An Empirical Analysis of the Determinants of Inflation in Nigeria

Abstract

This paper investigates the determinants of inflation in Nigeria between 1980 and 2012. The properties of time series variables were examined through the use of OLS, Augmented Dickey-Fuller technique in testing the unit root property of the series and Granger causality test of causation between inflation and money supply, government expenditure, exchange rate, and interest rate, cointegration and vector error correction techniques was also employed. The results of unit root suggested that all the variables in the model are stationary. Inflation is stationary at level while money supply, government expenditure, exchange rate and interest rate are stationary at first difference. The results of Causality suggested causation between inflation and some of the included variables. The Johansen cointegration result shows that there existed long run relationship between inflation and the included variables. The VEC error correction result also confirmed the existence of long run relationship between the variables of the model with only money supply and exchange rate causing interest rate. The OLS results revealed that money supply and interest rate influenced inflation positively, while government expenditure and exchange rate influenced inflation negatively. Therefore, a good performance of the economy in terms of price stability may therefore, be achieved by reducing money supply and interest rate and also increasing government expenditure and exchange rate in the country. A major policy implication of this study is that concerted effort should be made by policy makers to stabilize prices (inflation) by reducing money supply and interest rate as well as increasing government expenditure and exchange rate; most importantly increasing exchange rate and reducing interest rate.

Key words: Inflation, effects, Error Correction Method, co-integration, money supply