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AN ANALYSIS OF THE DETERMINANTS OF INFLATION IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1     Background of the Study

Inflation has emerged as a pressing concern within the socio-economic landscape of Nigeria, evoking widespread discussions in both households and the media. The escalating prices have permeated various aspects of the nation's life, exerting profound impacts on the supply of essential commodities, including food, shelter, and overall infrastructural development. The enduring rise in prices presents a formidable economic challenge in Nigeria and across Africa, eroding the purchasing power of currency and diminishing both investment value and the standard of living (Greenidge and Dacosta, 2009; Olatunji et al., 2010).

The inception of inflation in Nigeria dates back to the 1970s, coinciding with a meteoric surge in oil revenue. This period witnessed an unprecedented expansion of public expenditure, fueled by the oil windfall, leading to a substantial increase in aggregate demand. The resulting inflationary pressures were further exacerbated by the augmentation of money supply, a consequence of the monetization of oil earnings and the Udoji Salary Awards of 1974, which substantially raised wages (Anyanwu, 1992; Aiyede, 2002). Despite subsequent fiscal and monetary measures aimed at curtailing inflation, its rates continued to escalate, profoundly impacting the nation's economic growth and citizens' living standards (Okah, 1986).

Against this backdrop, the study focuses on unraveling the determinants of inflation in Nigeria, employing annual time series data spanning from 1981 to 2017. This carefully chosen timeframe encapsulates pivotal policy eras in Nigeria, including the pre–Structural Adjustment Program (SAP) era, the SAP era, and the post–SAP era. The selection is deliberate, offering a comprehensive assessment of inflation determinants over distinct policy epochs.

The study employs the Auto–Regressive Distributed Lag (ARDL) methodology, substantiated by the outcome of the Augmented Dickey-Fuller (ADF) unit root test, indicating the integration properties of the variables. The ARDL bounds test underscores a robust long-run relationship among the variables, necessitating the estimation of both short-run and long-run effects. Notably, the research identifies significant determinants of inflation in Nigeria, distinguishing between short-term and long-term impacts.

In conclusion, the study contends that inflation in Nigeria is influenced by both demand–pull and cost–push factors. It advocates for the establishment of social infrastructure conducive to private investment, emphasizing the need for a nuanced understanding of the multifaceted forces steering inflation dynamics in the country. The findings of this research are anticipated to contribute substantively to the comprehension of inflationary processes and inform policy discussions geared towards fostering economic stability in Nigeria.

1.2     Statement of the Problem

The persistent challenge of inflation in Nigeria prompts a multifaceted exploration of its determinants and implications. The economic ramifications, historical context rooted in the 1970s oil boom, and the efficacy of past and present policies demand scrutiny. This study delves into the interplay of factors such as the real output gap, money supply, government expenditure, total import, exchange rates, GDP of key industries, interest rates, and unemployment, aiming to discern their roles in inflation dynamics. Beyond economic consequences, the research investigates the impact of inflation on social welfare, emphasizing the need for policies that enhance citizens' access to basic needs. Ultimately, the study seeks not only to identify the root causes of inflation in Nigeria but also to offer actionable insights for policymakers to formulate effective strategies and foster economic stability.

1.3     Objectives of the Study

1. Examine the relationship between the real output gap and inflation, investigating the contribution of economic output gaps to inflationary pressures.

2. Ascertain the impact of money supply on inflation, evaluating how monetary factors influence overall price levels.

3. Analyze the connection between total government expenditure and inflation, assessing the implications of public spending on inflationary trends.

4. Examine the dynamics between total import and inflation, exploring how international trade and import activities contribute to inflationary pressures.

5. Evaluate the influence of the nominal exchange rate on inflation, considering how fluctuations in exchange rates impact overall price levels.

1.4     Research Questions

The research questions aim to guide the investigation into the determinants of inflation in Nigeria. These questions are:

1. How does the real output gap relate to inflation in the context of the Nigerian economy, and what is its contribution to inflationary pressures?

2. What is the impact of money supply on inflation, and how do monetary factors influence the overall price levels in Nigeria?

3. What is the connection between total government expenditure and inflation, and what are the implications of public spending on inflationary trends in the country?

4. How do the dynamics of total import contribute to inflation, and what role do international trade and import activities play in shaping inflationary pressures in Nigeria?

5. What is the influence of the nominal exchange rate on inflation, and how do fluctuations in exchange rates impact overall price levels within the Nigerian economy?

