The Effect of Inflation and Interest Rate on Economy Growth in Nigeria

Chapter One of The Effect of Inflation and Interest Rate on Economy Growth in Nigeria

INTRODUCTION 

Background of the study

Rapid output growth and low inflation are the most common objectives of macroeconomic policy in both developed and developing economies. In Nigeria, the formulation and implementation of monetary policy by the Central Bank of Nigeria (CBN) was aimed at maintaining price stability which is consistent with the achievement of sustainable economic growth. The monetary authority strives to achieve the governments overall inflation objective through effective monetary management, which entails setting intermediate and operating targets in tandem with the assumed targets for GDP growth, inflation rate and balance of payments.

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. High inflation is known to have many adverse effects: it imposes welfare costs on the society; impedes efficient resource allocation by obscuring the signaling role of relative price changes; discourages savings and investment by creating uncertainty about future prices; inhibits financial development by making intermediation more costly; hits the poor excessively, because they do not hold financial assets that provide a hedge against inflation; and reduces a countrys international competitiveness by making its exports relatively more expensive, thus impacting negatively on the balance of payments, and perhaps more importantly, reduces long-term economic growth (See Ghosh and Phillips, 1998; Khan and Senhadji, 2001; Billi and Khan, 2008; Frimpong and Oteng-Abayie, 2010). Overall, businesses and households are thought to perform poorly in periods of high and unpredictable inflation, Barro (1996).

Most policymakers, however, agree that they should not allow inflation to fall below zero because the costs of deflation are thought to be high, Billi and Khan (2008). Even though some evidence suggests that moderate inflation helps in economic growth, Mubarik (2005), the overall weight of evidence so far clearly indicated that inflation is inimical to growth. Consequently, policymakers should aim at a low rate of inflation that maximizes general economic well-being.

A considerable amount of literature examining the relationship between inflation and economic growth in both developed and developing economies are available. However, several of those studies focused specifically on whether the relationship between inflation and long-run growth is negative and a nonlinear one – positive or nonexistent relationship at low rate of inflation but becomes negative at higher rates, see Fischer (1993) who first identified the relationship. If such a nonlinear relationship exists, then it should be possible, in principle, to estimate the inflexion point, or a threshold, at which the sign of the relationship between the two variables would switch. Consequently, Khan and Senhadji (2001) produced the threshold level for both developed and developing countries in a cross-country panel data framework. The authors arrived at a threshold level range of 11 – 12 per cent for developing countries, including Nigeria. Even though cross-country studies were justified based on their ability to generalize empirical findings, specific country studies can provide specific evidence relevant for the country under study, as Kremer et al. (2009) suggested that inflation threshold in non-industrial countries and the appropriate level of inflation target might be country-specific. This becomes necessary due to heterogeneous factors obtainable in different countries. Although Chimobi (2010) examined the relationship between inflation and growth in Nigeria, no attempt was made to provide an optimal inflation rate for policy decisions. Fabayo and Ajilore (2006) arrived at a threshold level of 6 per cent for Nigeria using annual data from 1999 – 2013. However, Bruno and Easterly (1998) argue that the negative relationship between inflation and growth, typically found in cross-country regressions, exists only in high frequency data and with extreme inflation observations, which Khan and Senhadji (2001) confirmed that the extent of the relationship is stronger at high frequencies.

Statement Of Problem

The effect of inflation and interest rate on economy growth in Nigeria is quite a serious problem. The country experiences on inflation is no longer the problem but the fact that inflation problem seems to have reached the crisis dimension. Changes in interest rate determines the rate of inflation. The nominal interest rate is a function of the real interest rate and inflationary expectation.

Since independence, we have been suffering from inflation and interest rate till central bank interned their new system abolished all control on interest rate and allow banks to fix their own interest rate.

Objective of the study

This research work titled “Inflation on economic growth of Nigeria: implication for gross National product 1999 – 2013” the specific objectives of this research work includes the following:

1.  To examine the effect of inflation rate on the economic growth of Nigeria.

2.  To identify the implication of inflation on the gross national product from 1999 to 2013.

3.  To evaluate the relationship between inflation and economic growth and development of Nigeria.

4.  To examine the inflation rate at which inflation has affected on the gross national product of Nigeria.

 Research Question

1.  To what extent has inflation rate affected the economic growth of Nigeria?

2.  What are the implications of inflation on the gross national product from 1999 to 2013?

3.  Is there any relationship between inflation and economic growth and development of Nigeria?

4.  To what extent has inflation rate affected on the gross national product of Nigeria?

Research Hypothesis

The researcher formulated the following research hypothesis:

Ho: Inflation rate has no effect on the economic growth of Nigeria from 1999 to 2013.

H1: Inflation rate has affected the economic growth of Nigeria from 1999 to 2013.

Ho: Inflation has no implication on the gross national product of Nigeria from 1999 to 2013.

H1: Inflation has so many implications on the gross national product of Nigeria from 1999 to 2013.

Ho: There is no significant relationship between inflation and economic growth and development of Nigeria.

H1: There is significant relationship between inflation and economic growth and development of Nigeria.

Ho: Inflation has not affected the gross national product of Nigeria from 1999 to 2013.

H1: Inflation has affected the gross national product of Nigeria from 1999 to 2013.