TITLE PAGE

ANALYSIS OF THE DETERMINATIONS OF INFLATION IN NIGERIA

(1980-2010)

BY

MUHAMMAD HALIMATU-SADIYA MUSA

EC/2009/716

A PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENT FOR THE AWARD OF BACHELOR OF SCIENCE
(B.Sc) DEGREE IN ECONOMICS

DEPARTMENT OF ECONOMICS
FACULTY OF MANAGEMENT AND SOCIAL SCIENCES
CARITAS UNIVERSITY AMORJI-NIKE, ENUGU STATE

AUGUST, 2013

i
 APPROVAL PAGE

This project work has been approved as meeting the requirements of the

Department of Economics, Caritas University, Amorji-Nike, Enugu for the

award of Degree (B.Sc).

……………………….. ………………………
MR. EZEKIEL .O. UCHE DATE
(PROJECT SUPERVISOR)

……………………….. ………………………
BARR. P.C. ONWUDINJO DATE
(HEAD OF DEPARTMENT)

……………………….. ………………………
DR. C.C. UMEH DATE
(DEAN, FACULTY OF MGT
& SOCIAL SCIENCE)

……………………….. ………………………
EXTERNAL EXAMINER DATE

ii
 DEDICATION

This project work is dedicated to the God almighty who gave me the wisdom,

knowledge, understanding, guidance, and protection throughout my stay in

Caritas University.

iii
 ACKNOWLEDGEMENT

I acknowledge the Almighty God for his guidance and protection

throughout my stay in Caritas University.

My immense gratitude goes to my unique parents Alhaji and Hajiya Musa

Muhammad who see education as the best gift you can offer a child. I thank

them so much for their financial and moral support throughout these period of

study.

I am grateful to Mr Ezekiel .O. Uche, my project supervisor for his

patience and advice that led to the success of this work. I am equally grateful to

my Head of Department Barr. Onwudinjo, my lecturers, Prof. Onah, Prof.

Udabah, Dr. Umeadi, Mr Ojike, Chief. Odike, Mr Odo, Mr Osodiuru, Mr

Odionye, for all their efforts throughout these four years of study.

I thank my siblings Abdulazeez, Shamsudeen, Sharifatu, Abbah and my

cousins Waheedah, Ibrahim, Aisha. I also thank my course mates and friends

Hajiya Aisha Kabiru, Abdul, Ahmed, Hikmah, Habiba, Jesam, Emem,

Francisca, Chinasa, Amaka, Austine, Chineze Miracle, Amaka, Nnamdi, Izu,

Sanusi, Uthman and Zuwwaira. God bless you all.

Muhammad Halimatu-sadiya
August, 2013

iv
 ABSTRACT
Inflation has become a heading topic of discussion in the Nigeria economy and
other countries of the world. The press as its effect penetrates more deeply into
the nation’s life. It has become something of a platitude to say that sharp,
continuous increase in price is among the serious economic problems of our
time. The main purpose of the study is to highlight the determinants of inflation
in Nigeria and to check the trend of inflation over time (i.e. 1980 -2010) and the
measures to curb it. The methodology involves the use of ordinary least square
econometric techniques using PC Give econometric package. These include T-
test, to test the explanatory power of the estimates, the F-test to determine the
significance of the entire regression plan and the second order tests, which
includes test for auto-correlation, normality test, heteroscedasticity test and
multicollinearity test. The objective of the study are to determine the possible
determinants of inflation rate in the country and to provide economic policies
and solutions to the issue of inflation in Nigeria. The data were largely the
secondary data which are collected from CBN statistical bulletin. The data are
collected for inflation rate and its determinants from 1980-201o. The dependent
variables are money supply, government expenditure, real gross domestic
product and real exchange rate. The regression result shows that real exchange
rate, Government expenditure have a negative impact on inflation while money
supply and real GDP have a positive impact on inflation respectively. This
implies that an increase in real exchange rate, Government expenditure will
reduce inflation while an increase in money supply and real GDP will increase
inflation. The researcher recommends that monetary and fiscal policies should
be used to control and direct economic activities of a country to avoid inflation.

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 TABLE OF CONTENT

Title page........................................................................................................... i
Approval page ................................................................................................... ii
Dedication ......................................................................................................... iii
Acknowledgement ............................................................................................ iv
Abstract ............................................................................................................. v
Table of content ................................................................................................ vi

CHAPTER ONE: INTRODUCTION

1.1 Background of the study ............................................................................. 1
1.2 Statement of the problem ............................................................................ 3
1.3 Objectives of the study................................................................................ 4
1.4 Research hypothesis .................................................................................... 4
1.5 Significance of the study ............................................................................. 5
1.6 Scope and Limitation of the study .............................................................. 6

CHAPTER TWO
2.1 Literature Review........................................................................................ 7
2.2 Theoretical Review ..................................................................................... 7
2.2.1 Effects of Inflation ................................................................................... 11
2.2.2 Determinant of Inflation in Nigeria ......................................................... 13
2.3 Empirical Review........................................................................................ 16
2.3.1 The Nigerian recent inflationary experience ........................................... 17
2.4 Limitations of the previous study. .............................................................. 20

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CHAPTER THREE
3.0 Research Methodology ............................................................................... 22
3.1 Research Design .......................................................................................... 22
3.2 Methodology ............................................................................................... 22
3.3 Model specification ..................................................................................... 23
3.4 Model Evaluation ........................................................................................ 23
3.5 Economic A’priori Criteria ......................................................................... 24
3.6 Statistical Criteria or first order .................................................................. 25
3.7 Econometric Criteria or second order test .................................................. 26
3.8 Data required and sources ........................................................................... 27

CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS

4.1 Presentation and interpretation of result ..................................................... 28
4.2 Economic a’priori criteria ........................................................................... 29
4.3 Statistical criteria (first order test) .............................................................. 30
4.4 Econometric criteria .................................................................................... 33

CHAPTER FIVE
5.1 Summary of finding, Recommendations and Conclusion .......................... 38
5.2 Recommendations ...................................................................................... 39
5.3 Conclusion ................................................................................................. 40
Bibliography...................................................................................................... 41
Appendix ..........................................................................................................