1.5     Significance of the Study

The significance of this study lies in its potential to contribute valuable insights to both academic discourse and practical policymaking regarding inflation in Nigeria. By unraveling the determinants of inflation, the research provides a nuanced understanding of economic dynamics, offering policymakers a foundation for evidence-based decision-making. The findings can inform the design and implementation of targeted policies to mitigate inflationary pressures, fostering economic stability. Moreover, the study's exploration of historical contexts and policy eras contributes to a comprehensive understanding of Nigeria's economic evolution. This holistic perspective enhances the study's relevance, as it not only addresses current challenges but also informs strategies that align with the nation's economic history. Ultimately, the research endeavors to provide a substantial knowledge base that can guide stakeholders in their efforts to navigate and manage the complexities associated with inflation in the Nigerian context.

1.6     Scope of the Study

This study delves into the determinants of inflation in Nigeria, focusing on annual time series data spanning the extensive period from 1981 to 2017. This timeframe has been strategically chosen to encompass key policy eras, including the pre–Structural Adjustment Program (SAP) era, SAP era, and post–SAP era. By doing so, the research aims to capture the diverse economic policies implemented in Nigeria and their impact on inflation over time. The analysis employs the Auto–Regressive Distributed Lag (ARDL) methodology, grounded in the outcomes of the Augmented Dickey-Fuller (ADF) unit root test, ensuring robustness in assessing the integration properties of variables. The scope extends to evaluating short-run and long-run effects, providing a comprehensive understanding of the determinants of inflation in Nigeria. This study contributes to the broader economic literature by offering insights into the intricacies of inflation dynamics within the Nigerian context.

1.7     Limitations of the Study

While conducting the research on the determinants of inflation in Nigeria, several limitations should be acknowledged:

1. Data Limitations: The study relies on historical time series data from 1981 to 2017, and any limitations or inaccuracies in the available data during this period could impact the robustness of the findings. Additionally, the unavailability of more recent data may restrict the study's ability to capture the latest economic trends and developments.

2. Modeling Constraints: The research utilizes the Auto–Regressive Distributed Lag (ARDL) methodology, which is subject to certain assumptions and limitations. While this approach is widely used, variations in modeling choices or potential misspecifications could affect the accuracy of the results.

3. External Factors: External factors such as geopolitical events, global economic shifts, or unforeseen circumstances may influence inflation dynamics but are not comprehensively addressed in the study. These externalities could introduce complexities that the study may not fully capture.

4. Generalization Challenges: The findings are specific to the Nigerian context and may not be directly generalizable to other economies. Economic conditions and policy responses vary, and caution should be exercised when extrapolating the results to different contexts.

5. Inflation Metrics: The study primarily focuses on overall inflation, and potential variations across different sectors or regions within Nigeria may not be fully explored. An in-depth sectoral or regional analysis could provide a more nuanced understanding of inflationary forces.

6. Assumption of Causality: While the research identifies relationships between variables and inflation, establishing definitive causality can be challenging. The study acknowledges correlations but does not necessarily imply direct causation.

7. Policy Implementation Dynamics: The study assesses the impact of policy eras on inflation, but the complexities of policy implementation, effectiveness, and potential lag effects are acknowledged as limitations. A more detailed examination of policy mechanisms may require further research.

Recognizing these limitations is essential for interpreting the study's findings accurately and guiding future research endeavors to address these constraints for a more comprehensive understanding of inflation dynamics in Nigeria.

1.8     Definition of Terms

1. Inflation: A sustained increase in the general price level of goods and services in an economy over a period, resulting in a decrease in the purchasing power of a currency.

2. Determinants: Factors or variables that have a direct or indirect influence on the occurrence or magnitude of a particular phenomenon, in this context, the determinants of inflation in the Nigerian economy.

3. Auto–Regressive Distributed Lag (ARDL) Methodology: A statistical approach used for analyzing the long-run and short-run relationships among variables in time series data, allowing for the inclusion of lagged values and addressing potential unit root issues.

4. Augmented Dickey-Fuller (ADF) Unit Root Test: A statistical test used to determine the stationarity of a time series data set, a crucial step in time series analysis to ensure reliable results.

5. Pre–Structural Adjustment Program (SAP) Era, SAP Era, and Post–SAP Era: Distinct periods in Nigeria's economic history marked by specific policy implementations, with the pre-SAP era preceding the Structural Adjustment Program and followed by the post-SAP era, each characterized by unique economic policies and challenges.

6. Real Output Gap: The difference between an economy's actual output and its potential output, representing the cyclical fluctuations in economic activity.

7. Money Supply (M2): The total amount of money in circulation in an economy, including physical currency, demand deposits, and other liquid assets.

8. Nominal Exchange Rate: The rate at which one country's currency can be exchanged for another, without adjusting for inflation or other economic factors.

9. Gross Domestic Product (GDP): The total value of all goods and services produced within a country's borders over a specific time period, serving as a key indicator of economic health.

10. Interest Rate: The cost of borrowing money or the return on investment, influencing economic activities such as spending, saving, and investment.

11. Unemployment: The percentage of the labor force that is unemployed and actively seeking employment, a critical indicator of economic health and labor market dynamics.

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