Continental J.

Social Sciences 8 (1): 22 - 33, 2015 ISSN: 2141 - 4265

©Wilolud Journals, 2015 http://www.wiloludjournal.com
Printed in Nigeria doi:10.5707/cjsocsci.2015.8.1.22.33

RESEARCH PAPER

INFLATION AND ECONOMIC GROWTH IN NIGERIA: AN IMPACT ANALYSIS

Ezeanyeji Clement I and Ugochukwu. F. Ejefobihi

Department of Economics, Faculty of Social Sciences, Chukwuemeka Odumegu Ojukwu University,
Anambra State, Nigeria.

ABSTRACT
Inflation and its effect on economic growth has been a primary concern of policy makers the
world over. Inflation is a social malady as well as a pervasive economic process whose effects
are felt by all and sundry in all sectors of the economy. As such, its growth has been the
macroeconomic problem in Nigeria that seems to be intractable. The study adopts an Ordinary
Least Square (OLS) of simple regression model in order to test the impact of inflation on
economic growth of Nigeria between 1991 and 2013. Gross Domestic Product (GDP)
represents the dependent variable while inflation rate (INF) represents the independent
variable. The debate on the effect of inflation on economic growth has remained perennial and
has attracted substantial theoretical and empirical efforts. The study recommends that the
Nigerian Government should adopt various policy measures (both monetary and fiscal) to
reduce inflation to an acceptable level.

KEYWORDS: Gross Domestic Product, Economic Growth, Inflation rate, conintegration,

Granger Causality.

Received for Publication: 23/01/15 Accepted for Publication: 14/03/15

Corresponding author: drsundayeze@gmail.com

INTRODUCTION

Inflation is a persistent increase in the prices of goods and services in an economy (Ojo 2000 as cited in Umaru and
Zubairu, 2012). Economic growth, on the other hand reflects the increase in the Gross Domestic Product (GDP) of a
country.

The growing interest in price stability as a major goal of monetary policy is an acknowledgement of the observed
phenomenon that high inflation disrupts the smooth functioning of a market economy. High inflation is known to
have many adverse effects. It imposes welfare costs on the society; impedes efficient resource allocation,
discourages savings and investment by creating uncertainty about future prices; inhibits financial development by
making intermediation more costly; hits the poor hard, and reduces a country’s international competitiveness by
making its exports relatively more expensive, thus impacting negatively on the balance of payments, and perhaps
more importantly, reduces long-term economic growth (Ghosh and Phillips, 1998; Khan and Senhadji, 2001, Billi
and Khan, 2008; Frimpong and Oteng-Abayie, 2010).

However, a considerable amount of literature examining the relationship between inflation and economic growth in
both developed and developing countries are available. Most of the literature arrived at a consensus that one of the
fundamental objective of macroeconomic policies in both developed and developing countries is to sustain high

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 Ezeanyeji and Ugochukwu: Continental J. Social Sciences 8 (1): 22 - 33, 2015

level of economic growth with a low level of inflation rate. This is because, according to (Kingman, 1995), a high
level of inflation disrupts the smooth functioning of a market economy.

However, much less agreement exists about the precise relationship between inflation and economic performance,
and the mechanism by which inflation affects economic activity at the macroeconomic level. This has generated a
significant debate both theoretically and empirically. A series of studies by Wai, 1959; Bhelia, 1960; and Johansen,
1967 found no conclusive empirical evidence for either a positive or a negative association between inflation and
economic growth. While the structuralists argue that inflation is crucial for economic growth, the monetarists posit
that inflation is harmful to economic growth (Doguwa, 2012).

The two basic aspects of the debate relate to the presence as well as nature of relationship between inflation and
growth and the direction of causality. However, the impact of inflation on economic growth cannot be
overemphasized.

Commenting on the inconclusive nature of the relationship between inflation and economic growth, Friedman
(1973) noted that some countries have experienced inflation with and without development and vice versa. Wai
(1959) argues that there is no relationship between inflation and economic growth. He noted that growth has been
possible without inflation in some countries while in others; there have been inflation without growth. Similarly,
Johansen (1967) posits that there is no convincing evidence of any clear association, positive or negative, between
the rate of inflation and the rate of economic growth. He argues that it is not inflation that determines economic
growth but the application of knowledge, through technical and managerial change and the improvement of human
capacities.

