CAUSES OF INFLATION IN NIGERIA AND POSSIBLE SOLUTIONS

INTRODUCTION

Inflation poses one of the most serious economic problems of our time. Inflation is a problem in all facets of life and in all economic entities.  The government of any nation is concerned with the responsibility of ensuring that her plans and programme are not frustrated by unpredictable and galloping prices.  Every firm desires a stable macro-economic environment that is devoid of unrepentant price change that can bring about reliable forecast and planning.  An individual also strives that he is not worse off by unexpected price increase.  All these bring home the need to explore the study of inflation so as to form a timeless and dependable model of its tendency (Taiwo, 2011). One of the fundamental goals of a modern economic system is to keep prices of goods and services stable at rates that would not be detrimental to the economic system.  The attainment of this goal, of ensuring that prices do not rise continuously, it is very crucial in that non-attainment of the goal carries with it dire micro and macroeconomic consequences. At the microeconomic level, the unfair wealth redistribution that may accompany an upward movement of prices could encourage hoarding of unspent income, increase the cost of borrowing and therefore constrain investment spending by businessmen.  At the macroeconomic level, an upward inflationary pressure may make the export of goods and services in an economy to dwindle because the prices of tradable may become less competitive in the international markets thereby discouraging foreign purchases and consumption of such tradable.

Meaning of Inflation

The concept of inflation has been defined as a persistence rise in the general price level of broad spectrum of goods and services in a country over a long period of time. Inflation has been intrinsically linked to money, as captured by the often-heard maxim „„inflation is too much money chasing too few goods‟‟. Hamilton (2001) inflation has been widely described as an economic situation when the increase in money supply is „„faster‟‟ than the new production of goods and services in the same economy. Piana (2001) economists usually try to distinguish inflation from an economic phenomenon of a onetime increase in prices or when there are price increases in a narrow group of economic goods or services. Inflation has also been described as a general and persistent increase in the prices of goods and services in an economy. Inflation rate is measured as the percentage change in the price index (consumer price index, wholesale price index, producer price index etc).   

Types of Inflation

There are three major types of inflation according to neo-Keynesians. The first is the demand-pull inflation, which occurs when aggregate demand is in excess of available supply (capacity). This phenomenon is also known as the Phillips curve inflation. The output gap can result from an increase in government purchases, increase in foreign price level, or increase in money supply.  The second is known as cost-push inflation, „„commodity inflation‟‟ or „„supply shocks‟‟ inflation and occurs in the event of a sudden decrease in aggregate supply, owing to an increase in the price/cost of the commodity/production where there are no suitable alternatives (Thomas, 2006). This type of inflation is becoming more common today than before, as evident in the rising price of housing, energy and food. It is often reflected in price/wage spirals in firms, whereby workers try to keep up their wages with the change in the price level and employers pass on the burden of higher costs to consumers through increase in prices. The third type, referred to, as structural inflation, is built-in inflation, usually induced by changes in monetary policy.

Relationship between Inflation, Money Supply, Exchange Rate and Gross Domestic Products:  There are many studies that focused on the relationship that exist between inflation and other economic variables such as money supply, Gross Domestic Product (GDP) and Exchange rate. 

Taking from the old classical equation, an increase in the quantity of money will generate a proportionate increase in general price level.  By this, the monetarist posts a direct causality between money supply and inflation.  This school of thought insists that increase in money supply may arise from deficit government expenditure or expansionary debt financing which may combine to increase general price level.   

In Nigeria, a number of studies have been undertaken on the subject of money supply and prices.  A particular case is Ajayi (1978) who investigated the relationship between money, prices and interest rates in Nigeria.  He concluded that money is one of the significant causes of rising price level.  His finding reflected the traditional approach where the relationship between money and prices is assumed to be direct and one way.  

GENERAL CAUSES OF INFLATION ON NIGERIA ECONOMY

The causes of Nigerian inflation for some time period could be traced to several studies such as Tegene (1989), Baro (1995), Moser (1995), Bruno and Easterly (1998), Erbaykal and Okuyan (2008), Awogbemi and Ajao (2011) among others.

Changes in money supply, credit to government by banking system, government deficit expenditure, industrial production and food price indices are underlined factors that contribute to inflationary tendencies in Nigeria.  Increase in government expenditure financed by monetization of oil revenue and credit from banking system could also be responsible for the expansion of money supply which in turn (with lagged effect) contributes to inflationary tendencies. Growth in the money supply is another determinant of inflation. When money supply growth increases substantially, inflation also increases and when there is a decline in monetary growth rate, there is a strong relationship between increase in money supply and inflation. Rising cost of goods are often taken to be counter-productive and negative to an economy.  The most significant effect of inflation is its impact on the revenues of the government.  When it is higher than previously planned and thought, the revenues of the government will increase.  Inflation is also responsible for inefficiencies and non-performance of an economy.  It makes budgeting and future planning difficult for economic agents and imposes a drag on productivity, particularly when firms are forced to shift resources away from products and services thereby discouraging investment and retarding growth (Orubu,2009).

Other causes include the following:

1.The Money Supply: Inflation is primarily caused by an increase in the money supply that outpaces economic growth. Ever since industrialized nations moved away from the gold standard during the past century, the value of money is determined by the amount of currency that is in circulation and the public’s perception of the value of that money. When the Federal Reserve decides to put more money into circulation at a rate higher than the economy’s growth rate, the value of money can fall because of the changing public perception of the value of the underlying currency. As a result, this devaluation will force prices to rise due to the fact that each unit of currency is now worth less.