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 CHAPTER ONE

1.1 BACKGROUND OF THE STUDY

The avoidance of rapid increase in general price level which is inflation is

one of the micro economic objectives of any economy. When the price level

rises, each unit of currency buys fewer goods and services. Consequently,

inflation also refers to erosion in the purchasing power of money, a loss of real

value in the internal medium of exchange and unit of account in the economy. A

chief measure of price inflation is the price inflation rate, the annualized

percentage change in a general price index (normally the consumer price index)

over time.

Solow (1979), for instance, sees inflation as going on when one needs

more and more money to buy some representatives bundle of goods and

services, or sustained fall in the purchasing power of money, a sustained rise in

price level(Johnson,1972).A persistence and appreciable rise in the general level

of prices(Shapiro,1994)and a continuing rise in prices as measured by an index

such as the consumer price index (CPI) (Dernbury and Mc Dongall).

Robert J. Gordon (1986) describes three major types of inflation as the

“triangle model” and these includes demand pull inflation, cost-push inflation

and built-in inflation.

1
 The demand pull inflation occurs when aggregate demand for goods and

services is greater than the aggregate supply such that the resultant excess

demand cannot be satisfied by running down on existing stocks, diverting

supplies from the export market to the domestic market, increasing imports.

The cost-push also known as supply shock inflation caused by drops in

aggregate supply due to increased prices of inputs, for example take for instance

a sudden increase in the supply of oil, which would increase oil prices,

producers for whom oil is a part of their cost could then pass is on to consumer

in the form of increase prices.

Built-in inflation is induced by adaptive expectations and involves

workers trying to keep their wages up with prices and firms passing their higher

labour cost unto their customer as higher prices leading to a “vicious circle” The

presence of inflation in a country leads to a fall in the function of money as a

medium of exchange and a store of value.

The beginning of inflation in Nigeria can be said to be a direct result of

policies of the country’s Governments to stimulate a fast rate of economic

growth and development since 1951 when ministerial Government was

introduced. Inflationary trend since independence shows the rate of inflation as

been 11.4 percent in 1980,7.7 percent in 1982,23.2 percent in 1983,40 percent

in 1984 and 40.9 in 1989. (Anyanwu, 1995). Inflation has continued recently to

be a leading topic in Nigeria’s families and press as its effects penetrate more

2
deeply into the nation’s life. It has become something of a platitude to say that

sharp, continuous increases in prices are among the most serious economic

problem of our time.

Inflation can also be in form of galloping inflation which is a situation

where by inflationary rate becomes immensurable and uncontrollable. The

central bank of Nigeria (CBN) being part of the macroeconomic management

agency indulges in finding out the determinants of inflation in the economy and

set up the required macroeconomics policies that will help to reduce the

inflationary rate in the economy.

1.2 STATEMENT OF THE PROBLEM

Inflation has a negative Impact in the economy as a whole. It is backed up with

an increment with the wages and salaries of workers and also leads to fall in

standards of living and economic development of the nation.

High or unpredictable inflation rate are regarded as being harmful to the

overall economy. They add deficiencies in the market and make it difficult for

companies to budget or plan long term. Uncertainty about the future purchasing

power of money discourages investment and savings.

In Nigeria, some of the macro economic variables determining inflation

are said to be real Gross Domestic Product (GDP), exchange rate, government

expenditure and money supply. Therefore, the study is intended to look into the

3
possible determinants of inflation and recommend solutions to the inflationary

trends in the Nigerian economy.

1.3 OBJECTIVES OF THE STUDY

The study has the following objectives:

1. To identify and analyses the possible determinants of inflation rate in the

country.

2. To identify variables which have significant impact on inflation in

Nigeria?

3. To suggest possible course of action to remedy the problem.

1.4 RESEARCH HYPOTHESIS

This hypothesis is formulated to acquire necessary information and basis

assumption of the study. Hypotheses are formulated in two forms namely:

Null hypothesis (H0)

Alternative hypothesis (Hl)

Null Hypothesis

A null hypothesis is a hypothesis which states a no difference or no relationship

exists between two or more variables. In fact it is a hypothesis stated in the

negative direction.

4
Alternative Hypothesis

This is a hypothesis which specifies any of the possible conditions not

anticipated in the null hypothesis. It specifies the conditions which we hold if

the null hypothesis does not hold. Infact it is the hypothesis stated in the

positive direction.

HO: There is a no significant relationship between inflation rate and money

supply, exchange rate ,gross domestic product and government expenditure

leading to a negative impact on inflation in Nigeria

HO:Ko=O

HI: There is significant relationship between inflation rate and money supply,

exchange rate, gross domestic product and government expenditure leading to a

positive impact on inflation in Nigeria.

HI:Kl=O

1.5 SIGNIFICANCE OF THE STUDY

This study apart from the set objectives will be important in the following ways:

1. It will help policy makers in their zeal to establish policy measures for

handling the issue of inflation in Nigeria.

2. It will serve as a guide line for future research work on this particular

issue.

5
 3. It will assist policy makers to appreciate variables that impact on Nigeria

inflation, with a view to manage such variables appropriately and

effective.