Also in a study on Nigeria’s inflation growth nexus, Chimobi (2010) investigate the existence of a relationship
between inflation and economic growth using annual data for the period 1970-2005. The study finds no co-
integrating relationship between the two variables. Using Granger Causality test, however, the study established
unidirectional causality running from inflation to economic growth. However, the studies on the nonlinear
relationship between inflation and economic growth argue that at low inflation levels, the relationship between
inflation and economic growth is non-existent or positive while at higher levels of inflation, the relationship
becomes significant and negative.

However, despite these plethora of studies both for developing and developed countries, the literature on inflation
and economic growth in Nigeria is still very scanty (Omoke, 2010). How much inflation impacted on economic
growth in Nigeria still remains a question.

The main thrust of this paper, therefore, is to empirically examine the impact of inflation on the economic growth in
Nigeria using the Ordinary Least Square method and to examine the Causality amongst the variables using the
Granger Causality Approach. The long-run relationship of the variables is evaluated using Johansen Co-integration
analysis. The rest of the study is organized as follows. Section 2 presents the review of related literature, section 3
discloses the methodology for data analysis, section 4 discussions and interpretation of the results is undertaken
while section 5 shows the conclusions and recommendations.

REVIEW OF RELATED LITERATURE

There have been extensive theoretical and empirical researches examining the relationship between inflation and
economic growth both in the content of developed and developing countries.

The growth theory literature on inflation-growth nexus in the 1950s emphasized the positive impact of inflation on
the rate of economic growth while the costs of inflation detailed in Fisher and Modighani (1978) suggested a

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 Ezeanyeji and Ugochukwu: Continental J. Social Sciences 8 (1): 22 - 33, 2015

negative association through the new growth theory mechanisms. Other strands of related literature have also argued
that the negative relationship between inflation and growth is not universal and hence non-linear.

Many studies, for example, Paul et al (1997), CBN (1974), Barro (1995), Malla (1997) etc used annual data for
some countries to examine the inflation-growth nexus, and found mixed evidences as the relationship was negative
in some countries and positive in others.

A study by Kremer, et al (2009) using panel data from 63 countries (both industrial and non-industrial countries)
confirmed the effect of inflation on long-term economic growth. Their findings revealed that inflation affected
growth when it exceeded 2 percent threshold for industrial countries and 12 percent for non-industrial countries, and
that below these levels, the relationship between inflation and economic growth was significantly positive.

Another study by Mallik and Chowdhury (2001) examining the relationship between inflation and GDP growth for
four South Asian countries (Bangladesh, India, Pakistan and Sri Lanka) found that a long-run positive relationship
exists between GDP growth rate and inflation for all four countries. There are also significant feedbacks between
inflation and economic growth as moderate inflation was found to be helpful to economic growth.

In another study by Ayyoub, Chaudhry and Farooq (2011), a negative and significant inflation growth relationship is
found to exist in the economy of Pakistan. The result of the study shows that prevailing inflation is harmful to the
GDP growth of the economy after a certain threshold level. Salian and Gopal Kumar (2010) maintain that there is a
long-run negative relationship between inflation and GDP growth rate in India.

Faria and Carneiro (2001) investigated the relationship between inflation and economic growth in the context of
Brazil which has been experiencing persistent high inflation until recently. Analyzing a bivariate time series model
(that is, vector autoregression) with annual data for the period between 1980 and 1995, they found that although
there exist negative relationship between inflation and economic growth in the short-run, inflation does not affect
economic growth in the long-run. Their empirical results also support the superneutrality concept of money in the
long run. This in turn provides empirical evidence against the view that inflation affects economic growth in the
long run.

Hodge (2005) conducted a study on the relationship between inflation and growth in South Africa in order to test
whether South African data support the findings of Gross-section studies that inflation has long-run negative effect
on growth. According to Hodge (2005), inflation drags down growth over the long-term, while in the short-run,
growth above its trend requires accelerating inflation.

Seleteng (2006) in his study seeks to estimate the optimal level of inflation, which is conducive for economic growth
in Lesotho, using quarterly time-series data set for the period of 1981 to 2004. The estimated model suggests a 10
percent optimal level of inflation above which, inflation is detrimental for economic growth.

