1.1 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. 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 A. & Zubairu A. A., 2012). One of the financial problems experienced by Argentina, Brazil, Bolivia, Africa and Latin America amidst others is inflation Deo Gregorio (1992).
In general, inflation can be defined as the rise in the level of prices maintained over a given period in an economy. 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 R.G. & Chrystal K.A., 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 V, 2002).
Inflation is categorized into various degrees and they are as follows: hyperinflation (3 digits), 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 (2% to 5%), (Umaru A. & Zubairu A. A., 2012).
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. A low inflation rate leads to lower nominal and real interest rate that in turn reduces the cost of borrowing. 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. Inflation at a low level is necessary for economic growth, (Hossain E, Ghosh B.C, & K.Islam, 2012). 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. High rate of inflation makes firms and households channel their resources from activities that are productive to other nonproductive activities to enable them reduce the burden of bearing inflation tax. Because of this, there is a high risk of losing money due to variability of relative prices leading also to a high chance of windfall gains.
(Leijonhufvud A, 1977) is of the opinion that high inflation makes financial authorities use different instruments such as the fiscal and monetary policies to protect their financial assets from inflationary erosion. High inflation leads to a decline for labor available, thus leading to a decrease in production and in turn low growth. Zero inflation is not also encouraged in an economy because it is equally unsafe and harmful, it makes an economy stagnant (That is a period where economic growth increases at a very slow rate and is usually characterized by unemployment) in the economy.
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 a 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 alsoa factor that expanded money supply which also resulted in a rise in the general level of prices in Nigeria, (Oriavwote V. E. & Samuel J. E, 2012).
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.
(Mallik G. & Chowdhury A., 2001) are of the opinion that there is a positive relationship between inflation and growth.
(Fisher, S, 1993) believes that there is a negative relationship between inflation and growth.
(Sidrauski M , 1967) believes that there is no relationship whatsoever between inflation and growth.
While (Umair M. & Raza U.) found out that high rate of inflation does not directly affect growth, they believe that inflation leads to high unemployment which in turn affects economic growth in the country.
1.2 STATEMENT OF PROBLEM
The Nigerian economy has remained underdeveloped for a long period despite being blessed richly with huge human and natural resources.
Since mid 1960s, inflation has become so serious and contentions a problem so serious in Nigeria. Though inflation rate is not new in the Nigerian economic history, the recent rates of inflation have been a cause of great concern to many. During the period under review (1982–2015), there has been an upsurge in the inflationary rates leading to major economic distortions. The continued over valuation of the naira in 1980, even after the collapse of the oil boom engendered significant economic distortions in production and consumption as there was a high rate of dependence on import which led to balance of payment deficits.
There is almost a universal consensus that macroeconomic stability, specifically defined as low inflation (Rao and Yesigat, 2015), is positively related to economic growth.
Over the years the question of the existence and nature of the link between inflation and growth has been the subject of considerable interest and debate (Erbaykal and Okuyan, 2008).
Due to the inflationary situation savers find out that the value of their savings is eroded hence they are forced to add their current consumption thus hindering capital formation and the nation’s economic growth. Current inflation rates in Nigeria have tremendously complicated and continued to complicate the task for makers of government fiscal and monetary policies.
Inflation worsens the balance of payment positions. Inflation has helped forced up interest rates thus determining investment and so by doing reduces the real values of aggregate consumer wealth such as government debt and money. It has inhibited and distorted consumer spending by rising domestic prices relative to foreign prices, the currency inflation inhibits exports and stimulates imports thus, depleting the nations scarce foreign resources.
(Kumapayi et al. 2012) reveals that over the last few decades, high inflation in Nigeria has caused yield on investment to decline while government policy objectives has been adversely affected as the real size of its budget shrinks with rising inflation which has hampered economic growth
Contrarily, Omotosho and Doguwa (2013) found that the periods of high inflation volatility in Nigeria are associated with periods of specific government policy changes, shocks to food prices and lack of coordination between monetary and fiscal policies.
However, most previous studies have focused on the effect of inflation on growth in developed countries while little attention has been paid to developing countries. It is therefore imperative to conduct a research into the effect of inflation on economic growth in developing countries with special focus on Nigeria, which is the main thrust of this study.
1.3 OBJECTIVE OF THE STUDY
The objectives of this study are;
1.To measure the impact of inflation on the Nigerian economy and its effects on Real Gross Domestic Product of Nigeria based on the annual time series data from 1982-2015.
1.4 RESEARCH QUESTIONS
For achieving adequate research results, the following research questions are stated:
1.5 RESEARCH HYPOTHESIS
H0: inflation does not have any significant impact on economic growth of the Nigerian economy
H0: interest rate does have any significant impact on economic growth of the Nigerian economy.
H0: exchange rate does not have any significant impact on economic growthin Nigerian.
H0: narrow money supply does not have any significant impact on economic growth in Nigerian.
1.6 SIGNIFICANCE OF THE STUDY
This research will enable us to understand the factors responsible for the persistent rise in the price of goods and services produced in the economy. If the cause and source of inflation in Nigeria are identified and elaborated, 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. 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.
1.7 SCOPE OF THE STUDY
The study covers a period raging from 1982-2015. The period was chosen in order to have serious investigation into the economic activities. The multiple regression models will be employed in determining the functional relationship between inflation and the research variables.