Impact of Inflation on Investment and Economic Growth
CHAPTR ONE
OBJECTIVE OF THE STUDY
The objective of this study is to examine the impact of inflation on investment and economic growth. The specific objectives of this study are to:
- analyze the trend of inflation and economic growth in the country over the years.
- investigate the relationship between inflation, investment and economic growth in Nigeria.
- examine the effect of inflation on investment and economic growth in Nigeria.
CHAPTER TWO
REVIEW OF LITERATURE
Conceptual Literature
The meaning of the basic concepts was reviewed couple with the causes, types, effects and remedies to inflation within and outside the Nigerian economy.
The concept of Economic Growth
According to Balami (2006) Economic growth which is always proxied by GDP often conceptualized as increase in output of an economy‟s capacity to produce goods and services needed to improve the welfare of the country‟s citizens. Growth is seen as a steady process which involves raising the level of output of goods and services in the economy. Growth is meaningful when the rate of growth is much higher than population growth because it has to lead to improvement in human welfare. Therefore, growth is seen as a steady process of increasing the productive capacity of the economy and hence, of increasing national income, being characterized by higher rates of increase of per capita output and total factor productivity, especially labour productivity. According to Fajingbeji and Odusola (1999) though economic growth is associated with an increase in capital per head, capital is not the only requirement for growth. Thus, if capital is made available without, at the same time, providing a framework for its use, it will be wasted. And as Hemming (1991) observed, that growth is influenced by the composition of expenditure, since certain types of spending have more effects on growth. Essential among these types of spending are provision of socioeconomic infrastructure, operations and maintenance, and general administrative and legal frameworks. Arguing in the same vein, Ogiogio (1995) emphasized that adequate funding of public sector recurrent budget makes for an effective and functional civil service, and hence, the effectiveness of implementation of development policies and programmes. As analysed by Hemming (1991), even apparently less productive expenditure, security, for example, provides social and political stability that is necessary for growth, and reducing such spending could be counter-productive. The main conclusions that can, therefore, be derived from these studies are that, public expenditure contributes to growth, and that composition rather than the level which is important.
This theses is concern with the rate of growth of the economy i.e. GDP growth rate. The rate of GDP growth can be measured by adopting the well-known compound interest formula as a framework. We can recall the compound interest formula
Yt = Yo(1 + r)t ———————————————— (2.1)
Where Yt is the current year output/income, Yo is the previous year output/income; r is the compound rate of growth of Y (GDP). Assuming t = 1, equation one will be written as follows
Yt = Yo(1 + r) ———————————————— (2.2)
Yt/Yo = 1 + r —————————————————— (2.3)
Therefore r = Yt/Yo– 1 ————————————– (2.4)
Equation (2.4) can therefore be used as a framework for measuring rate of growth of GDP in the country. According to Balami (2006) there are three different measurements for economic growth namely: nominal measurement of growth, real output growth rate as a measure of economic growth and growth measured in per capita values. According to
Wikipedia, the free encyclopedia (2013) economic growth is measured as a percentage change in the Gross Domestic Product (GDP) or Gross National Product (GNP). These two measures, which are calculated slightly differently, total the amounts paid for the goods and services that a country produced. As an example of measuring economic growth, a country that creates $9,000,000,000 in goods and services in 2010 and then creates $9,090,000,000 in 2011, has a nominal economic growth rate of 1% for 2011. Inflation or deflation can make it difficult to measure economic growth.
CHAPTER THREE
RESEARCH METHODOLOGY
Framework for methodology
Over the years there have been a number of economists trying to interpret the relationship between growth, inflation. There are two possible explanations of this relationship – one in the short term and another in the long term. In the short term there is an inverse correlation between the three. As per this relation, when unemployment is low and inflation on the high side, economic growth is expected to be high.
The Okun‟s (1962) law suggests that in the US, the ratio between and a shift in output is the law through which GDP shift from the trend is enlarged by approximately 3percent if unemployment rate grows by 1percent above its natural rate level (McConnel and Brue,1996). This ratio is better known as Okun‟s law. In his earlier researches he concluded that this ratio was approximately 3 to 1, but after some later analyses the ratio of 2 or 2.5 to 1 was accepted as the representative one. Okun‟s law is a reduced version of the Phillips regularity, more precisely, of the segment pertaining to the research of the relation between inflation and output. Okun‟s law has been used for specific projections of economic growth. When there are no vacancies for those willing to work, potential output is irrevocably lost. Unrealised output is measured by shift from the long-term tendency of GDP growth and it is called „„GDP gap‟‟. When GDP follows trend line, economy trends can be projected and then there is natural unemployment rate. The higher the unemployment rate, the greater the shift of GDP from its trend Popovic and Popovic, (2009). The Okun‟s law and the Phillips postulate are the basis for the analysis of the effect of inflation on growth as used in this thesis. The Okun‟s model was adopted and modified to incorporate inflation on the growth of the Nigerian economy.