Bruno and Easterly (1998) investigated possible relationship between inflation and economic growth using cross
country data and found that inflation has negative effect on medium to long term economic growth and showed that
the relationship in influenced by countries with extreme values.

Ahmed and Mortaza (2005) believe that moderate and stable inflation rates promote the development process of a
country, and hence economic growth as it supplements return to savers, enhances investment, and therefore,
accelerates economic growth.

However, it is observed that under modern capitalist economy, inflation remains the central contradiction of
economic growth. A neoclassical economist Tobin (1965), on his own view holds that inflation affects the economic
growth and performance.

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Inflation also impacts on consumption, salaries, wages, etc negatively and its asserts that inflation, apart from the
fact that it leads to under redistribution of income, it also reduces the hiring standard of the fixed income earners and
as such, economic growth is retarded.

Tobin (1965) postulates that an increase in inflation can result in high output, while Sidrauski (1967) showed that an
increase in inflation does neither affect neither output nor economic growth.

A study to ascertain the existence (or not) of a relationship between inflation and economic growth in Nigeria was
carried out by Omoke (2010). The study employed the cointegration and Granger Causality test while consumer
price index (CPI) was used as a proxy for inflation and the GDP as a perfect proxy for economic growth to examine
the relationship. The result of the test showed that for the periods, 1970-2005, there was no cointegrating
relationship between inflation and economic growth for Nigeria data. The results showed the same at different lags.
Unidirectional causality was seen running from inflation to economic growth showing that inflation indeed has an
impact on growth.

Also Chimobi (2010) used Nigerian data on CPI and GDP for the period 1970-2005 to the existence or not, of a
relationship between inflation and economic growth and its causality. He adopted the Johausen-Juselius
cointegration technique and Engle-Granger causality test. A stationarity was found at both 1 and 5 percent level of
significance. After testing for causality at two different lag periods (lag 2 and lag 4), he found the result suggesting
unidirectional causality running from inflation to economic growth. Thus, the study maintained that the
unidirectional causality found is an indication that inflation indeed impacts on economic growth.

Fabayo and Ajilore (2006) in their paper titled “inflation-How Much is too Much for Economic Growth in Nigeria”
using annual data from 1970-2003 suggested the existence of threshold inflation level of 6 percent for Nigeria. They
explained that above this threshold, inflation impacted negatively on the growth performance of the economy while
below it, the inflation-growth relationship is significantly positive.

In examining the impact of inflation on economic growth and development in Nigeria between 1970 to 2010,Umaru
and Zubairu (2012) found that inflation possessed a positive impact on economic growth through encouraging
productivity and output level and on evolution of total factor productivity.

The foregoing review reveals that there is a nexus between inflation and economic growth. Therefore, the impact of
inflation on economic growth of Nigeria is the target of this study.

METHODOLOGY
The study adopts an Ordinary Least Square (OLS) of simple regression model in order to test the impact of inflation
on economic growth of Nigeria between 1991 and 2013. Gross Domestic Product (GDP) represents the dependent
variable while inflation rate (INF) represents the independent variable. The data is analysed using E-View software
package.

Test of statistical significance are conducted using the F-statistics test, t-test, unit root test and co-integration test.
These tests are essential in testing the reliability of the parameter estimates.

MODEL SPECIFICATION
The model specifies that inflation (INF) impacts heavily on the economic growth of Nigeria (RGDP), which is
represented thus:

RGDP = f (INF)…………………………………………………………………(1)
This can be specifically expressed in explicit econometric (linear equation) form as:

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 Ezeanyeji and Ugochukwu: Continental J. Social Sciences 8 (1): 22 - 33, 2015

RGDP =βo+β1INF+µ……………………………………………………………(2)

Where
RGDP= Real Gross Domestic Product in Nigeria
INF= Inflation rate in Nigeria
βo= The intercept of regression equation
β1= The slope of the regression equation
µ= Error term or stochastic variables.

The presence of error term (µ) takes care of other variables that have influence on economic growth but not
specified in the model like money supply, interest rate, balance of payment, among others.

Adopting a log-linear specification taking the natural logarithm both sides of the equation and assuming linearity
among the variables give.