1.6 SCOPE AND LIMITATION OF THE STUDY

This study covers a period of 30 years ,that is from 1980-

2010.However,this work like another works especially in the social sciences

,has its own limitation .In the first instance ,this study will be constrained by the

amount of relevant research materials and data that are available to the

researcher at the time of conducting this study .More so, paucity of official data

,their reliability when ever available as well as the inconsistencies in the data

published by different sources on the same topic, all pose a challenge in the

conduct of this study.

Therefore, in spite of these constraints, attempt shall be made to ensure

that these draw-backs do not in anyway, significantly affect the findings of this

study.

6
 CHAPTER TWO

2.1 LITERATURE REVIEW

INTRODUCTION: Cookey A. E. (1998) says that this is a process of

summarizing, paraphrasing and for commenting on the theories, methods and

findings that are related to a topic or research problem.

Samuelson (1979) stated that “How we perceive the observed facts depends on

the theoretical spectacle we wear”. Facts according to him might tell a different

story to scientific observes. This statement is relevant in the review of causes of

inflation in macroeconomic environments because these are theories being

identified as causes of inflation by some scholars. Therefore a review of

relevant literature is necessary.

2.2 THEORETICAL REVIEW

Inflation is a central issue to policy makers and analysts. High inflation

rate can exert on domestic macro-economic condition with potential of deviate

the economy from the path of sustainable growth and development. For a

developing economy, like Nigeria, characterized by significant structural

imbalances and uncertainties and sight to the dynamics of inflation is very

pertinent. It has been for decades threatening to be in future one of the most

crucial macro economic problems facing most countries in the world. For most

countries the maintenance of price stability continues to be the overriding

objective of monetary policy. This objective of monetary policy is to ensure

7
sustainable growth and development as well as strengthen the purchasing power

of the domestic currency, among others. Addeji O. S. (2004). “Inflation

Dynamics in Nigeria”.

According to Hamilton (2001), inflation is an economic situation when

the increase in money supply is “faster” than the new production of goods and

services in the economy.

Piana (2001) says that it is when price increases in a narrow group of

economic goods or services.

Ojo (2000) and Melberg (1992) say it is a general and persistent increase

in the prices of goods and service in the economy.

Paul A. Samuelson and William D. Nordhaus (N.D) say inflation occurs

when the general level of prices and cost is rising, when there is cost-push,

increase in cost of raw materials which has effect in increase in price and also

when demand for certain project increase, it leads to an increase within the

economy.

In recent times, there have been three dominant schools of thought on the

causes of inflation:

1) The neo-classical/ monetarist school

2) The neo-keynesian school

3) The structuralists school

The monetarists following the quantity theory of money (QTM) have

propounded that the quantity of money is the main determinant of the price

8
level. The quantity theory of money is traceable to bring fishers famous

equation of exchange.

MV = PQ - - - - - (1)

Where M = stock of money

V = velocity of circulation of money

Q = volume of transactions which take place within the given period

P = general price level in economy.

Transforming the equation by substituting y (total amount of goods and services

exchanged for money) for Q, the equation now becomes:

MV = Py - - - - - (2)

The monetarist emphasize that any change in the quantity of money affects only

the price level or the monetary side of the economy with the real sector of the

economy totally insulated. This indicates that changes in the supply of money

do not affect the real output of goods and services but their values or the prices

at which they are exchanged only.

The Neo-Keynesians attributes inflation to diminishing returns of

production. This occurs when there is an increase in the velocity of money and

an excess of current consumption over investment.

It combines both aggregate demand, supply, and assumes a Keynesian

view on the short run and a classical view on the longrun. It focuses on

productivity signals diminishing returns to scale consequently induces

inflationary pressures, resulting mainly from overheating of the economy and

9
widening output gap, from the neo-Keynesian perspective, budget deficit do not

cause inflation. What causes inflation are reduction in efficiency caused by

excessive present consumption versus investment.

A major development under this theory is the concept of potential output

which at times is referred to as the natural output. This level of output also

corresponds to natural rate of unemployment or what is called the non-

accelerating inflation rate of unemployment (NAIRU).

According to the Neo-Keynesians, inflation depends on the level of

potential output or natural rate of unemployment.

The Neo-Keynesians identified three major types of inflation namely:

1) The demand pull inflation

2) The cost push inflation

3) The structural inflation

The demand pull inflation occurs when aggregate demand is excess of

available supply. This phenomenon is also known as “Philips Curve” inflation.

The output gap can result from an increase in government purchases, increase in

the foreign price level or increase in money supply.

The cost-push inflation also known as the “commodity inflation” or

“supply stock” inflation occurs in the event of a sudden decrease in aggregate

supply owing to an increase in the price/ cost of the commodity or production

where there is no suitable alternative (Thomas, 2006). This type of inflation is

10
becoming more common today than before as evident in the rising price of

housing, energy and food.

The structural inflation is the budget inflation usually induced by changes

in monetary policy. The structuralists attribute the cause of inflation to

structural factors and underlying characteristics of an economy (Adamson

2000).

Asogwa (1991:242) says that structural inflation is said to result from the

supply shocks including insufficient foreign exchange supply for financing

importation.

Anyanwu (1993) says that structuralists explain the longrun inflationary

trend in developing nations in terms of certain structural rigidities, foreign

exchange constraint, fall in export earnings, hoarding, political instability etc.

The structuralists argue that urbanization and rising incomes may be met

by the agricultural sector is poor because of the structural constraints within that

sector and inelastic supply constitutes a structural inflationary factor.

2.2.1EFFECTS OF INFLATION

Inflation has both negative and positive effects as discussed below:

1) Discourages savings: Inflation discouragessavings which leads to low

capital formation. During the period of inflation, people are discouraged

from saving because money looses it’s value daily there by making people to

spend more of their income on goods and services. instead they invest their

11
 money on investments likely to have stable values. This is a negative effect

of inflation.

