CHAPTER ONE

INTRODUCTION

1.1 Background of the study

The prominent issues in the field of macroeconomics border on the trilogy of unemployment, output growth and inflation. According to Dornbusch and Fischer (1992), as far as the topic of inflation is concerned, the policy issue is how to keep inflation low; and if it is high, how to reduce it without causing a recession. Mankiw (1997) explains the term inflation as “the overall increase in prices”. It is a fact that the problem of inflation is one that is being battled by all economies both developed and less developed although a larger brunt of its impact is felt more by less developed economies (Orji, Ugbe and Ifeanyi , 2015)

Macroeconomists and monetary policy advisors world over are convinced that more unstable prices are potentially damaging to the growth of any economy. This conviction is driven by the apperceive hypothesis advanced by Milton Friedman (1977). Friedman’s hypothesis has been approached from two angles. The first looks at the interrelationship between the inflation rate and inflation uncertainty and the latter presents an extension of the former relationship by looking at the link between inflation uncertainty and output growth (Hachicha and Lean, 2013). Friedman particularly argued that rising inflation was associated with a higher level of inflation uncertainty and this uncertainty was detrimental to growth because it rendered market price system less efficient for coordinating economic activity causing difficulty on the path of economic agents in terms of deciding how to use resources (Ndoricimpa, 2014). Friedman postulated in his argument that full employment policy objective of the government tends to increase the rate of inflation and this in turn creates a strong pressure to counter this effect, and that the perception of this pressure increases uncertainty about future course of inflation. Succinctly put, the link between inflation and inflation uncertainty according to Friedman is that a higher level of inflation leads to greater uncertainty about the future course of government policy. In a period of low inflation, policy makers will endeavor to sustain it at that level, but when inflation is high, they face a trade-off between the cost of further inflation and a resultant recession associated with disinflation (Orji et al, 2015).

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Figures from the Central Bank of Nigeria (CBN) statistical bulletin (2010) show that inflation figures in Nigeria have persistently been rising and falling in a volatile manner with values ranging from 6.12% in 1960 to 1.7% in 1970; 33.9% in 1975 to 10% in 1980; and 72.8% in 1995 to 12.4% in 2009.

Nigeria has had four major regimes of inflation rate in excess of 30% since 1970. The first of these episodes was 1975 with an inflation rate of 33.9%. The factors responsible for this development according to Doguwa and Omotosho (2011), included drought in Northern Nigeria which resultantly pushed up food prices as well as excessive monetization of the large inflow of dollars that accrued from the oil boom. Some measures adopted to curb the situation included the reduction in import duties on a relatively large number of goods and raw materials, a conscious monetary policy targeted at encouraging banks to lend more to productive sectors of the economy and setting up of the anti-inflation task force which recommended the establishment of the productivity, prices and income board. These explain the gradual decline in average inflation rate during the period 1976 – 1983.

Fig.1.1.                               Graph of inflation figures in Nigeria 1970-2012

INF

80

70

60

50

40

30

20

10

0

1975        1980        1985        1990       1995        2000        2005        2010

Source: Author’s computation (with inflation data from CBN website)

In 1984, inflation rate hit 41% as a result of the expectations of imminent devaluation of the naira. This was met with a price control response by the military regime bringing inflation rate down to

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5.5% in 1985. The fiscal expansion budget of 1988 brought about the third regime of high inflation rate which spanned from 1988 to 1989. This expansion was financed by the CBN. Increased agricultural production helped moderate inflationary pressures in 1990 as inflation rate fell to 8.2%. The fourth period which was indeed the most disturbing inflationary experience lasted about five years starting from 1992 and reaching an all-time peak of over 80% in 1995. Monetary growth and fiscal expansion were largely responsible for this. In response to this, the government strengthened stabilization measures in the economy as it entrenched effective monetary policy, fiscal discipline and exchange rate stability. This led to a drop in the inflation rate to 7.1% in 2000 from over 80% in 1995 (Doguwa and Omotosho, 2011).

A background on output growth in Nigeria from 1970 to 2012 will be helpful to throw light on how output has fared. According to Ekpo and Umoh (2015), the Nigerian economy has had a truncated history. In the period 1960-70, the Gross Domestic Product (GDP) recorded 3.1 percent growth annually. During the oil boom era, roughly 1970-78, GDP grew positively by 6.2 per cent annually - a remarkable growth. However, in the 1980s, GDP had negative growth rates. In the period 1988-1997 which constitutes the period of structural adjustment and economic liberalization, the GDP responded to economic adjustment policies and grew at a positive rate of 4 percent. In the years after independence, industry and manufacturing sectors had positive growth rates except for the period 1980-1988 where industry and manufacturing grew negatively by - 3.2 percent and - 2.9 percent respectively. The growth of agriculture for the periods 1960-70 and 1970-1978 was unsatisfactory. In the early 1960s, the agricultural sector suffered from low commodity prices while the oil boom contributed to the negative growth of agriculture in the 1970s. The boom in the oil sector lured labour away from the rural sector to urban centres.

According to Ekpo and Umoh (2015), the contribution of agriculture to GDP, which was 63 percent in 1960, declined to 34 percent in 1988. This was not because the industrial sector increased its share but due to neglect of the agricultural sector. It was therefore not surprising that by 1975, the economy had become a net importer of basic food items. The apparent increase in industry and manufacturing from 1978 to 1988 was due to activities in the mining sub-sector, especially petroleum. The economy never experienced double-digit inflation during the 1960s. By 1976, however, the inflation rate stood at 23 per cent. It decreased to 11.8 per cent in 1979 and jumped to 41 percent and 72.8 percent in 1989 and 1995, respectively. By 1998, the inflation rate

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had, however, reduced to 9.5 per cent from 29.0 percent in 1996. Between 1978 and 1986, except for 1979 and 1985 when GDP showed positive growth, the economy continued to register negative growth rates. This inevitably led to issues of high inflation, high unemployment rate and fiscal imbalance. The stabilization and austerity measures of the Shehu Shagari regime (1979-83) did not arrest the deepening crisis. The balance of payment did not improve. There was an increase in external loans which further accelerated the debt over-hang situation. It was clear that the economy was suffering from stagflation. The country's industrial capacity utilization, which was 73.6 per cent in 1981, declined consistently during the period such that by 1989, it was 31 per cent. Manufacturing which grew at 14.6 per cent in 1981 reduced to 3.2 per cent in 1989. This poor performance occurred despite various stabilization policies of the 1980s. The structure of the economy made it vulnerable to external shocks and policies. The problems were so severe that restructuring of the economy was inevitable Ekpo and Umoh (2015).Consequently, the Structural Adjustment Programme (SAP) was introduced in 1986. The programme was aimed at changing and realigning aggregate domestic expenditure and production patterns so as to minimize dependence on imports; enhance the non-oil export base, and bring the economy back on the path of steady and balanced growth.

Unfortunately the economic reform programme appeared to have only intensified speculative and trading activities rather than increasing production. The proliferation of merchant banks, finance houses, deregulation of interest rates, privatization of the economy and the new industrial policy did not bring in the needed foreign direct investments. The private sector did not live up to expectations, despite the then favourable environment. During structural adjustment, the private sector was supposed to serve as an engine of growth. Rather sadly, after eight years of structural adjustment measures and even currently, the private sector has not been able to respond adequately to the desire for increased production and output, employment and stable prices.

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