LRGDP = βo + β1INF + µ………………………………………………………..(3)

Also, in order to avoid a spurious regression, we subject each of the variables used to unit root (or stationary) test so
as to determine their orders of integration, since unit root problem is a common feature of most time-series data.

TEST OF BEST REGRESSION

To determine if the above model is the best model to explain this relationship, the following condition must be met:
1. R2 must be high at least above 60%
2. There will be no serial autocorrelation in the model.
3. The residual must be normally distributed.
4. There will be no heteroskedasticity in the model. In other words the model must be homoskedastic.

When all these conditions are met, the model will be regarded as the best regression model to explain the
relationship between RGDP and INF.
a. T- Statistics: It is used to test the significance of the parameter estimate at a certain level of significance. It
can test for null hypothesis against the alternative hypothesis. If the probability at which T is significant in
our regression results for any independent is less than or equal to our chosen level of significance (0.05),
we reject the null hypothesis (Ho) which states that the independent variable in question is not significant.
This invariably means accepting the alternative hypothesis (H1) which states that the independent variable
in question is statistically significant in our model.
b. F-Test: This measures the statistical significance of explanatory variable (s) in the model, which is
calculated thus:

R2 1-R2

K-1 n-k

Where R2= Co-efficient of determination

K= No of parameters (βo+β1)
N= Sample size

The degree of freedom is calculated as Df= k-1

n-k

Where k-1 is the numerator from the table and n-k is the denominator.

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UNIT ROOT TEST

This is the test of stationarity or non-stationarity under time series variables. In this case, the results suggest significant
relationship between the variables. The study employs Augmented Dickey-Fuller (ADF) tests to examine the variables in the test.
It is formulated thus:

∆Yt=pYt-1+Ut

The hypothesis test for the Unit root:

Ho: P = 0 (unit root)
H1: P ≠ 0 (no unit root)

Decision Rule: If t* < ADF critical value, reject the null hypothesis, that is, unit root does not exist.

CO-INTEGRATION TEST
This test is carried out to determine the long run relationship between the dependent and independent variables when one or more
of the variables is/are non-stationary at a level. This means, they have stochastic trend (Johansen, 1999). This test is used to
check if the independent variable (s) can predict both at present (short-run) or future (long-run). Co-integration of two or more
time series suggests that there is a long-run or equilibrium relationship between them (Gujarati and Porter, 2009). This study
adopts Johansen Co-integration test.

Apriori Expectation: This states that Nigeria’s economic growth is positively and directly influenced by inflationary trends. As
inflation increases, economic growth is retarded.

This states that economic growth in Nigeria is positively correlated or impacted by inflation.

RESULTS AND DISCUSSION

The table 1 presents data on Real Gross Domestic Product (RGDP) and inflation rate, all given in millions (naira). The table
represents a sample of the inflation and economic growth of Nigeria: An impact Analysis from 1991-2013.

Table 1: The Results of Log form of OLS Regression

Dependent Variable: RGDP
Method: Least Squares
Date:02/09/15 Time:20:09
Sample: 1991 2013
Included observations 23
Variable Coefficient Std. Error t-statistic Prob.
C 9.748160 0.340738 28.60899 0.0000
INF -0.039163 0.012375 -3.164762 0.0047

R-Squared: 0.988792; F-statistic:10.01572; Prob(F-statistic): 0.004670; Adjusted R-

squared: 0.900682; Durbin-Watson Stat: 0.364388
Source: Author’s Computation (using E-View 7.1 Output).

Functional model: RGDP=βo+β1INF +µ

Substituted coefficients:
LRGDP= 9.748160-0.039163INF+ µ

Real gross domestic product (RGDP) that is, constant, revealed that the independent variable has a negative
relationship with the RGDP. The autonomous GDP (constant) showed the level of Real Gross Domestic Product

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(RGDP) Nigeria will produce if the variable used as independent variable, that is, if inflation rate is to be held
constant, the level of real GDP in Nigeria will be 9.748160 million naira. The coefficient of β1 (inflation rate) is
negative and statistically insignificant indicating that -0.039163 inflation has negative impact on economic growth
of Nigeria.

