Analysis Of The Determinations Of Inflation
Inflation, a fundamental concept in economics, refers to the sustained increase in the general price level of goods and services in an economy over a period of time. Several factors contribute to inflationary pressures, including monetary factors such as excessive money supply growth, fiscal policies like deficit spending, and external shocks such as changes in global commodity prices. Additionally, demand-pull inflation can arise from increased consumer spending or investment, while cost-push inflation results from rising production costs, like wages or raw materials. Moreover, expectations of future inflation can influence current price-setting behavior, leading to a self-reinforcing cycle. Central banks play a crucial role in managing inflation through monetary policy tools, aiming to strike a balance between stimulating economic growth and controlling inflationary pressures to maintain price stability. Understanding these determinants is essential for policymakers and businesses alike in navigating economic environments characterized by fluctuating inflation rates.
Inflation has become a heading topic of discussion in the Nigeria economy and other countries of the world. The press as its effect penetrates more deeply into the nation’s life. It has become something of a platitude to say that sharp, continuous increase in price is among the serious economic problems of our time. The main purpose of the study is to highlight the determinants of inflation in Nigeria and to check the trend of inflation over time (i.e. 1980 -2010) and the measures to curb it. The methodology involves the use of ordinary least square econometric techniques using PC Give econometric package. These include T-test, to test the explanatory power of the estimates, the F-test to determine the significance of the entire regression plan and the second order tests, which includes test for auto-correlation, normality test, heteroscedasticity test and multicollinearity test. The objective of the study are to determine the possible determinants of inflation rate in the country and to provide economic policies and solutions to the issue of inflation in Nigeria. The data were largely the secondary data which are collected from CBN statistical bulletin. The data are collected for inflation rate and its determinants from 1980-201o. The dependent variables are money supply, government expenditure, real gross domestic product and real exchange rate. The regression result shows that real exchange rate, Government expenditure have a negative impact on inflation while money supply and real GDP have a positive impact on inflation respectively. This implies that an increase in real exchange rate, Government expenditure will reduce inflation while an increase in money supply and real GDP will increase inflation. The researcher recommends that monetary and fiscal policies should be used to control and direct economic activities of a country to avoid inflation.
Title page
Approval page
Dedication
Acknowledgement
Abstract
Table of content
CHAPTER ONE:
1.0 INTRODUCTION
1.1 Background of the study
1.2 Statement of the problem
1.3 Objectives of the study
1.4 Research hypothesis
1.5 Significance of the study
1.6 Scope and Limitation of the study
CHAPTER TWO
2.1 LITERATURE REVIEW
2.2 Theoretical Review
2.2.1 Effects of Inflation
2.2.2 Determinant of Inflation in Nigeria
2.3 Empirical Review
2.3.1 The Nigerian recent inflationary experience
2.4 Limitations of the previous study.
CHAPTER THREE
3.0 RESEARCH METHODOLOGY
3.1 Research Design
3.2 Methodology
3.3 Model specification
3.4 Model Evaluation
3.5 Economic A’priori Criteria
3.6 Statistical Criteria or first order
3.7 Econometric Criteria or second order test
3.8 Data required and sources
CHAPTER FOUR:
4.0 DATA PRESENTATION AND ANALYSIS
4.1 Presentation and interpretation of result
4.2 Economic a’priori criteria
4.3 Statistical criteria (first order test)
4.4 Econometric criteria
CHAPTER FIVE
5.1SUMMARY OF FINDING, RECOMMENDATIONS AND CONCLUSION
5.2 Recommendations
5.3 Conclusion
Bibliography
Appendix
1.1 BACKGROUND OF THE STUDY
The avoidance of rapid increase in general price level which is inflation is one of the micro economic objectives of any economy. When the price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also refers to erosion in the purchasing power of money, a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the price inflation rate, the annualized percentage change in a general price index (normally the consumer price index) over time.
