CAUSES, EFFECT AND SOLUTION TO INFLATION IN NIGERIA: A CASE STUDY OF EDO STATE

CHAPTER ONE

INTRODUCTION

BACKGROUND TO THE STUDY

The word inflation rings a bell in the market economics of the world. It is a monster that threatens all economics because of its undesirable eects. The problem of inflation surely is not a new phenomenon. It has been a major problem in the country over the years.Inflation is defined as a generalised increase in the level of price sustained over a long period in an economy (Lipsey and Chrystal, 1995). Inflation is a household word in many market oriented economics. Although several people, producers, consumers, professionals, non-professionals, trade unionists, workers and the likes, talks frequently about inflation particularly if the malady has assumed a chronic character, yet only selected few knows or even bother to know about the mechanics and consequences of inflation. Aer an appreciable economic performance in the early 1970s, the Nigeria economy witnessed some anxious moment in the late 1970s to mid 1980s. Severe pressures built up in the economy mainly because of the expansionary fiscal policy of the federal government during these years. This was accompanied by high monetary expansion as the huge government deficit was financed largely by the Central Bank of Nigeria. This was exacerbated by the transfer of government sector deposits to the banks and the resultant increase in their free reserves with adverse consequences on the general price level.

The inflationary pressure was further aggravated by high demand for imports of both intermediate inputs and consumer goods due to over valuation of the naira which made imports relatively cheaper than locally manufactured goods. In this case, the impediments to development may be referred to as cost. Economics theory, however, postulates that for the profit to be maximized, cost should be minimized. One of the main cost is inflation, which has turned into a canker worm eating deep into the nation’s path of economic progress. However, as fiscal discipline was restored in the second half of 1999, the pressures on the exchange rate and domestic prices moderated significantly. The economy faced renewed pressures and some uncertainty towards the end of the year as the C.B.N gradually relaxed its tight monetary policy. Undoubtedly one of the macroeconomic goals which the government strives to achieve is the maintenance of stable domestic price level. This goal is pursued in order to avoid cost of inflation or deflation and the uncertainty that follows where there is price instability (Salam et al, 2006). The eects of inflation on economic growth will be examined bearing in mind that a country will grow faster in real terms if inflation is reduced to a barest minimum. Perhaps it should be mentioned here that inflation is not incompatable with growth.

STATEMENT OF THE PROBLEM

There is almost a universal consensus that macroeconomic stability, specifically defined as low inflation, is positively related to economic growth. Over the years the question of the existence and nature of the link between inflation and growth has been the subject of considerable interest and debate (Erbaykal and Okuyan, 2008). Although the debate about the precise relationship between these two variables is still open, the continuing research on this issue has uncovered some important results. In particular, it is generally accepted that inflation has a negative effect on medium and long-term growth (Bruno and Easterly, 1998). Inflation impedes efficient resource allocation by obscuring the signalling role of relative price changes, the most important guide to efficient economic decision-making (Fischer, 1993). If inflation is inimical to growth, it obviously follows that policymakers should aim at a low rate of inflation. But how low should inflation be? Should it be 10 percent, 5 percent, or for that matter, zero percent? Or put in other words, is there a level of inflation at which the relationship between inflation and growth become negative? The empirical test of the impact of inflation on the Nigerian economy which is the subject matter of this study shall provide precise answer to the relationship between inflation and growth and how the problem could be tackled.