Effect Of Inflation On Consumption Pattern Of Farming Household In Nigeria

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EFFECT OF INFLATION ON CONSUMPTION PATTERN OF FARMING HOUSEHOLD 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 expenditurefor 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 
CPIPCXRGDP
1981-19904.54-0.300.31
1991-20009.410.240.25
2001-20100.350.370.80

 

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:

  1. 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:

  1. 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.

Effect Of Inflation On Consumption Pattern Of Farming Household In Nigeria

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