2) Employment:It generates or creates full employment. Afolabi(1990:109)

argued that some form of inflation is desirable in an economy because it

generates or creates employment for the unemployed masses. During this

type of inflation, employers will be willing to absorb more people when

profit is rising, thus reducing the rate of unemployment to the minimum. The

argument is supported by the Philip’s curve, which defines a trade off

between therate of inflation and unemployment. This is a positive effort of it.

3) Redistribution of Income and Wealth: Inflation increases the effect of

inequality in the distribution of income and wealth by taking income from

poor and weak and giving to the strong and rich business men, making the

poor impoverished. This is a negative effect of it.

4) Gainful to Debtors: During the period of inflation; borrowers or debtors

benefits as the expense of the lenders or creditors. Inflation reduces the value

of money and debtors pay back money which has less value compared with

the one they borrowed thereby making creditors to loose.

5) Industrial Unrest: Inflation also brings about industrial unrest because

workers anticipate a further rise in price, trade unions get into the habit of

asking for wage increase and attempt by employers to resist such demands

may lead to industrial unrest. This is a negative effect of inflation.

12
2.2.2 Determinants of Inflation in Nigeria

Odusola and Akinlo(2001) showed that inflation in Nigeria was largely

determined by the absence of fiscal prudence on the part of government.

Asogwa (1991) noted this view and concluded that industrial output, net

export, current money supply, exchange rate changes and domestic food prices

were key determinants of inflation in Nigeria.

(Adamson 2000, Mashal 2000) concluded that backward and forward

looking expectations, growth in broad money, rate of exchange of the real

income and price violability were the variables that influence inflation

behaviour in Nigeria.

Other determinants of inflation can be referred to as:

1) Excessive Deficit- financing and rapid increase in Government

Expenditure:

Government experiences deficit financing when it spends more than it

receives through taxation and other sources. Government borrows more money

to meet government expenditure. This increase the volume of money leads to

increase in price level if it is not matched by increase in productivity. In Nigeria

increased government expenditure has been a major cause of inflation in the

annual budget.

13
2) Hoarding and Black market created by the Activities of Middlemen and

Monopolist:

Hoarding and black market are common practices in a developing

economy because future prices are taken into consideration when presen buying

and selling are being made. If future prices are expected to be higher, then

consumers will tend to buy more at the present prices and hoard the goods.

There are too many middlemen in the chain of distribution of goods and

services in Nigeria who have too much love for money and therefore hoard

available commodities in order to sell at higher prices. The sellers in turn at

perceiving that future prices will be higher hoard some of the products being

supplied to them with the aim of selling them at higher prices in future. This

creates artificial shortage of supply and the goods will be sold to consumers

willing to buy higher prices at that point in time rather than in future. A “black

market” is created and this can be seen in the sell of petroleum products

especially fuel and kerosene in Nigeria.

Therefore hoarding creates artificial shortage of essential commodities

and drives prices up. On the aspect of money, some people who have influence

from government quarters monopolize the supply of essential goods thereby

selling at higher prices than themarket price.

3) Increase in the population:

Increase in population without a corresponding increase in the production

of goods and services leads to inflation. Nigeria as a nation increase in

14
population everyday due to illiteracy especially in the rural areas in which

majority of the dwellers gives birth to up to ten children whereas they will be

able to cater for only two.

An increase in population growth increases the demand for goods and

services andsince there is no corresponding increase in supply, the demand pull

inflation is experienced which occurs when demand exceeds supply.

4) Sharp Depreciation of the Naira Exchange Rate:

Exchanging rate is the price of one country’s currency expressed in terms

of other currencies. In Nigeria, the demand for foreign currencies is high

especially the British pound sterling and American dollar. In 2008, the British

pound was N250 for one British pound through it fluctuates depending on the

state of the economy. Importers on the other hand raise the prices of goods and

this is turn leads to inflation pressures in Nigeria as well (Gbosi 2000).

5) Low Domestic Productivity in both the Industrial and Agriculture

sectors:

Shortage of capital, adequate manpower, poor infrastructural facilities

like poor road network leads to low domestic productivity in both industrial

Agricultural sector. This low productivity leads to shortage of agricultural

products such as food stuffs like garri, rice, yam, vegetables etc.

6) Printing of High powered Money:

This is a situation in which people in secret societies, have various means

of getting millions or billions of naira which are brought into circulation without

15
detection. This type of money supply can neither be controlled by using fiscal or

monetary policy. They spend their money unnecessarily with regard to its effect

in the economy and such spending fuels the inflationary pressure in Nigeria

economy because such money is spent on luxuries instead of productive

ventures in Nigeria.

7) Removal of subsidies on Petroleum Products and Fertilizer:

There was a reduction in government expenditures subsidies on

petroleum products in 1990 including petrol, kerosene, gas, diesel, oil and fuel

oil. This may lead to increase in inflationary spiral in Nigeria (Anyanwu 1990).

There was also a reduction in subsidy on fertilizer. (NPK). In 1989 and 1990

which led to higher farm production cost lowering output and increasing prices

of food stuffs.

8) Expansion of the Private sector:

The expansion of the private sector also tends to raise the aggregate

demand. For huge investment increase employment and income, thereby

creating more demand for goods and services. But it takes time for the output to

enter the market. This leads to rise in prices. Ubiele A. (1997) “Determinants of

inflation”.

