IMPACT OF INFLATION AND MONEY SUPPLY ON ECONOMIC GROWTH IN NIGERIA

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ABSTRACT

The study examined the impact of money supply and inflation on economic growth in Nigeria over the period of 1980-2015 using the Nigerian time series data. The study applied OLS to estimate the modeled relationship. As a matter of necessity, we subjected our variables to time series econometric tests using the Augmented Dickey Fuller (ADF) unit root test for stationary and Engle Granger co-integration procedure and other post estimation diagnostic tests. The empirical result showed that there is a positive relationship between money supply and economic growth while inflation showed a negative relationship which conforms to a priori expectations. This study therefore concluded that the government should make policies that support money supply while inflation should not be a worrisome situation because it was insignificant according to the estimated result.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Inflation refers to the persistent and the continuous rise in the general level of prices of goods and services in an economy. Different economies in different parts of the world experience inflation, the differences lie in the timing, causes, duration and in their prevailing economic conditions. Suffice to say then that, be it developed, developing or underdeveloped; economies of countries of the world does witness rise in price. For some economies it could be mere fluctuations, while for some others, it is consistent and continuous rise in price. Amidst this rise in general price level, there are some country’s economies that experiences growth. For such country, inflation has a positive effect. On the other hand, there are some economies that witness economic downturn as an aftermath effect of inflation. For this category of countries, inflation has an adverse or negative effect and in such economy, inflation is intolerable as Nembee and Madume (2011) looked at inflation as one of the factors that create uncertain business environment in Nigeria and other LDC (Less Developed Countries) which makes foreign investors to choose a wait option for investment. They added that macroeconomic reform policies or measures often adopted to address the shocks at times induce uncertainty in the domestic economy.

Over the years in Nigeria, the economy has been experiencing rise in price and there has been also economic growth over time as well, this has been a matter of concern for economists overtime as it remains a fact that the real income of the citizens are affected during inflation unless with compensatory income via subsidy or outright increase in the workers’ salaries. The latter is another economic problem which when not accompanied by increased productivity will lead to more inflationary tendencies in the economy because the value of money would have fallen when the increased incomes fail to bring about more productivity from the wage increases.

According to Fatukasi (2012), in Nigeria, notwithstanding the several efforts directed by the government to curb inflation, these efforts have not yielded positive or desired results as high price level continued to cause setbacks in the growth rate of the living standard of the most Nigerians who are either on fixed income or are unemployed. He added that it has adverse effects on investment productivity, balance of payment and therefore reduced growth rate of the Gross Domestic Product (GDP). The several impulses of inflation in any economy have made it an issue of concern for policy makers.

According to Aminu and Anono (2012), parts of the macroeconomic goals which the government strives to achieve are the maintenance of stable domestic price level and full employment in order to avoid cost of inflation and the associated uncertainties. When inflation is above single digits level and remain spiral, investors are reluctant to invest and this affects the future growth outcome of the country. This may partly explain why domestic producers in Nigeria cry of overhead cost thereby making the foreign imported goods to have competitive advantage in terms of cost and quality over the domestic commodities.

Inflationary pressure in Nigeria has several negative implications on the economy leading to poor domestic production as the cost of producing domestically discourages the investors at the domestic economy giving rise to more importation at the expense of export with the effect of creating deficit balance of payment especially the non-oil trade balance.

Fatukasi (2012) pointed out that upsurge inflationary rates often lead to major economic distortions such as balance of payment deficit, devaluation of naira, reduction in purchasing power of the working class which makes the workers unions to embark on frequent agitations for higher wages. The issue of frequent down tooling by the workers in Nigeria has negative impact on the economy as productivities are cut, services paralysed especially in the educational and health sectors. When the health and educational sectors are continuously out of service, the human capital function will suffer set back and ultimately affect the pace of economic development of the country.

The several impulses of inflation in any economy have made it an issue of concern for policy makers. According to Aminu and Anono (2012), parts of the macroeconomic goals which the government strives to achieve are the maintenance of stable domestic price level and full employment in order to avoid cost of inflation and the associated uncertainties. When inflation is above single digits level and remain spiral, investors are hesitant to invest and this affects the future growth outcome of the country. This may partly explain why domestic producers in Nigeria cry of overhead cost thereby making the foreign imported goods to have competitive advantage in terms of cost and quality over the domestic commodities. According to Adebiyi (2009), in the long run, high and variable inflation increases consistently discourages investment and reduces economic growth. Inflation is the consistent and persistent increase in the general price level a given economy. Inflation is inversely related with the value of money. Cost push inflation results from surge in the factor inputs such as labour wages, raw materials which is often passed to the final consumers by the supplier or the producer to final consumers in the form of higher prices of commodities.