Solow (1979), for instance, sees inflation as going on when one needs more and more money to buy some representatives bundle of goods and services, or sustained fall in the purchasing power of money, a sustained rise in price level(Johnson,1972).A persistence and appreciable rise in the general level of prices(Shapiro,1994)and a continuing rise in prices as measured by an index such as the consumer price index (CPI) (Dernbury and Mc Dongall).
Robert J. Gordon (1986) describes three major types of inflation as the “triangle model” and these includes demand pull inflation, cost-push inflation and built-in inflation.
The demand pull inflation occurs when aggregate demand for goods and services is greater than the aggregate supply such that the resultant excess demand cannot be satisfied by running down on existing stocks, diverting supplies from the export market to the domestic market, increasing imports.
The cost-push also known as supply shock inflation caused by drops in aggregate supply due to increased prices of inputs, for example take for instance a sudden increase in the supply of oil, which would increase oil prices, producers for whom oil is a part of their cost could then pass is on to consumer in the form of increase prices.
Built-in inflation is induced by adaptive expectations and involves workers trying to keep their wages up with prices and firms passing their higher labour cost unto their customer as higher prices leading to a “vicious circle” The presence of inflation in a country leads to a fall in the function of money as a medium of exchange and a store of value.
The beginning of inflation in Nigeria can be said to be a direct result of policies of the country’s Governments to stimulate a fast rate of economic growth and development since 1951 when ministerial Government was introduced. Inflationary trend since independence shows the rate of inflation as been 11.4 percent in 1980,7.7 percent in 1982,23.2 percent in 1983,40 percent in 1984 and 40.9 in 1989. (Anyanwu, 1995). Inflation has continued recently to be a leading topic in Nigeria’s families and press as its effects penetrate more
deeply into the nation’s life. It has become something of a platitude to say that sharp, continuous increases in prices are among the most serious economic problem of our time.
Inflation can also be in form of galloping inflation which is a situation where by inflationary rate becomes immensurable and uncontrollable. The central bank of Nigeria (CBN) being part of the macroeconomic management agency indulges in finding out the determinants of inflation in the economy and set up the required macroeconomics policies that will help to reduce the inflationary rate in the economy.
1.2 STATEMENT OF THE PROBLEM
Inflation has a negative Impact in the economy as a whole. It is backed up with an increment with the wages and salaries of workers and also leads to fall in standards of living and economic development of the nation.
High or unpredictable inflation rate are regarded as being harmful to the overall economy. They add deficiencies in the market and make it difficult for companies to budget or plan long term. Uncertainty about the future purchasing power of money discourages investment and savings.
In Nigeria, some of the macro economic variables determining inflation are said to be real Gross Domestic Product (GDP), exchange rate, government expenditure and money supply. Therefore, the study is intended to look into the
possible determinants of inflation and recommend solutions to the inflationary trends in the Nigerian economy.
1.3 OBJECTIVES OF THE STUDY
The study has the following objectives:
1. To identify and analyses the possible determinants of inflation rate in the country.
2. To identify variables which have significant impact on inflation in Nigeria?
3. To suggest possible course of action to remedy the problem.
1.4 RESEARCH HYPOTHESIS
This hypothesis is formulated to acquire necessary information and basis assumption of the study. Hypotheses are formulated in two forms namely:
Null hypothesis (H0)
Alternative hypothesis (Hl)
Null Hypothesis
A null hypothesis is a hypothesis which states a no difference or no relationship exists between two or more variables. In fact it is a hypothesis stated in the negative direction.
Alternative Hypothesis
This is a hypothesis which specifies any of the possible conditions not anticipated in the null hypothesis. It specifies the conditions which we hold if the null hypothesis does not hold. Infact it is the hypothesis stated in the positive direction.
HO: There is a no significant relationship between inflation rate and money supply, exchange rate ,gross domestic product and government expenditure leading to a negative impact on inflation in Nigeria
HO:Ko=O
HI: There is significant relationship between inflation rate and money supply, exchange rate, gross domestic product and government expenditure leading to a positive impact on inflation in Nigeria.