2.3 EMPIRICAL REVIEW

Nigeria as a nation depends highly on the oil sector which provides about

20% of GDP: 95% of foreign exchange earnings and 65% of budgetary

revenues. The attention given to agricultural sector is low in respect to the oil

16
sector. The peasant farmers who constitute the bulk of the labour force cannot

fully adjust prices of the agricultural products due to low price, elasticity of

supply.

In Nigeria, inflation is on the increase and policy measures are to be taken

to control it in the economy. Onwioduokit E. A. (1999) “fiscal deficits and

inflation Dynamic in Nigeria.

2.3.1 THE NIGERIAN INFLATIONARY EXPERIENCE

Inflation is used to describe the persistent rise in the general prices of

goods and services in an economy.

Adebayo (1999) identifies three commonly applied indexes in the

measurement of inflation, these are the Consumer Price Index (CPI) Wholesale

Price Index (WPI), and Gross National Product (GNP), implicit price deflation.

In Nigeria presently, the CPI is adopted during laspeyre’s formula. CPI

measures changes in the retail price of selected basket of goods and services in

both rural and urban area.

But some economists recently argue that price indexes may not measure

inflation rate accurately. For instance, Boskin et al (1998) argues that the CPI

often neglected improvements in the quality of goods and services. the

implication of this argument is that price index tend to overstate inflation rate

and thus, understate inflation rate and thus understate economic growth.

17
However price indexes are still widely used to quantity inflationary phenomena

since no empirical study has confirmed significant over statement of inflation.

Economists generally believe that every economy that desires rapid

economic growth requires a low rate of inflation to serve as a stimulus to

investment and spur development.

From the stand point of causal factors, three main types of inflation

identified in literature are demand pull, cost push, and structural inflation.

Demand-pull inflation occurs when there in excessive demand for goods

and services arising from excessive monetary creation usually from sustained

pursuit of expansionary fiscal and monetary policies.

Cost-push inflation on the other hand is initiated by increase in the cost of

production.

The structuralists conception practice of inflation is the long term/ run

inflation. Inflation trend in developing countries, engendered by structural

rigidities, market impetrations and social tensions (relative in elasticities of food

supply, foreign exchange constraints, protective measures, hoarding, political

instability etc).

According to Onwioduokit (1999), a number of empirical studies carried

out for various time periods to ascertain the causes of inflation in Nigeria

established some significant positive relationship between inflation and factors

such as growth of money supply, growth in bank credit and government deficit

expenditure. For effective control of inflation, the orthodox Keynesians

18
emphasized restrictive fiscal policy to reduce aggregate demand, while the

orthodx monetaries argued for tight monetary policy to slow down the growth

of rate of money supply.

Inflation rate from 1980-1987 was 16.11, 17.40, 6.94, 38.77, 22.63, 1.03,

13.67 and 9.69 respectively. Episodes of inflation in Nigeria during the period

spanning 1988-2003 can be chronicled into the following time phases: 1988-

1989, 1992-1996, 1997-2000 and 2001-2003.

The Nigerian economy recorded relatively low inflation rate averaged

10.2 percent during the period 1990-1991. The main factors are improved food

supply and tight monetary policy pursed during this period.

During the period of 1992-1995, inflation rate averaged 59.4 percent and

reduced to 29.3 percent by the end of 1996. The persistent pressures on price

level during 1992-1996 was attributed largely to huge government fiscal

financed wholly by the Central Bank of Nigeria (CBN). This resulted in excess

liquidity in the banking system and a substantial increase in domestic aggregate

demand. Other factors explaining high inflationary episode during this period

were increase on production costs including rising interest rates and high

transportation cost rising from the sharp rise in the prices of petroleum products,

high cost of transportation and farm inputs.

However, the decrease in inflation rate from 72.8 percent in 1995 to 29.3

percent in 1996 was largely attributed to improved supply of foreign exchange

stability in naira exchange rate ($1=N70.36 and $1=N69.84 in 1995 and 1996

19
respectively) sustained fiscal discipline, tight monetary policy, relatively good

harvests of staple increased importation of rice and rehabilitation of roads which

eased transport bottlenecks nation wide. Jhighan (1997).

Inflation moderated significantly from a double digit during 1992-1996 to

single digit averaging 8.0 percent during the period 1997-2000. This was

attributed to the combination of factors which brought about the moderation of

inflationary pressures in 1996.

The episode of two digit rate resurfaced in the economy during the period

2001-2003 averaging 15.2 percent. The major contributory factor was the

liquidity surfeit in the economy arising from the expansionary fiscal operations

of the three tiers of government.

In 2005, inflation declined to 8.8 percent. This trend was reversed again

in 2006 where the non-food rose to 12.8% and the food inflation declined to

5.6%. In 2007, the non-food inflation had a reverse trend i.e. drop to 9.2% while

the food-inflation had a sharp drop to 1.9%. The downward movement in

monthly food inflation in 2006 is an indication that Government policies on

Agriculture is working. Also, the inflation rate from 2007-2010 was 6.6, 15.1,

13.9 and 11.8 respectively (NBS, CBN Statistical Bulletin).

2.4 LIMITATION OF PREVIOUS STUDY

The second chapter was limited in showing only the theories and

mathematical factors that explains the various variables that determine inflation

in Nigeria within the dated time (1980-2010).

20
 The weakness in the structuralists school is like the sluggishness in the

export growth is not really structural but the result of failure to exploit export

opportunities because of overvalued exchange rates, also no separation is made

between autonomous structural rigidities and induced rigidities resulting from

price and exchange control or mismanagement of government intervention.

Economist also argued that the Philips curve relates to the short run and it

does not remain stable. It shifts with changes in expectation of inflation.