The inflation rate in Nigeria jumped from 6.938 in 2000 to 18.869 percent in 2001, 12.883 percent in 2002, 14.033 percent in 2003, 15.001 percent in 2004, 17.856 percent in 2005, and down to 8.218 percent in 2006 and 5.413 percent in 2007. It further rose steadily to 11.581 percent in 2008, 12.543 percent in 2009, 13.72 percent in 2010, 10.84 percent in 2011, 12.21 percent in 2012, 8.47 percent in 20.13, 4.74 percent in 2014 and 0.94 percent in 2015. This trend reveals that within a period of two decades, Nigeria only witnessed single digit inflation rates in seven years (1986, 1990, 1989, 1999, 2000, 2006 and 2007) which is indicative of negative signals of Nigeria’s investment environment (IMF, 2011).

Inflationary pressure in Nigeria has several negative implications on the economy leading to poor domestic production as the cost of producing domestically discourages the investors at the domestic economy giving rise to more importation at the expense of export with the effect of creating deficit balance of payment especially the non-oil trade balance. This is consistent with Abaukaka (2011) that found out that the non-oil trade balance has never maintained a positive position and he concluded that the overall trade balance of Nigeria is only smoothened by the surplus since 1970 oil trade balance account within the period of his study.

Similarly, Fatukasi (2012) pointed out that upsurge inflationary rates often lead to major economic distortions such as balance of payment deficit, devaluation of naira, reduction in purchasing power of the working class which makes the workers unions to embark on frequent agitations for higher wages. The issue of frequent down tooling by the workers in Nigeria has negative impact on the economy as productivities are cut, services paralysed. Therefore, it is our aim in this study to test whether rise in price has had positive or negative effect on economic growth in Nigeria.

Money supply on the other hand is the amount of money in circulation in the economy at any point oftime. It not only includes the currency & coins in circulation, but it also includesdemand & time deposits of banks, post office deposits and such related instruments.

The relationship between money supply and economic growth has been receiving increasing attention than any other subject matter in the field of monetary economics in recent years. Because of the importance of economic growth among the macro-economic objectives of nations (developed and developing), persistent concern has always been given among monetary economist including Mckinnon (1973), Shaw (1973), Fry Mathieson (1980), Odedokun (1997), Levine (1997) and Asogu (1998) to the relationship between money supply and output.

Economists differ on the effect of money supply on economic growth. While some agreed that variation in the quantity of money is the most important determinant of economic growth, and that countries that devote more time to studying the behaviour of aggregate money supply rarely experience much variation in their economic activities (Handler 1997). Others are Skeptical about the role of money or gross national income Robinson (1950, 1952). Kuznet (1955) supports the view that financial markets start growing as the economy approaches the intermediate stage of the growth process and develop once the economy becomes matured. This connotes that economic growth stimulates increased financial development. Steve (1997) and Domigo (2001), explain that there may not be possibility of economic growth without an appropriate level of money supply, credit and appropriate financial conditions in general.

Evidence in the Nigerian economy has shownthat since the 1980’s some relationship existbetween the stock of money and economic growthor economic activity. Over the years, Nigeria hasbeen controlling her economy through variationin her stock of money. Consequent upon the effectof the collapse of oil price in 1981 and the B.O.Pdeficit experienced during this period, variousmethods of stabilization ranging from fiscal tomonetary policies were used. Interest rates werefixed and these were said to be beneficial to bigborrower farmers (Ojo, 1989). Ikhide and Alawode(1993) while evaluating the effect of StructuralAdjustment Programme (SAP) concluded thatreducing money stock through increased interestrates would lower gross National product. Thus, the notion that stock of money varies with economicactivities applies to the Nigerian economy (Laidler, 1993). The output development and other economicgrowth processes (via interest rate deregulation) inthe Nigerian economy calls for considerable testof the validity of Friedman and Mieselman (1963)work on the Nigerian economy. The implication ofthe stability of the relationship between moneyand economic growth will show the effectivenessof monetary policy following the conventionalHicksian IS-LM analysis.