The coefficient of determination (R2) is 0.988792, which shows 98.88% change in the independent variable
(inflation rate). The goodness of fit however explains that there exists a weak relationship between these variables,
that is, seventeen per cent of distortion in LRGDP is caused by unstable economy and not suitable for analyzing the
relationship that existed between the real GDP and the independent variables used in the model. The contributions of
these factors are captured by the error term (µ), which has 99% greater influence as shown in the analysis.

T- Statistics
The test is carried out, to check for the individual significance of the variables which statistically, the t-statistics of
the variable under consideration is interpreted based on the following statement of hypothesis.
H0: The estimated parameters are not significant.
H1: The estimated parameters are significant.

Decision Rule:
If t-calculated > t-tabulated, we reject the null hypothesis (H0) and accept the alternative hypothesis (H1), and if
otherwise, we select the null hypothesis (H0) and reject the alternative hypothesis (H1).

Level of significance = α at 5% = 0.05

Degree of freedom: N-K

Where n: Sample Size.

K: Number of Parameter.
The T-statistics is summarized in Table 2:

Table 2: T-statistic
Variables t-value t-tab Remark
LRGDP 28.60899 ±1.7 Significant
INF -3.164762 ±1.7 Significant
Source: Author’s Computation (using E-View 7.1 Output)

The t-statistics is used to test for individual significance of the estimated parameters.

Table 2 results show that real gross domestic product (LRGDP) and inflation rate (INF) are significant. However,
this proof that inflation rate have negative relationship with the LRGDP and also significant on the Nigeria’s
economic growth.

Test
From the regression analysis, the value of F-calculated is 10.01572. In other to get the F-tabulated for decision
making, the degree of freedom is calculated thus:

D.f= k–1 = 2 – 1 = Ft 0.05 = 4.32

n–k 23 – 2

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That is, 10.01572 > 4.32, F- calculated is greater than F-tabulated, and thus reject the null hypothesis (H0). This
implies that the explanatory variable (inflation rate) is statistically insignificant in explaining the variability in the
dependent variable (real gross domestic product).

Unit Root Test

Most economic variables that exhibit time series are not stationary and using non-stationary variable in the model
might lead to spurious or fake regression which cannot be relied upon for precise prediction (Gujarati and Porter,
2009). It becomes necessary to determine whether the variables are stationary, that is, whether they have
characteristics of unit root. This is done by employing Augmented Dickey – Fuller (ADF) test.

If the ADF test statistic is less than Mackinnon critical values, then we conclude that there is no unit root and thus
reject the null hypothesis (H0) and vice versa. The result of the stationarity test with trend and intercept is presented
in Table 3

Table 3: Unit Root Test

Variables ADF-Statistic Critical value Order of Integration
LRGDP -5.743972 -3.808546 2
(0.0002) -3.020686
-2.650413
INF -5.025554 -3.920350 2
(0.0012) -3.065585
-2.673459
Source: Author’s Computation (E-View 7.1 output).

From Table 3, it can be observed that real gross domestic product data in Nigeria is non-stationary at its original
level, that is, 1st difference, but becomes stationary at its 2nd difference. The ADF test for output, 2(-5.743972)
>Makinnon critical values at 1%, 5% and 10% that is, -3.808546; -3.020686; and -2.650413 respectively.

On inflation rate, the data shows non-stationarity as shown in the table. The ADF test for inflation rate, 2(-5.025554)
> Mackinnon Critical Values at 1%, 5% and 10% (- 3.920350,-3.065585,-2.673459), implying that inflation rate in
Nigeria has unit root in 2nd difference.

Co-Integration Test
Co-integration test is carried out in order to determine the long-run relationship between the dependent and
independent variables when one or all of the variables is/are non-stationary at a level, which means they have
stochastic trend. It is usually used to check if independent variable(s) can predict the dependent variable both at a
short or long-run.

The study uses Johansen (1999) co-integration econometric framework to examine long run (future) relationship
among dependent and independent variables

Table 4: Johansen Co-Integration Test

Hypothesized No. of Eigenvalue Trace Statistic Critical Value 0.05 Prob.**
CE(s)
None* 0.866011 65.03626 15.49471 0.0000
At most 1* 0.798735 28.85635 3.841466 0.0000
Source:Author’s Computation (E-view 7.1 Output)
*(**) denotes rejection of the hypothesis at 5% or 1% significance level. Trace test indicates 2 co integrating
equation(s) at 5% significance level.