21
 CHAPTER THREE

3.0 RESEARCH METHODOLOGY

3.1 RESEARCH DESIGN

This deals with the identification of the method and procedure for

obtaining the information needed to save the problems. mathematical models

have in recent found a place in most economics and business research (cooking

1999) and this is a result of its being able to present reality in precise manner

thereby enhancing our understanding of it . them researcher used the secondary

data collection in trying to obtain data from a sample .using specific time

interval of 1960.2010.the method of data collection ,source of data and

statistical took for testing hypothesis is described. this study is specifically built

on the econometric approach to the study of inflation rate and its determinants.

3.2 METHODOLOGY

Data used for this study are mainly secondary data which were collected from C

B N statistical bulletin and National Bureau of statistics (CBN). The data was

collected for inflation rate and its determinants from 1980 to 2010. The study

employed the econometric techniques of ordinary least square (OLS) that is

multiple regression analysis which is the most frequently used techniques to

estimate the relationship of casual nature. It enables us to predict an unknown

variation from a known variable .the variation that is estimated is the dependent

variable from which the estimation was done is the independent variable.
22
3.3 MODEL SPECIFICATION

This involves the expression of the relations between variables of the study in a

mathematical form.

Symbolically, therefore, we have -:

INF=f(GOVEXP, M2,RER,RGDP)

Where INF= Rate of inflation.

GOVEXP = Government Expenditure

M2= Money Supply

RER=Real Exchange Rate

RGDP= Real Gross domestic product

Mathematically, the model is expressed in a single equation form as

INF=B0+B1,GOVEXP+B2M2+B2RER+B4RGDP +U.

Where U =random variation

B0 =estimate of the time intercept.

B1to B4=coefficients of the variables.

3.4 MODEL EVALUATION

This method contains that the technique that will be used in finding out whether

the estimates obtained are theoretically and statistically significant for the

purpose of the study and the following methods are adopted by the researchers

for evaluating her estimates.

23
3.5 ECONOMIC A PRIORI CRITERIA

This criteria is to determine whether the parameter estimates contains to the

economic theoretical a priori expectations.

TABLE 3.1

Variable Definition A. Prior

Expectation
1 Real Exchange This is the price of a country’s currency Negative (-)
Rate in relation to other currencies of the
word. It is expected that devaluation in
the country’s exchange rate will bring
about a rise in inflation.
2 Real Gross This is the monetary value of goods and Negative (-)
Domestic Product services produced in the geographical
boundary of a country in a given year. It
is expected that an increase in the real
Gross Domestic product will bring about
a fall in inflation.
3 Money Supply This is the volume of money in the Positive (+)
economy which is made up of currency
(not or coin) and deposits with
commercial banks. It is expected that an
increase in money supply will increase
inflation.
4 Government This is the current spending and Positive (+)
Expenditure investment by the central government
and local authorities on the provision of

24
 social goods and services which is
financed by taxation and borrowing. It is
expected that an increase in government
expenditure bring about a rise in
inflation.

3.6 STATISTICAL CRITERIA OR FIRST ORDER TEST:

This test is determined by statistical theory and aimed at evaluating the

reliability of the parameter estimate. It includes the following:

a) Student T-test: This is used to determine the significance

of the individual parameter in which the calculated t –values in the

regression result is compared with the t-tabulated at the n-k degree of

freedom and 5% level of significance.

b) F-test: This is used to determine the significance of the

entire regression plan that is the overall significance of the parameter

estimates.

c) Coefficient of multiple determination (R2)

This measures the percentage change in the dependent variation as

explained by changes in the independent variation. it measures the

goodness of fit of the regression plan.

25
3.7 ECONOMETRIC CRITERIA OR SECOND ORDER TEST:

This test is set by the theory of econometrics and it investigates whether the

assumption of the econometric method employed are satisfied or not .the test

carried out under this criteria includes the test for auto –correction, Normality

test,test for heteroscedasticity test, comuticollinearity test and for stationarity.

Test for Auto-Correlation:

This test is conducted to ensure that assumption of the OLS (Ordinary Least

Square) is not violated. The Durbin–Watson test will be applied.

Null Hypothesis Decision Reject O<d< dL

No positive auto correlation

No positive Auto correlation No decision dL≤d≤du

No negative auto correlation Reject 4-dL<d<4

No negative auto correlation No decision 4-du≤d≤4-dL

No auto correlation, positive or Do not reject du<d<4-du

negative

Normality test:

This test is conducted to find out if the error terms are normally

distributed with zero mean and constant variance that is of U1N (0, 52). This is

one of the assumptions of the classical linear regression model. Skeweness and

Kurtosis will be used to determine this between 0 and 3 ranges.

26
Test for multicollinearity:

The co linearity of the variables used in the model would be carried out.The

essence of this is to find out if there is co linearity among the variable used in

this study or not.

Test for heteroscedasticity:

The essence of this test is to see whether the error variance of each

observation is constant or not. When the error has no constant variance over

time, the OLS estimate though unbiased, is highly unreliable and cannot be used

for forecasting and policy analysis.

3.8 DATA REQUIRED AND SOURCES:

Data used for this study are mainly Secondary data which were collected

from CBN statistical Bulletin, and National Bureau of Statistics (NBS). The

data were collected for inflation rate and its determinants for 1980-2010.

27
 CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.1 PRESENTATION AND INTERPRETATION OF RESULT

The data for this analysis relates to the periods of 1980-2010.The result of

the model was obtained by estimating various forms of the model equation.The

modeling procedure employed is the classical linear regression model.

However,our analysis is based on the equation stated in chapter three and the

result obtained as presented below.

