THE IMPACT OF INFLATION ON PRIVATE CONSUMPTION EXPENDITURE AND ECONOMIC GROWTH IN NIGERIA

ABSTARCT

This   study   empirically   examine   the   impact   of  inflation   on  private   consumption expenditure and economic growth in Nigeria using an annual time series data spanning from 1981-2012. In this study, modern time series econometric methodology such as Unit Root  Testing,  Johansson   Co-integration   test,  Vector   error  co-integration   granger causality test(VEC)   and Vector Error Correction  Model (VECM)  where employed  to model both the long run   and   short   run   relationships   between   inflation, economic growth, interest rate as (explanatory variables) and private consumption expenditure as (dependent  variable).  Augmented  Dickey- Fuller (ADF) and Phillips–Perron  (PP) test were conducted and the results show that all the data are not stationary at a level but after  the  first  difference  they  become  stationary.  The  Johansson  co-integration  test indicates that there exists a long run relationship between the variables for the period of study.  However,  the VEC  Granger  Causality  result  shows that  inflation  is positively granger  causes  private  consumption  expenditure  for  the  period  of  study  and  there happens to be no causality flowing from inflation to economic growth, neither is there causality  from economic growth  to inflation  in the short run. However,  the  long-run model  result  shows  a negative  impact of inflation  on economic  growth  for the study period. It implies that I per cent increase in inflation will  result in 0.69 decreases in economic performance (RGDP). It   could therefore be  recommended  that Government together  with the central Bank of Nigeria   should develop and pursue prudent monetary and  fiscal  policies  that  would  aim  at  reducing  and  stabilizing  both  the  micro  and macroeconomic indicators especially inflation targeting, so as to boast the growth of the economy.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The management of the economy is a major concern of governments all over the world. Governments  of countries  feel compelled  to ensure,  through appropriate  policies  that their  economies  are  managed  to  achieve  desirable  macroeconomic  objectives.  These objectives include: price stability; economic growth;  full  employment;  and balance of payments equilibrium.  The achievement  of stable  prices and attainment  of sustainable economic growth had been the central  objectives of macroeconomic  policies for most countries in the world today. This is so because the achievement of other objectives like full  employment  and  balance  of  payment  equilibrium  are  also  determined  by  the achievement of price stability and economic growth. (Ohale & Onyema, 2002)

Economic growth is dependent upon the productive effort of a society and investment of resources. An increase in production and investment will lead to economic  growth. A country’s rate of growth can be affected by inflation through its effect on investment. An increase in inflation rate reduces the return on investment, both on physical and human capital. Lower returns mean less accumulation and innovation and hence a lower rate of growth.  Growth in output of goods and  services  is a  good  way of bringing material benefits to the citizens. This is through fostering those developments such as increased investment, technical progress, increase in demand, amongst others, which are conducive to the growth of the economy. Investment is required to maintain output per head in the face  of  an  increase  in the  size  of  labour  force.  Moreover,  increase  in  consumption expenditure makes producers to respond by increasing their capacity and by so doing, promote economic growth. Nevertheless, as the level of economic activities increase, an economy experiences growth (Ohale & Onyema, 2002; and Apere, 2006).

Private  consumption   expenditure  constitutes  the     largest     component     of     total consumption expenditure  in Nigeria  and  accounts  for  more  than  65%  of  the  Gross Domestic     Product,  GDP  (  National  Bureau  of  Statistics,  2010).     Thus,  private consumption   expenditure   is   a   core   component   of   aggregate   demand.   Although consumption is determined by other factors such as interest rate,  relative prices, capital gains, wealth, attitude and expectation and availability of  consumer credit. The major

determinant   of   consumption   expenditure   is   income.   Individuals   increase   their consumption expenditure as income increases.  A little disturbance in this component will have a far reaching effect on the nation’s aggregate demand. A consumption-led growth will in turn result into increase in production and  investment-led  growth and eventual move the economy to a higher growth  trajectory.  An increase in private consumption expenditure causes a rise in GDP,  other things being unchanged  (Mishra & Fasoranti,

2013).

