures in Nigeria prominent among which are fiscal and monetary. But despite the intensified use of this policy over the years, inflation still remains a major treats to Nigerian economic growth.

 

Despite the various policies that have been adopted by the monetary authority, inflation has remained the greatest problem to the economic growth of the nation. Inflation has remained at the double digit until 2017 that inflation has average of 18.5% CBN annual report 2017. Hence the main thrust of this study shall be to evaluate the impact of inflation on economic growth of Nigeria

  • Objective of the Study

The aim of this study is to measure the relationship between inflation and economic growth on the Nigerian economy and its effects on Real Gross Domestic Product of Nigeria. A study of this nature is important to an economy where price level is unstable. Therefore, the main objective of this study is to evaluate the impact of inflation on economic growth in Nigeria and the specific objective is to investigate the long run relationship between inflation and economic growth in Nigeria (over the specified time period).

1.4 Research questions

 

This research work is guided by the following research questions:

  1. What is the impact of inflation on economic growth in Nigeria?
  2. What is the long run relationship between Inflation and economic growth in Nigeria?

1.5 Research hypothesis

Following the above research question, our hypothesis is stated in a null form thus:

  1. Ho: inflation has no significant impact on the economic growth in Nigeria.
  2. Ho: There is no long run relationship between inflation and economic growth in Nigeria.

1.6 Justification of the study

This study is very important to macroeconomists, financial analyst, academicians, policy makers and central bankers officials in understanding the responsiveness of 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. More so, this study aims at identifying the relationship between inflation and growth and how inflation affects growth rate in the economy. Inflation in Nigeria is determined by major macroeconomic variables such as fiscal deficits, money supply, interest rate and exchange rates (Bayo, 2005).The study would serve as a tool and a guide towards the formation of policies and how they are implemented to help curb the problem of inflation in the country and increase growth.

1.6 Scope of the study

This study covers a period of 26 years, that is, from 1980-2016. 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.


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