This study we have thus far examined the effect of inflation on economic growth in Nigeria from 1981 to 2015. The study employed the OLS estimation technique period the following were result were found; There is no long run relationship between inflation (and other control variables) and economic growth in Nigeria, Inflation has a negative and significant effect on real economic growth in Nigeria, Exchange rate has a negative and insignificant effect of real economic growth in Nigeria. There is no causal relationship between economic growth, inflation and exchange rate in Nigeria. These results have important policy implications for both domestic policy makers and development partners, implying that controlling inflation is a necessary condition for promoting economic growth. Thus, policy makers should focus on maintaining inflation at a low rate (single digit).
1.1 BACKGROUND TO THE STUDY
Inflation is defined as a general increase in the level of price sustained over a long period in an economy (Lipsey and Chrystal, 1995), that is, a persistent rise in the price levels of commodities and services, leading to a fall in the currency’s purchasing power (Osuala, Osuala and Onyeike, 2013). 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). 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 (Idalu, 2015). The growing interest in price stability as a major goal of monetary policy is an acknowledgement of the observed phenomenon that high inflation disrupts the smooth functioning of a market economy.
To achieve this objective, the Central bank Act of 1958 named the Central Bank of Nigeria as the monetary authority, charged with the responsibility to formulate and implement monetary policy to enhance economic growth and price stability (Olalere, 2016). This goal is pursued in order to avoid cost of inflation or deflation and the uncertainty that follows where there is price instability (Salam et al, 2006).
The Nigerian economy has witnessed series of high inflation in the 1970s and 1980s with an average of 15.07% and 20.18% respectively (with an all-time high of about 40.9% in 1989), the 1990s was no better as the average inflation for that period was over 28% and neither was 2000s as average inflation rate from 2000 – 2015 is placed at 11.83% (CBN, 2015). The issue of double digits inflation can be traced back to 1960s following the government’s monetary policy 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). After the boom in oil revenue of the country in 1970, there was a rise in government expenditure and aggregate demand without an 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 and Samuel, 2012).
There is however no consensus on the relationship between inflation and economic growth. The debate has seen controversial stands amongst economist both theoretically and empirically. Theories and previous studies about the relationship between inflation and economic growth have shown that there might be no relationship Sidrauski (1967); Johanson (1967); and Wai (1959), negative relationship (Fisher, 1993);De Gregorio (1993); Barro (1995, 1996); Brunno and Easterly (1995); Malla (1997); Faria and Carneiro (2001); and Dewan and Husein (2001) or positive relationship (Mallik and Chowdhury, 2001) between these two variables. Also in the literature, there are divergent views on the impact of inflation on the economic growth in Nigeria.
Based on this contradiction in the opinions of researchers on the nature of an impact on economic growth, this posed an empirical question that does inflation promote or retard economic growth? Consequently, this paper attempts to answer the above question by empirically analyzing the impact of inflation on the economic growth in Nigeria.
1.2 STATEMENT OF THE PROBLEM
Price stability is an essential precondition before which economic development can be ensured. The Nigerian economy has been bedeviled by series of price instability with consistent double digit inflation rate this has contributed to the underdevelopment of the economy.
The Nigerian government in 1986 launched a structural adjustment programme targeted at ensuring self-sufficiency of the economy and an attempt to diversify the economy. However, as the effects of SAP gathered momentum, the Growth rate fell drastically in 1990 from 8.3% to 1.2% in 1994, while inflation rose drastically from 7.5% in 1990 to 57.0% in 1994. In 1994, the central bank of Nigeria (CBN) devaluated the local currency (Naira), which led to a fall in amount of agricultural output as machines and raw materials (imported) became expensive. In 1995, the rate at which financial institutions lend money to individuals and firm stimulated inflation to rise to 72.8%.
Severe pressures built up in the economy mainly because of the expansionary fiscal policy of the federal government during these years. This was accompanied by high monetary expansion as the huge government deficit was financed largely by the Central Bank of Nigeria. This was exacerbated by the transfer of government sector deposits to the banks and the resultant increase in their free reserves with adverse consequences on the general price level. The inflationary pressure was further aggravated by high demand for imports of both intermediate inputs and consumer goods due to over valuation of the naira which made imports relatively cheaper than locally manufactured goods. Undoubtedly one of the macroeconomic goals which the government strives to achieve is the maintenance of stable domestic price level. This goal is pursued in order to avoid cost of inflation or deflation and the uncertainty that follows where there is price instability (Salam et al, 2006). The relationship between inflation and economic growth remains however a controversial one, both in theory and empirical findings. Some argue that inflation is positively related to growth, some refute this claim saying inflation is negatively related to growth while others are of the opinion that inflation and growth are not related. In the same vein, some authors argue a bidirectional relationship between inflation and economic growth while others suggest a unidirectional relationship between growth and inflation.
Thus, this study intends to investigate the relationship between inflation and economic growth rate in Nigeria.
1.3 RESEARCH QUESTIONS
Following the above problem statement, the research questions are thus;
- Does inflation have any effect on economic growth in Nigeria?
- What causal relationship exists between inflation and growth rate in Nigeria?
1.4 OBJECTIVES OF THE STUDY
The broad objective of this study is to examine the impact of inflation on economic growth in Nigeria; the specific objectives are to;
- Determine the effect of inflation on economic growth in Nigeria.
- Determine the causal relationship that exists between inflation and economic growth in Nigeria.
1.5 RESEARCH HYPOTHESES
The study hypotheses, as stated in their null forms, are given as;
- H0: There is no significant relationship between inflation economic growth in Nigeria.
- H0: There is no Causal relationship between inflation and economic growth in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
If the cause and source of inflation in Nigeria are identified and tackled, it will lead to an increase in investment, productivity, exports, and employment opportunities, which would bring about increase in economic growth and development in the country. This study aims at identifying the relationship between inflation and growth and how inflation affects growth rate in the economy. 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; it will also be an addition to existing knowledge and a reference material for students and researchers.