The impact of inflation on private consumption and economic growth reflects through its impact on income redistribution,  profits, investments and efficiency of firms.  Inflation affects real value of wages,  salaries,  rents and interest.  The result  of this  is that the quantity of goods and services which money income can buy is affected. In other words, private consumption  can be affected  by inflation through  its  effects on real value of wages, salaries, rents and interest. The effect of inflation on profit however depends on the type of inflation. Demand pull inflation leads to an increase in the level of profits. This may therefore encourage investment. On the other hand, cost push inflation tends to squeeze profit. This is because there will be  no excess demand; and firms will find it difficult to pass along their rising cost in the form of higher prices to customers. This discourages  production.  Inflation  could  affect  economic  growth  through  its effect  on investment;  it impairs investment  if it encourages spending instead of lending. This is because it will reduce loanable funds. This is seen from the point that reduction in funds that are  loanable will lead to increase  in the rate of interest as creditor’s demand for higher returns, to guide against the falling value of money.

From  the  above,  one  can  see  that  the  impact  of  inflation  on  private  consumption expenditure and economic growth is motivated by the relevance of private consumption and economic growth and the consequences of inflation in the economy.

1.2 Statement of the Problem

The relevance of private consumption expenditure and economic growth to the economy of  any  nation  is  also  the  rationale  why  government  focuses  on  ensuring  improved standard of living and a steady rate of economic growth. The  study of the impact of inflation  on  private  consumption  and  economic  growth  however  became  necessary because; price instability may impede government’s  effort to achieve improved  living

standard  and  a  steady  growth  rate  if  not  checked  empirically  and  then  formulate appropriate  policies. The outcome of policies on inflation may be  misleading without investigating its impact on consumption and growth within a given period of time.

Governments of countries put in place different  policies and programme over time  to ensure the achievement of stable prices. Nigeria in an attempt to ensure price stability, since  the  attainment  of  independence  in 1960,  implemented  various  anti-inflationary policy measures.  From 1993 attention  and objectives  of policy  makers shifted  to the achievement of single digit inflation (Essien & Eziocha 2002). Both monetary and fiscal policies as well as wage freeze, price control, exchange  rate and other measures have been  employed  to  stem  the  tide  of  sustained  increase in the  general  price  level.  In retrospect,  it appears that in spite of these  efforts;  the achievement  of price stability objective has been limited.

Kumapayi,(2012)  reveals that over the last few decades, high inflation in Nigeria  has caused  yield  on investment  to  decline  while  government  policy objectives  has  been adversely affected as the real size of its budget shrinks with rising inflation which has hampered economic growth. On the contrary, Omotosho and Doguwa(2013) found that the periods of high inflation volatility in Nigeria are associated with periods of specific government  policy changes,  shocks  to  food  prices  and  lack of coordination  between monetary and fiscal policies.  The table  below depicts on average,  the growth rate of inflation, private consumption expenditure and economic growth.

Table 1.1: Average growth rate of inflation, private consumption expenditure and economic growth in Nigeria

Periods	Variables
	CPI	PCX	RGDP
1981-1990	4.54	-0.30	0.31
1991-2000	9.41	0.24	0.25
2001-2010	0.35	0.37	0.80

Source: Central Bank of Nigeria: Statistical Bulletin, 2012 Edition.

As it is shown in the table above, the average growth rate of consumer price index in Nigeria for the periods 1981-1990 was 4.54. It increased by 107.27% (from 4.54 to 9.41) between  the  periods  1991-2000.  This  increase  was  followed  by a sharp  decrease  of

96.28% (from 9.41 to 0.35) for the periods 2001-2010. A look at the private consumption expenditure reveal a similar trend with CPI during the periods 1991-2000, as it recorded an increase of 225%. This however was not the case between the periods 2001-2010; it increase further by 54.17%. Finally for RGDP,  the trend was different from CPI and PCX. A decrease of 19.35% was recorded during 1991-2000. For the periods 2001-2010, though similar in trend with PCX in the sense that an increase was recorded; but was still different as a tremendous  increase of 220% was observed  compared to CPI and PCX during this period.

Though, rise in prices is extrinsic in the growth process. Inflation is there with the growth of the economy and it is expected to be moderate and gradual. Stable and  low prices overtime brings about economic growth. But Nigeria’s inflation has not been moderate and gradual. For example, the increase in CPI was very high (107.27%); and during this period the average growth rate of RGDP decreased. However the period CPI decreases, the growth  rate of RGDP became  very high.  In addition,  when CPI rises during the periods 1991-2000, PCX also rises. This is however not the expectation. It is expected that prices should be stable or low  overtime to bring about economic growth; and an increases  in prices  (inflation)  should  lead  to  fall  in consumption  expenditure.  These therefore raise puzzles about the impact inflation has on private consumption expenditure and economic growth in Nigeria.