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The result from Table 4 reveals that there is co-integration among two variables since the Max-Eigen Statistic value
of 65.03626 > critical value of 15.49471 at 5% level of significance. It becomes necessary to reject the null
hypothesis of none ** and conclude that there is the existence of long-run relationship among the variables (real
gross domestic product and inflation rate in Nigeria). Though the variables may wander away from themselves, but
in the long-run, they will co-integrate.

Test of Normality
6
Series: Residuals
Sample 1991 2013
5 Observations 23

4 Mean -1.81e-15
Median 0.001770
Maximum 1.435364
3 Minimum -2.936976
Std. Dev. 1.057683
Skewness -0.765637
2
Kurtosis 3.613764

1 Jarque-Bera 2.608108
Probability 0.271429

0
-3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5
Figure 1: Test of Normality

The result of the Normality test shows that Jarque-Bera value is 2.608108 with a probability of 0.271429, this
probability value, however is more than 0.05 meaning that we cannot reject the null hypothesis; instead we reject the
alternative hypothesis and accept the null hypothesis which states that the residual is normally distributed. Based on
this however we conclude that the residual is normally distributed. This result is in line with what was desired.

Heteroskedasticity Test
Table 5Heteroskedasticity Test: Breusch-Pagan-Godfrey
F-statistic 0.226151 Probability 0.6393
Obs*R-squared 0.245050 Probability 0.6206
Source: Researchers E-view 7.1 Output Result

The result of the Heteroskedasticity Test: Breusch-Pagan-Godfrey shows that the prob (F-stat) is 0.6393 while the
prob (Obs* R2) is 0.6206, these are greater than 0.05 implying that we cannot reject the null hypothesis instead we
reject the alternative hypothesis and accept the null hypothesis which states that there is no Heteroskedasticity or
there is a Heteroskedasticity in the model. Based on this, we conclude that the model is Heteroskedasticity which is
very much desirable. This however can be said to improve as a result of the introduction of log in the model.

Tests for Granger Causality

The granger causality test result between economic growth (RGDP) and inflation in Nigeria (INF) is presented in
Table 6.

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Table 6: Granger Causality between LRGDP and INF

Null Hypothesis F-Statistics Prob.
D(INF,3) does not Granger Cause D(LRGDP,3) 2.10015 0.1620
D(LRGDP,3) does not Granger Cause D(INF,3) 3.89703 0.0472
Source: Researchers E-view 7.1 output Result

The result in Table 6 reveals that INF granger cause economic growth in Nigeria. This means that economic growth
can be predicted with great accuracy by using past values of INF, all other thing remaining unchanged or held
constant. On the other hand, economic growth does not granger cause INF. This reveals a unidirectional causal
relationship between INF and economic growth in Nigeria.

From the results in Table 6, it can be seen that the regression is a best regression model. This is because it met the
four conditions required in determining the best regression: the result of R2 is very high (98.87), the model is
normally distributed, there is no serial autocorrelation in the model, and there is heteroskedasticity in the model.
Based on this, we rely on this model as the best regression model to explain the relationship between the dependent
and independent variables.

RECOMMENDATION AND CONCLUSION

Inflation growth has been the macroeconomic problem in Nigeria that seems to be intractable over the years.
Nigerian government has adopted various policy measures (both monetary and fiscal) to reduce inflation growth to
an acceptable level but all these policies seem to have no effects as the study indicates.

Having considered the impact of inflation on the economic growth of Nigeria from 1991 to 2013 covering a period
of 23 years, the study was able to establish that inflation impacted negatively on economic growth of Nigeria. An
analysis of the study shows the level of real GDP in Nigeria at 9.748160 million naira while the coefficient of β1
(inflation rate) is negative and statistically insignificant at –0.039163. This shows that inflation has impacted
negatively on economic growth of Nigeria during the years under study.

A major policy implication of this result is that concerted effort should be made by policy makers in Nigeria to
reduce inflation to the barest minimum. This could be done by adopting various policy measures (both monetary and
fiscal) to reduce inflation growth to an acceptable level. But all these policies seem to have no effects as any attempt
to solving the inflation problems would entail a trade off among other competing macroeconomic and social
variables such as employment, economic growth, balance of payments, and social safety nets etc.

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