Regression Dependent Variable:INF

Method:Ordinary least square

Period Of Study:1980-2010

Included Observation:31

Variable Coefficient Standard error t-statistics t-prob. PartyRỳ

Constant 38.165 11.053 3.453 0.0019 0.3144
M2 6.2875e-006 4.9047e-006 1.282 0.2112 0.0594
RGDP 1.0462e-005 2.8340e-005 0.369 0.7150 0.0052
RER -0.061193 0.030228 -2.024 0.0533 0.1362
GEXP -2.6854e-005 1.2805e-005 -2.097 0.0459 0.1447
R2 = 0.258647 F(4, 26)=2.2678 [0.0891] ȧ = 16.5285
DW = 1.14 RSS = 7102.988992 for 5 variables and 31
observations.

28
Where R2=Coefficient of multiple determination.

D.W=Durbin Watson.

Party R’Y=Partial R

INF=Inflation.

RSS=Residual sum of square.

From the above, the interpretation of the result as regard the coefficient of

various regressors is stated as follows:

The value of the intercept which is 38.165 shows that the Nigerian economy

will experience a 38.165 increase when all other variables are held constant.

The estimate coefficients which are 6.2875e-006 {M2} shows that a unit

increase in M2 will cause a 0.0000062875 increase in INF, 1.0462e-005

{RGDP} shows that a unit increase in RGDP will cause a 0.000010462 increase

in INF, -0.061193 {RER} shows that a unit increase in RER will cause a-

0.061193% decrease in INF,-2.6854e-005{GEXP} shows that a unit increase in

GEXP will cause a -0.000026854 decrease in INF.

4.2 ECONOMIC APRIORI CRITERIA:

The test is aimed at determining whether the signs and sizes of the results are in

line with what economic theory postulates. Thus, economic theory tells us that

29
the coefficients are positively related to the dependent variable, if an increase in

any of the explanatory variables leads to a decrease in the dependent variable.

Therefore, the variable under consideration and their parameter exhibition

of a priori signs have been summarized in the table below.

This table will be guarded by these criteria

When β > 0 = conform.

When β < 0 = not conform.

Variables Expected signs Estimate Remark

M2 + β>0 Conform

RGDP - β>0 Not Conform

RER - β<0 Conform

GEXP + β<0 Not conform

From the above table, it is observed that all except RGDP and GEXP

actually conforms to the economic theories.

4.3 STATISTICAL CRITERIA {first order test}

4.3.1. COEFFICIENT OF MULTIPLE DETERMINANTS {R2}:

The R2 {R-Squared} which measures the overall goodness of fit of the entire

regression, shows the value as 0.258647 = 25.8647% approximately 26%. This

30
indicates that the independent variables accounts for about 26% of the variation

in the dependent variable.

4.3.2. THE STUDENT’S T-TEST:

The test is carried out, to check for the individual significance of the

variables. Statistically, the t-statistics of the variables under consideration is

interpreted based on the following statement of hypothesis.

H0: The individual parameters are not significant.

H1: The individual parameters are significant.

T Test :

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% = 0.025

Degree of freedom= n-k

Where n: Sample size.

K: Number of parameter.

The t-test is summarized in the table below:

31
 Variables {t-value} t-tab Remark

Variables t-tab Remark

M2 {1.282} ± 2.056 Insignificant

RGDP {0.369} ± 2.056 Insignificant

RER {-0.024} ± 2.056 Insignificant

GEXP {-2.097} ± 2.056 Significant

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

parameters {β1, β2, β3 and β4}.

From the table above, we can deduce that GEXP {-2.097} is greater than 2.056

{going by absolute values} which represents the t-tabulated implying that

GEXP is statistically Significant.

On the other hand, the M2 {1.282}, RGDP {0.369}, RER {-0.024) are less than

the t-tabulated {±2.056} signifying that the M2, RGDP and RER are

statistically insignificant.

4.3.3. F-STATISTICS:

The F-statistics is used to test for simultaneous significance of all the

estimated parameters.

The hypothesis is stated;

32
 H0: β1 = β2 =β3=β3=β4

H1: β1 ≠ β2≠ β3≠ β3≠ β4

Level of significance: α at 5%

Degree of freedom:k-1/n-k

F- Test:

If the f-calculated is greater than the f-tabulated {f-Cal> f-tab} reject the null

hypothesis {H0} that the overall estimate is not significant and conclude that the

overall estimate is statistically insignificant.

From the result, f-calculated {2.2678} is less than the f-tabulated {2.69}, that

is, f-cal < f-tab. Hence, we accept the null hypothesis {H0} that the overall

coefficients are not statistically significant.

4.4 ECONOMETRICS CRITERIA

4.4.1. TEST FOR AUTOCORRELATION:

One of the underlying assumptions of the ordinary least regression is that

the succession values of the random variables are independent. In the context

of the series analysis, this means that an error {Ut} is not correlated with one or

more of previous errors {Ut-1}. The problem is usually dictated with Durbin-

Watson {DW} statistics.

33
 The durbin-watson’s test compares the empirical d* and du in d-u tables

to their transforms {4-dL} and {4-dU}.

Decision Rule:

1. If d* < DL, then we reject the null hypothesis of no correlation and accept

that there is positive autocorrelation of first order.

2. If d* > {4-dL}, we reject the null hypothesis and accept that there is

negative autocorrelation of the first order.

3. If dU< d* < {4-dU}, we accept the null hypothesis of no autocorrelation.

4. If dL < d* < dU or if {4-dU} < {4-dL}, that test is inconclusive.

Where: dL = Lower limit

DU = Upper limit

D* = Durbin Watson.

From our regression result, we have;

D* = 1.14

DL = 1.160

DU = 1.735

4-dL = 2.84

34
 4-dU = 2.265

Conclusion:

Since d*{1.14} < DL {1.160} then we reject the null hypothesis of no

correlation and accept that there is positive autocorrelation of first order.

