Journal of
Economics and International Finance

  • Abbreviation: J. Econ. Int. Finance
  • Language: English
  • ISSN: 2006-9812
  • DOI: 10.5897/JEIF
  • Start Year: 2009
  • Published Articles: 287

Full Length Research Paper

Inflation in Nigeria: How much is the function of money?

Mbutor O. Mbutor
  • Mbutor O. Mbutor
  • Research Department of the Central Bank of Nigeria, Nigeria.
  • Google Scholar


  •  Accepted: 04 December 2013
  •  Published: 31 January 2014

Abstract

Inflation is one of the most researched concepts in economics, yet there is always a noisy room when it is discussed. Most empirical literature suggests that excessive inflation is harmful to economic growth. The emphasis   on ‘excessive’ implies that some level of inflation would have a positive association with growth. Considerable study has gone into determining the points of inflexion where inflation becomes harmful. However, monetary policy makers are confronted with a different kind of problem trying to rein in inflation. And that has to do with determining the exact portion of the changes that occur in aggregate prices that could be attributed exclusively to the growth in money supply. This is a real problem because the demand-side inclination of central banks limits their activism against inflation to control of money growth only. Therefore, it is imperative for monetary authorities to isolate the contribution of money to the dynamics of inflation in order for policy to be properly targeted.   This is the main aim of this paper using Nigeria data. The data set spanned 1970 to 2012. However, Chow tests indicated several structural breaks in inflation. The most visible break coincided with the transition to market orientation in the economy, marked by high levels of inflation that peaked in 1995. Thus, for practical policy use, the operating model separates both episodes, and emphasizes the more current period. The gross domestic product (GDP), nominal exchange rate (X), and the maximum lending rate (I) are control variables, while inflation, proxied by the consumer price index (CPI) and broad money supply (M2) are focus variables. All variables enter in logarithm forms, except interest rate. The Trace statistic and Maximum Eigen factor test detected cointegration among the variables, with at least 3 cointegrated equations. The Vector Error correction technique was therefore found suitable and applied. The impulse response function showed a persistent positive relationship between inflation and money supply. However, the variance decomposition of inflation shows that GDP was the strongest contributor to inflationary developments in Nigeria, and that money supply accounts for up to 34.5 per cent of aggregate price changes until the tenth period. The result is reflective of the nature of the Nigerian economy as the GDP nests all the structural factors that impact inflation.
 
Key words: demand for money, monetary policy; vector error correction.