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Inflation
And Economic Growth: A Time Series Analysis
ABSTRACT
The essence
of this study is to empirically explore the impact of inflation and economic
growth in the context of the Nigerian economy. The study contends that while
high rates of inflation is detrimental to economic growth, moderate and stable
inflation rates supplements return to savers, enhances investment and therefore
economic growth of a country. Using annual data set on real GDP and inflation
rates for the period of 1970 to 2008, an assessment of empirical evidence has
been acquired through the ordinary least squares (OLS) estimation technique.
The empirical evidence demonstrates that there exists a statistically
insignificant impact of inflation on economic growth. This result indicates the
existence of structural constraints and a non – performing productive sector in
the Nigerian economy. However, base on the strength of our findings, we
recommend that macroeconomic policies aim at achieving sustain able economic
growth should not over concentrate at fighting inflation but should also focus
on factor input productivity, human capital development and good governance.
CHAPTER ONE
1.1 BACKGROUND OF THE STUDY
Over the
past few decades, the nexus between inflation and economic growth has continued
to dominate the center of stage of economics discuss amongst macroeconomists,
policy makers and the central bankers of both developed and developing
countries. Specifically, the central issue which has generated a plethora of
debate both theoretically and empirically is the question of whether inflation
is necessary or harmful for economic growth. The issue originally evolved from
the controversial notion between the structuralist and monetarists. In this
connection, and in line with the submission of the structuralists, Mundel
(1965) and Tobin (1965) cited in Mortaza and Ahmed (2005) suggest positive
relationship between inflation and economic growth through the new growth
theory. Their argument is validated on the premise that inflation leads to
increased capital accumulation, which promotes economic growth. Conversely,
Fischer and Modigliani (1978) cited in Mortaze et al (2005) suggest a negative
and non linear relationship between the rate of inflation and economic growth.
More interestingly, there are two
fundamental aspects in the inflation economic growth relationship. The first is
to determine the existence and nature of the relationship (correlation)
assuming that both macroeconomic variables exists, while the other has to do
with establishing the direction of causality (regression), in this regard.
Therefore, Friedman (1973) in
Chowdhury and Mallik (2001) explicitly summarizes the inconclusive nature of
the relationship between inflation and economic growth as follows:
“historically all possible combinations have occurred: inflation with or
without growth: no inflation with and without growth.
Not surprisingly therefore, several
economic theories and evidences from empirical studies have either supported or
refute the claim that high rates of inflation may have many adverse economic
and social consequences on economic growth. As noted by Obadan (1996:210)
Anyanwu (1995), and Barnugi et al (1997). Inflation not only dampens
macroeconomic viability by destroying domestic savings and investments, but it
also creates an unstable economic climate, causing distortions in relative
prices, resource allocation and distribution of income and wealth. High rates
of inflation can also lead to the non-productive expansion of the financial
system as has happened in Nigeria where the financial sectors share of the GDP
increased from 6.2 percent in 1989 to 9.02 percent in 1994 (CBN, 2004) while
inflation is often times caused by such factors as market imperfection, budget
constraint, exchange rate instability as well as supply and demand shocks. The
main economic consequences of inflation on economic growth can be distinguished
in two broad Categories; the internal and external consequences. Internally,
inflation can lead to a situation of conservative investment strategies and the
crowing out of the private sector especially when high inflation is also
associated with increased price variability alternately leading to lower levels
economic growth.
On the external sector inflation
reduces an economy’s international competitiveness by making its exports
relatively expensive thereby impacting negatively on the balance of payments
and economic growth. However, inflation can equally have some positive effects
on the economy through its impact on capital accumulation and capacity to
reduce the severity of economic recession by enabling the labour market to
adjust more quickly in a down turn and also reduces the risks that a liquidity
trap prevents monetary policy from stabilizing the economy (Anyanwu, 1995).
Historically, the Nigerian economy
has suffered years of economic setbacks and considerable levels of economic
instability as a result of the persistent growth of inflation. During the early
political independence era of the 1960s, inflation rates were relatively
modest. However, the oil boom era of the 1970s,kick started the double digit
inflation rates reported at 15.6%, 33.9% and 21.2% for 1971, 1975 and 1976
respectively (CBN 2005).
To date, although the relationship
between inflation and economic growth remains controversial and somewhat in
conducive, several empirical studies have confirmed either a positive or
negative relationship between the macroeconomic variable of inflation and
growth. Moreover, with time a general consensus evolved that moderate and
stable inflation rates promotes economic growth and vice versa (Mubarik, 2005).
This further raises the question of how low inflation should be.
The answer evidently depends on the
nature and structure of the economy and varies across countries. In this regard
recently, macroeconomists, have adopted a econometric technique simply by
looking at a non-linear or structural break effects, which states that the
impact of inflation on economic growth could be positive to a certain threshold
level and beyond this level the effects turns negative (Sweidan, 2004).
Against this background, therefore,
this study seeks to carryout an empirical research of the present relationship
between inflation and economic growth in Nigeria. This study is largely
motivated by the seminal work of Mallik
and Chowdhury (2000) in which they performed an econometric (i.e Engle –
Granger two – step cointegration procedure) analysis of the relationship
between inflation and economic growth for four South African countries
Bangladesh, India Pakistan and Sir Lanka. Following the works of Khan and
Senhadji (2001), Sweidan (2004) and Mubarik (2005), this work attempt to carry
out an empirical investigation of the relationship between inflation and
economic growth.
1.2 STATEMENT OF THE PROBLEM
Nigeria’s economic history can hardly
be completed without a full acknowledgement of the impact that inflation has on
the health of her economy. Following Nigeria’s political independence in 1960,
the economy experienced minimal levels of inflation and robust economic growth
characterized by internal and external balances.
However, the 1970’s, which is noted
as the era of the oil boom Singled the commencement of double digit inflation
episode. As Ekpo (1991) notes, “the inflationary spiral of the 1970s lead to a
situation of declining domestic savings and investments, falling agriculture
production, high levels of the employment, growing government expenditure as a
result of the narrowing of tax base of government over indebtedness and poor
levels of social services.”
Given the seemingly negative
consequences that inflation might have on economic growth. The central problem
that has always agitated the mind of scholars is to know the true impact of
inflation on economic growth.
1.3 OBJECTIVE OF THE STUDY
Generally, the primary objective of this work is to investigate the
impact of inflation on economic growth of Nigeria for the period under study
(1970 – 2008). It specifically seeks to achieve the below objective.
1. To determine the impact of inflation on
economic growth in the Nigerian
economy.
1.4 STATEMENT OF HYPOTHESIS
The following hypothesis is tested in
the study.
HO - There is no significant impact of inflation
on economic growth.
H1 - There
is a significant impact of inflation on economic growth.
1.5 SIGNIFICANCE OF THE STUDY
This study is significant in that, it
is expected to highlight the impact of inflation on economic growth in Nigeria
and also identifying the channels through which its transcends into the real
sector.
Based on the empirical findings,
recommendation shall be made on how inflation can be curb. The findings is also
expected to add to the body of knowledge in this area as well as spur up
interest for further research in allied fields.
1.6 SCOPE AND LIMITATION OF THE STUDY
This study is an investigation of the
impact of inflation on economic growth in Nigeria.Specifically, the study will
concentrate on inflation and other economic variables as they affect Nigeria
economic growth. Also, data analysis will be done through regression and the
data will be gotten from published materials of central bank of Nigeria.
The coverage of this study is between
1970-2008. the study of is nationally based and it is limited to Nigeria internal
variables, data and information.
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