Empirical Framework
This Thesis used multi-dimensional econometric procedure in estimating the effect of inflation on economic growth in Nigeria. The Ordinary Least Squares (OLS) techniques, and double log were employed to obtain the coefficients of the equation, the double log technique was used in estimating the elasticities of inflation on growth, Augmented Dickey-Fuller and Phillips-Perron tests were employed to test the presence of unit root in the series, after which Johansen cointegration test was employed to test the existence of long-run relationship between economic growth and the independent variables.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
Data presentation
Here data for the thesis are presented and analyzed.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
SUMMARY OF FINDINGS
This Thesis revealed that unemployment significantly and negatively affected economic growth in Nigeria for the period under study. The coefficients of unemployment rates and inflation rates were rightly signed, implying that they were consistent with the theoretical expectation of this Thesis. This was attributed to the dominant manifestation of inflation in Nigeria which was caused by the techniques of production adopted in the country (labour savings and cost push inflation). This Thesis found that the type of unemployment that characterized the Nigerian economy was structural and the type of inflation characterized the country was cost-push. Nigeria had been using capital intensive technique of production which is capable of increasing cost of production and hence inflation and unemployment; economic growth rates will deteriorate, making it difficult to achieving rapid and sustained economic growth rates. It was found in this Thesis that as inflation rates increased economic growth rates increased. However, as unemployment rates increases economic growth rates decreases. The f-statistics values in table 4.2, in models II, and III which measured the joint significance of the explanatory variables, was found statistically significant at 1 percent and 5percent level respectively as indicated by the corresponding probability values of 0.0083 and 0.0308. This implies that both inflation rates significantly affected economic growth rate in Nigeria.
The R2 values in table 4.2 are low and in all model implied that less than 50 per cent total variation in economic growth rate was explained by inflation rates. Coincidently, the goodness of fit of the regression remained weak after adjusting for the degree of freedom as indicated by the adjusted R2 values of less than 50 per cent. The
Durbin-Watson statistic values in table 4.2 and in all the models was observed to be higher than R2 values indicating that the model is non-spurious (meaningful). Durbin-Watson statistics values in model I and II were less than 2 (two) implied the presence of serial correlation among the error value, though there was a negligible serial correlation because their values were tending toward 2. This therefore, justified the need to conduct a unit root test. After taking the natural log of the data Durbin-Watson statistics value was found to be 2.4267 in model III implied the absence of serial correlation among the error values, thus making it possible to rely on the results of the model for policy guidance.
The results of unit root test were contained in table 4.4. The results revealed that all the variables of the model were found to be stationary at 1percent. The result further indicated that economic growth rate (ECGR), inflation rate (INF) were stationary at first difference 1(1). The ADF and PP statistics for all the variables are less than the critical values in negative direction.
The Johansen cointegration test results confirmed the existence of long-run relationship between economic growth rate, inflation rates as indicated by the TRACE-Statistic and also the Max- Eigen-statistics.
Table 4.1 shows that inflation rate was increasing in most of the years. There was no productivity, inflation and employment linkage. But literature reviewed shows that inflation is an economic woe that hinder not only investment but also economic growth in general. Nigeria has experienced high volatility in inflation rates. Since the early 1986‟s, there have been three major episodes of high inflation, in excess of 30percent. Literature reviews shows that there has been high rate of unemployment in the country spurred by the privatization programme of the government which was one of the core blueprints of the structural adjustment programme (SAP). The high unemployment negatively affected economic growth. The neglect of the agricultural sector, poor enabling environment, growth in money supply, disconnect between the institution providing the labour and industries employing them also affected economic growth. Inflation impacted negatively on the growth process of Nigeria. This confirms the existing literature that inflation is macroeconomic threat to any nation. In summary, this study revealed that there was a positive relationship between economic growth rates and inflation rates. Finally the null hypothesis that inflation have no significant effect on economic growth was rejected; because this Thesis found that inflation significantly affected economic growth in Nigeria during the period under review.