2. The National Debt: We all know that high national debt in Nigeria is a bad thing, but did you know that it can actually drive inflation to higher levels over time? The reason for this is that as a country’s debt increases, the government has two options: they can either raise taxes or print more money to pay off the debt. A rise in taxes will cause businesses to react by raising their prices to offset the increased corporate tax rate. Alternatively, should the government choose the latter option, printing more money will lead directly to an increase in the money supply, which will in turn lead to the devaluation of the currency and increased prices.

3. Huge Financial Outflow Spent in Prosecuting War against Terrorism: Boko Haram attacks provoked an immediate redefinition of the Nigerian national defense policy. It deployed a lot of resources to prosecute war against terror. The war on terror has many years and tens of billions of naira expended in the process. All this stretched Nigerian economy to its limit and added insult to injury to the already vulnerable economy.

4.  Cost-Push Effect: Another factor in driving up prices of consumer goods and services is explained by an economic theory known as the cost-push effect. Essentially, this theory states that when companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices. A simple example would be an increase in milk prices, which would undoubtedly drive up the price of a cappuccino at your local Starbucks since each cup of coffee is now more expensive for Starbucks to make.

5. Exchange Rates: Inflation can be made worse by our increasing exposure to foreign marketplaces. In Nigeria, we function on a basis of the value of the Naira. On a day-to-day basis, we as consumers may not care what the exchange rates between our foreign trade partners are, but in an increasingly global economy, exchange rates are one of the most important factors in determining our rate of inflation. When the exchange rate suffers such that the Nigeria currency has become less valuable relative to foreign currency, this makes foreign commodities and goods more expensive to Nigerian consumers while simultaneously making Nigeria goods, services, and exports cheaper to consumers overseas.

6. High Incidence of Fraud and Corruption: This is another factor that put stress in the system leading to its eventual collapse. Towards the build-up to the financial crisis, Nigeria began to witness an increased spate to corporate corruption and fraud. This was further worsened by complicity by audit and accounting firms. All these put pressure on the system making it more vulnerable to collapse (Oyebode,2009).

7. Devaluation of Naira and Rise in Inflation: The sharp drop in the prices of oil led to the depletion of the accumulated forex reserve to sustain imports. With time, Nigeria has no choice but to devalue its currency in the foreign exchange market. This led to increase in the prices of imported goods and worsening of the standard of living of her citizenry.

More so, other causes of inflation may occur under the following condition:

·        In the period of insurgencies (example Boko Haram) and ethnic uprising   government may resort to print more money to curb such menace.

·         In peacetime, when government engages in deficit financing (that is spending more than it collects from the public through loan and taxes.)

·         If having collected money by loan and taxes, government spends most of the fund on projects which do not directly and immediately produce consumer goods. Such projects include road works, construction of dams and airlines.

·         If the community receives more payment for the services of its factors of production than is justifies by productivity in the economy. For instance, if house rents rise sharply, landlords will receive more income. This may simulate building construction, which will pay out more money in wages, which in turn will be used compete for the purchase of the limited available consumer goods, including imports, and this will lead to price increase, a fall in the value of money, a demand for further increase in wages and so on.

SOLUTIONS

In spite of the seemingly apathetic position of the government of Nigeria in fashioning a coordinated policy action and response to inflation following solutions can mitigate the harsh realities of the crisis.

 Proper monitoring and surveillance of the Nation’s financial system: Most financial crisis stem from poor monitoring and supervision on the part of the regulators. The CBN and NDIC should dispassionately monitor the economy to ensure that financial recklessness is detected on time and nipped in the bud before they escalate into full blown crisis.  

•              Diversification of the Economy: It has become obvious that we cannot continue with our mono-product economy. In the time of crisis those with diverse sources of income stand better chances of surviving than those that depend on single product. Diversification aside from helping us cope with economic stress will facilitate increase in the national output and employment generation.

•              Creating enabling environment for doing business: The Federal Government should embark on massive invest in infrastructural development so as to create enabling environment for doing business. The excess crude should not be shared for consumption but for strategic investment to develop the nation’s infrastructure. This will increase the chances of FDI and migrant remittances flow for investment.

•              Bail-out and support for the capital market: The government should do within its power to encourage the capital market. If it can financially bail it out fine, otherwise necessary policy incentive should be used to stimulate active trading at the Nigerian Stock Exchange (NSE)

•              Support to SMES AND Massive Industrialization of the Nigerian economy: One sure way for Nigeria to overcome to challenges of unemployment, underutilization of domestic resources and industrial capacity and poor domestic output is for the government to initiate policies to encourage local manufacturers. Policies like tax incentives, strategic cluster support, entrepreneurship promotion

and financial support to SMEs could be used to stimulate private sector investor and industrialization.

Conclusion

It is very obvious that Nigerian government uses monetary and fiscal policies measures as tools for combating inflation and meeting various macro-economic objectives.  Evaluation of these policies showed that they do not work due to negligence of the correlation that exists between government expenditure, money supply and inflation.

Expenditure management and budget discipline should be taken seriously by Nigerian government.  This can be achieved by ensuring that all expenditures made match with revenue.

Nigerian government should also act productively in balancing its fiscal and monetary policy as well as institutional intervention with expectation on inflation.  This will prevent unexpected and unplanned reaction of prices which may have a counter-productive impact on the economy.

REFERENCES

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