4.4.2. NORMALITY TEST FOR RESIDUAL:

The Jarque-Bera test for normality is an asymptotic, or large-sample, test.

It is also based on the ordinary least square residuals. This test first computes

the skewness and kurtosis measures of the ordinary least square residuals and

uses the chi-square distribution {Gujarati, 2004}.

The hypothesis is:

H0 : X1 = 0 normally distributed.

H1 : X1 ≠ 0 not normally distributed.

At 5% significance level with 4 degree of freedom.

JB = + = 4.1817

While critical JB > {X2{2} df} = 9.48773

Conclusion:

Since 4.1817 < 9.48773 at 5% level of significance, we accept the null

hypothesis and conclude that the error term follow a normal distribution.

35
4.4.3. TEST FOR HETEROSCEDASTICITY

Heteroscedasticity has never been a reason to throw out an otherwise

good model, but it should not be ignored either {Mankiw Na, 1990}.

This test is carried out using White’s general heteroscedasticity test {with

cross terms}. The test asymptotically follows a chi-square distribution with

degree of freedom equal to the number of regressors {excluding the constant

term}. The auxiliary model can be stated thus:

Ut = β0+ β1M2 +β2RGDP + β3RER+ β4GEXP+β5M22+β6RGDP2

+β7RER2+β8GEXP2 + Vi.

Where Vi = pure noise error.

This model is run and an auxiliary R2 from it is obtained.

The hypothesis to the test is stated thus;

H0: β1 = β2 =β3 =β4 = β5 = β6= β7= β8 = 0 {Homoscedasticity}

H1: β1 ≠ β2≠ β3≠ β4 = β5 ≠ β6≠ β7≠ β8 = 0 {Heteroscedasticity}.

Note: the sample size {n} multiplies by the R2 obtained from the auxiliary

regression asymptotically follows the chi-square distribution with degree of

freedom equal to the number of regressors {excluding constant term} in the

auxiliary regression.

36
Decision Rule:

Reject the null hypothesis if X2cal> X2tab at 5% level of significance. If

otherwise, accept the null hypothesis. From the obtained results,

X2cal = 6.0504 < X2tab 0.05 {8} = 15.5 we therefore reject the alternative

hypothesis of heteroscedasticity showing that the error terms have a constant

variance and accept the null hypothesis showing that the error terms do not have

a constant variance.

4.4.4 TEST FOR MULTICOLLINEARITY

The term Multicollinearity is due to Ragnar Frisch. Originally it meant

the existence of a “perfect” or exact, linear relationship among some or all
explanatory variables of a regression model. The tests were carried out using
correlation matrix. According to Barry and Feldman {1985} criteria;
“Multicollinearity is not a problem if no correlation exceeds 0.80”.

INF M2 RGDP RER GEXP REMARK

INF 1.000 -
M2 -0.2618 1.000 Nm
RGDP -0.1282 0.8278 1.000 Nm,M
RER -0.1133 -0.3567 -0.3745 1.000 Nm,Nm,Nm
GEXP -0.3123 0.9672 0.7884 -0.4510 1.000 Nm,M,Nm,Nm

Where M = Presence of multicollinearity

Nm = No multicollinearity.

From the above table, we can conclude that multicollinearity do not exists
in all the variables.
37
 CHAPTER FIVE

5.1 SUMMARY OF FINDINGS, RECOMMENDATION AND

CONCLUSION

5.2 SUMMARY

The research work as conducted to ascertain the determinants of inflation

in Nigeria using econometric. Analysis within a period of thirty one years

(1980-2010) and it is based on Nigeria economy with Nigeria data.

Inflation is the dependent variable while money supply, real exchange

rate, real gross domestic product and government expenditure are the

independent variables. The statistical data was collected from CBN statistical

bulletin (2009,2010 edition).

The study found out that real exchange rate, government expenditure

have a negative relationship with inflation while money supply and real GDP

has a positive relationship with inflation.

The study also found out that money supply, real GDP, real exchange rate

has no significant impact on inflation while government expenditure is

statistically significant.

38
5.2 RECOMMENDATIONS

In line with the summarized research findings the following

recommendations are made:

1. The central bank should devices means of regulating

the supply of money. This is because if money supply is not properly

controlled, inflation would continue to grow thereby leading to deficit

balance of payment.

2. There should be war on money laundering and drug

trafficking so that excess demand necessitated by these monetary flows or

transfer can be controlled, thereby reducing the rate of inflation.

3. Policy maker should try to cushion the effect of

inflation on the economy when the need arises so that rise in exchange

rate, government expenditure ill not lead to inflationary pressure.

4. The government should reduce unnecessary

expenditure on non-development activities. This will also put a check on

private expenditure which is dependent upon government demand for

goods and services.

5. Government should ensure that there is a realistic

exchange rate which will lead to a gap between the official exchange rate

and the free market so that producers will not buy foreign exchange at the

parallel market thereby causing the cost push of inflation in Nigeria.

39
 6. Government should increase aggregate demand in

the economy to ensure that there is increase in domestic productivity so

that it ill not create a demand pull type of inflation. This would be

achieved through properly blended monetary and fiscal policies.

5.3 CONCLUSION

From the findings, of the work, it was discovered that there is a negative

relationship between exchange rate, real GDP, Government expenditure with

inflation. The negative relationship between these variables shows that adequate

control measure to inflation rate will help the nation in propelling a favorable

balance of payment that can lead to economic growth.

At this juncture we call for an effective policy making and

implementation towards these areas that will reposition the state of the

economy. Some researchers that may have interest on this area of research

should recommend factors that will maintain stability in prices of goods and

services.

40
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