There is no doubt whatsoever that a lot of empirical studies exists on the area of impact of inflation on economic growth but few on impact of inflation on private consumption expenditure in Nigeria. Most studies conducted on the impact of inflation on economic growth used OLS and granger causality techniques (see Osuala & Onyeike, 2013; Taiwo

& Muritala, 2011; Inyiama, 2013; Chimobi, 2010; Akekere & Yousuo 2012; and Oduh,

2012). None of the studies examined  the link between inflation,  private  consumption expenditure  and  economic  growth  in  Nigeria  simultaneously.  Therefore,  this  study simultaneously  examining the impact of inflation on private  consumption  expenditure and economic  growth in Nigeria  along side with other  control variables  in the same model. Few or none of these studies adopted  vector  error correction model (VECM) techniques which this study did. The inclusion of private consumption expenditure which

in most studies reviewed by this work was omitted was found to be a significant variable in understanding the relationship between inflation and economic growth in Nigeria. The variable is important because its play a dual role in determining the relationship between inflation and economic growth. This is because of the catalyst role it plays in growing the economy of a nation; while on the other hand giving rise  to the problem of inflation. Moreover it accounts for about two-thirds of domestic final spending, and thus it is the primary engine that drives future economic growth. Thus it will be a value added to the literature, especially in Nigeria.

1.3 Research Questions

The study seeks to answer the following questions:

i.    What is the impact of inflation on private consumption expenditure in Nigeria?

ii.   What is the impact of inflation on economic growth in Nigeria?

1.4 Objective of the Study

The  broad  objective  of  this  study  is  to  examine  the  impact  of  inflation  on  private consumption  expenditure  and  economic  growth  in  Nigeria.  The  Specific  objectives include:

i.         To examine the impact of inflation on private consumption  expenditure  in

Nigeria.

ii.        To examine the impact of inflation on economic growth in Nigeria.

1.5 Research Hypothesis

The study shall be guided by the following hypotheses which are stated in their null forms:

H01: inflation has no significant impact on private consumption expenditure in Nigeria. H02: inflation has no significant impact on economic growth in Nigeria.

1.6 Significance of the Study

This study is relevant for the fact that it will simultaneously establish the link between inflation, private consumption expenditure and economic growth in Nigeria, which very few or no study has examined. The methodological approach adopted for the study is also

new to study based on empirical findings  related to Nigeria. The inclusion of  private consumption expenditure which in most studies reviewed by this work was omitted was found to be a significant variable in understanding the relationship between inflation and economic growth in Nigeria. The variable is important because its plays a dual role in determining the relationship between inflation and economic growth. This is because of the catalyst role it plays in growing the economy of a nation; while on the other hand giving rise to the problem  of  inflation.  Moreover  it accounts  for about  two-thirds  of domestic final spending,  and  thus it is the primary engine that drives future economic growth. Thus it will be a value added to the literature, especially in Nigeria.  The results of the study will be significant to the monetary authorities. This is because it will provide relevance  information on the effect of inflation on the variables under study. In other words, it will reveal the effectiveness of her policy on price stability as a macroeconomic policy objective. The study would also serve as guide to the monetary authorities on the appropriate policies to adopt and at any given time. The results of the study will also be relevance to government and other stakeholders as well as policy makers. This is because it will reveal the performance of the monetary authorities. This therefore will enable the government to take appropriate decision on whether to change leadership of the current monetary authority or not.  Finally, the results of the study will also provide a platform for further studies on inflation, private consumption and economic growth.

1.7 Scope of the Study

This research work is concentrating on the Nigerian economy. For relevance and in-depth analysis, the study intends to investigate empirically the impact of inflation on private consumption expenditure, and economic growth in Nigeria with data spanning from 1981 to 2012.  The choice  of this period of reference  is  significant  because  inflation trend within the period under study constitute a  matter  of serious policy consideration.  The period  witnessed  a  steady  and  positive  growth  in  money  supply.  The  period  also encompasses the major landmark in our national economy; between 1981 to early part of

2001,  stringent  economic  stabilization  measures  were in operation  as a result  of  the dramatic down-turn of the international oil prices. Availability of data is an  important factor that was considered in choosing the terminal year of 2012. This study intends to use the following variables: CPI as proxy for inflation, real GDP as a proxy for economic growth, and private consumption expenditure as the main variables while interest rate is used as control variables.

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