On the Determinants of Inflation in Nigeria

Abstract

This paper sets out to examine the main economic determinants of inflation in Nigeria over the period 1980-2003 using quarterly data. Using, among other measures, the Hodrick and Prescott filter, inflation is decomposed into its trend, cyclical, seasonal, and, random components. Based on the time series characteristics of the variables used in the analysis, the paper adopted the generalto- specific modelling approach to investigate the main determinants of each component. The results confirm that, in the long run, inflation is largely and positively related to the level of (narrow) money supply and, marginally, to fiscal deficit. In the medium term inflation is observed to be positively related to exchange rate depreciation and the growth of money supply. In the short run, it is observed that inflation is positively related to growth in money supply and exchange rate depreciation while it is negatively related to growth in real GDP. Some marginal significance is observed for the influence of pump price adjustment of petroleum products. The paper further observes that inflation is positively related to growth in money supply, exchange rate and growth in non-oil GDP. It is further observed that money supply affects inflation in the short to long run while exchange rate is influential in the short to medium run. Since fiscal deficit and government borrowing in Nigeria are largely financed by the (central) banking system, the findings lend support to the conventional elements of a typical stabilisation programme that reducing both the budget deficit and credit to the government are crucial in fighting inflation. Finally, since the results indicate the negative impact of economic growth on inflation, structural reforms and infrastructural improvements to increase the country’s productive capacity should be considered important elements of an overall economic reform program.