HI:Kl=O
1.5 SIGNIFICANCE OF THE STUDY
This study apart from the set objectives will be important in the following ways:
1. It will help policy makers in their zeal to establish policy measures for handling the issue of inflation in Nigeria.
2. It will serve as a guide line for future research work on this particular issue.
3. It will assist policy makers to appreciate variables that impact on Nigeria inflation, with a view to manage such variables appropriately and effective.
1.6 SCOPE AND LIMITATION OF THE STUDY
This study covers a period of 30 years ,that is from 1980-2010.However,this work like another works especially in the social sciences ,has its own limitation .In the first instance ,this study will be constrained by the amount of relevant research materials and data that are available to the researcher at the time of conducting this study .More so, paucity of official data ,their reliability when ever available as well as the inconsistencies in the data published by different sources on the same topic, all pose a challenge in the conduct of this study.
Therefore, in spite of these constraints, attempt shall be made to ensure that these draw-backs do not in anyway, significantly affect the findings of this study.
Determinations Of Inflation:
Inflation is the rate at which the general level of prices for goods and services in an economy rises, leading to a decrease in the purchasing power of a currency. It is an important economic indicator that can have significant effects on individuals, businesses, and the overall health of an economy. Economists and policymakers use various methods and indicators to determine and measure inflation. Here are some key determinants and methods for measuring inflation:
- Consumer Price Index (CPI): The CPI is one of the most commonly used measures of inflation. It tracks the changes in the prices of a basket of goods and services typically consumed by an average household. By comparing the CPI over time, economists can determine the rate of inflation.
- Producer Price Index (PPI): PPI measures changes in the prices of goods and services at the producer or wholesale level. It can provide insights into inflationary pressures further up the supply chain, which can eventually affect consumer prices.
- GDP Deflator: The GDP deflator is a measure of the price level of all new, domestically produced, final goods and services in an economy. It’s used to calculate the real GDP and can indicate inflationary trends in an economy.
- Core Inflation: Core inflation excludes volatile items like food and energy prices, which can fluctuate significantly due to factors like weather and geopolitical events. This measure helps to identify the underlying inflationary trends.
- Wage Inflation: Rising wages can contribute to inflation as businesses pass on increased labor costs to consumers in the form of higher prices for goods and services.
- Demand-Pull Inflation: This occurs when there is an increase in aggregate demand (consumer spending, business investment, government spending, and net exports) that outpaces the economy’s ability to produce goods and services. When demand exceeds supply, prices tend to rise.
- Cost-Push Inflation: Cost-push inflation happens when the costs of production increase, leading businesses to raise prices to maintain their profit margins. Factors like rising energy prices, increased labor costs, or supply chain disruptions can trigger cost-push inflation.
- Monetary Policy: Central banks can influence inflation through their control of the money supply and interest rates. An expansionary monetary policy (increasing the money supply or lowering interest rates) can stimulate economic growth but may also contribute to inflation if demand grows too quickly. Conversely, a contractionary monetary policy can be used to combat inflation.
- Fiscal Policy: Government spending and taxation policies can also impact inflation. Increased government spending without corresponding revenue increases (deficit spending) can contribute to inflation if it leads to excess demand.
- Exchange Rates: Changes in exchange rates can affect inflation, especially in economies heavily reliant on imports. A depreciation of the domestic currency can increase the cost of imported goods, leading to higher prices.
- Inflation Expectations: People’s expectations of future inflation can influence their behavior. If individuals and businesses anticipate higher future prices, they may demand higher wages and raise their prices, contributing to inflation.
- Global Factors: International events, such as geopolitical conflicts, trade policies, and supply chain disruptions, can influence inflation by affecting the prices of imported goods and commodities.
In summary, inflation is a complex economic phenomenon influenced by a combination of factors, including changes in the prices of goods and services, shifts in demand and supply, monetary and fiscal policies, and external events. Economists and policymakers use various measures and indicators to assess and respond to inflationary pressures in an economy.