Valuation and analysis of the money supply helps the economist and policy makers to frame the policy or to alter the existing policy of increasing or reducing the supply of money. The understanding of money supply is important as it ultimately affects the business cycle and thereby affects the economy, this wok thus aims to investigate therelationship as well as determine the impact ofmoney supply on economic growth.

1.2 Statement of Problem

The issue of inflation has been a matter of concern for the economists overtime as it remain on arguable fact that the real income of citizens are grossly affected during inflation, except with compensatory income through subsidy or outright increase in the workers’ salaries. But unfortunately in the Nigerian context, the subsidies are removed and worker salaries either not paid or static to reduce the real value of naira in their hand.

In Nigeria, several efforts have been directed towards curbing inflation; surprisingly these efforts have not yielded positive or desired result as high price level continued to house setbacks in the growth rate of the living standard of most Nigerians who are either on fixed income or are unemployed.

Additionally, much as the government and its relevant agencies are trying to address inflationary situations in the country, the ugly menace has continued to have adverse effect on investment productivity, balance of payment and therefore reduce growth rate of the gross domestic product (GDP).Part of the macroeconomic goals which the government strives to achieve are the maintenance of stable domestic price level and full employment in order to avoid cost inflation and the associated uncertainties. In spite of all these efforts the domestic price levels soar daily and full employment a mirage as factors of production as well as human capital are under-utilized in this recessed economy of ours presently.

The domestic producers in Nigeria have consistently have cried for overhead cost which have made foreign imported goods to have competitive advantage in terms of cost and quality over the domestic commodities as occasioned by double digit level and spiral inflationary which cause investors to be reluctant to invest and consequently affect the future growth outcomes of the country.Inflationary pressure in Nigeria has several negative implications on the economy leading to poor domestic production as the cost of producing domestically discourages the investors at the domestic economy giving rise to more importation at the expense of export with the effort of creating deficit balance of payment especially the non-oil trade balance.

Finally, upsurge inflationary rates often lead to major economic distortions such as balance of payment deficit, devaluation of naira, reduction in purchasing power of the working class which makes the workers’ unions to embark on frequent agitations for higher wages. All these are what triggered the interest of the researchers to work on the subject matter.

 

1.3 Research Question

For achieving adequate research results, the following research questions are stated:

  1. What is the impact of money supply on the gross domestic product (GDP) in Nigeria?
  2. What is the impact of inflation on gross domestic product (GDP) in Nigeria?

 

1.4 Objective of the Study

The broad objective of the study is to evaluate the impact of inflation on money supply on the economic growth of the Nigerian economy. The specific objectives are as follows;

  1. To determine the impact of inflation on the gross domestic product (GDP) in Nigerian economy.
  2. To examine the impact of Money supply on the gross domestic product (GDP) in Nigerian economy.

1.5 Research Hypotheses

In this statement of hypothesis, the study adopts the null form of stating hypothesis which implies that the other wise of the statements becomes the alternative. The hypotheses are thus as follows:

H0: Inflation has no significant impact on the gross domestic product (GDP) in Nigerian economy.

H0: Money supply has no significant impact on gross domestic product (GDP) in Nigerian economy.

1.6 Scope of the Study

This study covers a period of 36 years spanning through 1980 to 2015.  However, this study is carried out in Nigeria.

 

1.7 Significance of the Study

If the cause and source of inflation in Nigeria are identified, impact of money supply determined, the researcher could offer a policy recommendation as to make better monetary and general economic policy which will bring about an increase in, productivity and output, which would lead to increase in economic growth and development in the country.

The study would serve as a tool and a guide towards the formation of policies and how they are to be implemented to help curb the problem of inflation in the country through monetary policy (money supply mechanism) and increase growth. It will be useful to academia in case of reference and further research on this area, to the public for enlightenment and information and for private and public investors and even government.

1.8 Organization of the Study

This research work covers five chapters which starts with introduction in chapter one, review of literature in chapter two, research methodology in chapter three, data presentation and analysis in chapter four and finally summary of findings, recommendation and conclusion in the final chapter.

1.9 Limitations of the Study

This research is constrained by time constraint and finance giving short period of academic session.