Background to the Study
Maintaining price stability and growth together in an economy is one of the central macroeconomic policy objectives of most developing countries in the world today. Also the central objective of macro-economic policies is to foster economic growth and keep inflation on a low level. In order to promote economic growth and strengthen the purchasing power of the domestic currency for the Nigerian economy, emphasis has been laid by the Central Bank of Nigeria on maintaining stability in prices through the use of expansionary or contractionary monetary policy, (Umaru & Zubairu 2012). Inflation according to Hamilton (2015) can be defined as the rise in the level of prices maintained over a given period in an economy. It can also be seen as a situation where “too much money is chasing too few goods” In other words, it refers to the general rise in the price of various goods or services thus leading to a fall in the purchasing power of a countries currency, (Lipsey & Chrystal 1995). Inflation is an economic situation and it occurs where an increase in the supply of money is greater than the amount of goods and services produced in a country, (Piana 2002). Inflation is categorized into various degrees and they are as follows: hyperinflation (3 digits % points), extremely high inflation (50 % to 100%), chronic inflation (15% to 30%), high inflation (30% to 50%), moderate inflation (5% to 25%-30%) and low inflation (1%-2% to 5%), (Umaru & Zubairu 2012).
Consequently, the need to understand the relationship between inflation and economic growth of the Nigerian economy become imperative and the dynamics of inflation became central to the success of monetary policy to ensure the achievement of price stability. An economy where the purchasing power of money is expected to retain acceptable value, low level of Inflation is beneficial for consumers and businesses to make long term plans. An economy where inflation is low, “households” will be encouraged to purchase more goods that are durable and increase the rate at which they invest. This will lead to an increase in productivity and mass production of goods and services thus boosting economic growth. . A situation whereby inflation is on a high level is harmful to the economy because a high inflation rate has negative effects on the economic performance of general activities. Inflation in Nigeria can be traced to the “Cheap Money Policy” which started in 1960. It was a monetary policy used by the government to encourage development of key sectors in the economy after the country got her independence. It was characterized by reductions in interest rate which was targeted towards certain sectors in the Nigerian economy. This policy was implemented to aid the execution of the first national development plan and later the prosecution of the civil war. This led to increased monetary expansion with the narrow and broad measures of money stock increasing at annual rates of 29.7% in 1961 and 44% in 1969. Consequently, inflation rose from 6.4% in 1961 to 12.1% in 1969, (Bayo, 2005). There was a boom in oil revenue of the country in 1970, this led to a rise in government expenditure and aggregate demand without accompanying increase in the amount of goods and services produced domestically, thus leading to an increase in the amount of money in circulation. Monetization of oil revenue is also a factor that expanded money supply which also resulted in a rise in the general level of prices in Nigeria, (Oriavwote & Samuel 2012).
Currently, the rate inflation as of October 2016 is 18.5%. These high rates have catapulted the price of goods and services to a level which is very difficult for masses of the country to attain. Therefore, there is no clear decision on the relationship between economic growth and inflation. Different studies have been carried out on inflation and economic growth and results generated from conducted research states different views and opinions to the relationship existing between inflation and growth.
The key macro-economic development between October 2016 to March 2017 is that inflation has declined markedly in many economies over the past two years and this disinflation is broad base across countries, measures and sectors larger for tradable goods than for services. The main drivers of recent disinflation are persistent economic slack and softening commodity prices. Most of the available measures of medium term inflation expectations have not declined substantially so far. However, the sensitivity of expectation to inflation surprises an indicator of the degree of anchoring of inflation expectation has increased in countries where policy rate have approach their effective lower bounds. While the magnitude of this change in sensitivity is modest, it does suggest that the perceived ability of monetary policy to combat persistent disinflation may be diminish in these economies.