CONCLUSION
The results of OLS revealed that increase in inflation rates raised economic growth rates; The coefficient inflation rates, though found consistent with theoretical expectations of this Thesis but was statistically insignificant in determining economic growth rates in Nigeria. The F-statistics values in all models of this Thesis indicated that inflation rates were jointly and significantly affected economic growth rates in the country at 1 percent and 5 per cent significant level. It can be concluded that there was the existence of long run relationship between economic growth, inflation. However, both structural rigidity and unstable monetary policy was been identified as the major causes of inflation and unemployment in Nigeria (Adamson, (2000). This Thesis concluded that the major cause of unemployment in Nigeria was the method of production adopted by the government in the country. The method of production adopted in this country was capital intensive (labour savings) which was capable of increasing unemployment rates thereby reducing economic growth rates. This Thesis further concluded that the nature of inflation in the country was cost-push attributed to the method of technology adopted and the level of poverty in the country. This will make it possible for inflation rates if regressed along to behave abnormally to growth rates of output in the country. A historical analysis of monetary policy in Nigeria within this framework suggests that monetary conditions might have been less accommodative and, hence, inflation in Nigeria might have been lower and less volatile than what was observed in the past had Nigeria followed prescriptions based on a rule consistent with price stability. In conclusion therefore, fight against inflation in Nigeria is not going to be easy or a short run affair, this was because what brought about high unemployment rates also brought about reduction in the growth rates of output in the country and what about high inflation rates brought about improvement in the growth rates of output in Nigeria. This Thesis concluded by saying that combating the challenges of the rising inflation and unemployment level in Nigeria is not a small task for policy makers and economic managers in Nigeria. The consequences of a growing inflation and unemployment phenomenon are so damning that Nigeria cannot afford them. Such implications are glaring in the economy of Nigeria where many negative developments were traceable to the non-availability of jobs for the teaming population of energetic youths coupled with a frequent rising in general price level. Therefore, the need to aptly address this ugly development becomes paramount.
RECOMMENDATIONS
Based on the findings made in the course of this study the following recommendations are made:
- Based on the coefficient of unemployment rate (-4.6727) in model III in Table 4.2, reduction in unemployment rate will increase economic growth rate. Precisely, 1 percent reduction in unemployment rates will increase economic growth by 4.6727 percent. This Thesis therefore, recommended that government and its relevant authorities should provide conducive investment environment by removing the structural rigidities that exist in the economy to create jobs. Government should endeavour to provide stable supply of power, good roads for transportation of goods and people, functional legal system, security of lives and property, infrastructural facilities etc. All these would boost employment by making goods and services readily available to meet the ever increasing demand in order to prevent inflation and subsequently lead to industrial expansion and improvement in growth rates of the economy which would provide employment opportunities for the people.
- Based on the coefficient of inflation rate (0.0246) in model III in Table 4.2; increase in inflation rate will increase economic growth rate. Precisely, 1 percent increase in inflation rates will increase economic growth by 0.0246 percent. This Thesis therefore, recommended the need to formulate policies to ensure relative price stability which may likely improve the welfare of Nigerians.
- The coefficients of elasticities in model III revealed the extent to which unemployment rates and inflation rates affects economic growth rates in Nigeria. It was found that economic growth rates was highly susceptible to change in unemployment given the elasticity coefficient of -4.6727 which is fairly elastic and less susceptible to inflation rates given the elasticity coefficient of 0.0246 which is fairly inelastic. This Thesis therefore, recommended that more effort should be channel toward reducing unemployment than stabilizing prices.
- This Thesis found that the type of inflation characterized the Nigerian economy was structural and cost-push respectively; hence the need by the government and relevant agencies to formulate policies to encourage selfemployment and reduce cost of doing business in the country so as to achieve a high, rapid and sustained economic growth.
REFERENCES
- Adamson, Y.K.(2000). „„Structural Disequilibrium and Inflation in Nigeria: A Theoretical and Empirical Analysis‟‟. Centre for Economic Research on Africa. New Jersey 07043: Montclair State University, Upper Montclair.
- Adofu, I. (2010), „„Accelerating Economic Growth in Nigeria, The role of Foreign Direct Investment‟‟.Current Research Journal of Economic Theory. Vol. 2(1),pp11-15.
- Ajao, W. (2004)Neglect of technical, vocational education increases youth unemployment. The Vanguard. 23 December, pp. 23.
- Akintoye I. R. (2008) Reducing Unemployment through the Informal Sector: A Case
- Study of Nigeria. European Journal of Economics, Finance and Administrative Sciences.Issue 11.
- Akomolafe C. O. and Adegun, O. A. (2009) Strategies of managing higher education for youth labour market in Nigeria. International NGO Journal. 4(10), pp. 456-460.
