Testing for Gibson’s Paradox: Evidence from Nigeria

Abstract

This paper is set to investigate the existence of a significant long-run relationship between nominal interest rates and price levels and examine the possible causal link between the variables of interest using quarterly data on Nigeria for the periods of 1970 – 2012. Maximum likelihood method of co-integration, suggested by Johansen (1988, 1991) and Granger causality in an ADL model with p and q lags suggested by Koop (2005) are implemented to determine the number of co-integrating vectors and verify the nature and direction of causality between nominal interest rates and the price levels in Nigeria respectively. The co-integration results show that the null hypothesis of no significant long-run stable relationship between nominal interest rates and the price levels is rejected for Nigeria with the identification of one co-integrating vector. This result fines support for Gibson Paradox in Nigeria which supports the view that nominal interest rates and the price levels trend together over a long period of time and on the positive note too. When the ADL models were estimated to gauge the extent of both long and short run causality between the variables of interest, the results suggest the existence of a very strong causal link from nominal interest rates to price levels, in the long run while no causality was identified in the short run. This portrays nominal interest rate as a veritable tool for the moderation of general price level in Nigeria. This by implication puts forward the fact that supply rather than demand side dominates in determining the level of consumer price index in Nigeria. Therefore policy efforts to drop inflation while keeping the nominal interest rate high may prove ineffective in Nigeria as the two share strong positive correlation.

Keywords: Nominal interest rates, price level, Gibson paradox, cointegration, Nigeria