THE IMPACT OF INFLATION ON PRIVATE CONSUMPTION EXPENDITURE AND ECONOMIC GROWTH IN

ABSTRACT

This study empirically examine the impact of inflation on private consumption expenditure and economic growth in Nigeria using an annual time series data spanning from 1981-2012. In this study, modern time series econometric methodology such as Unit Root Testing, Johansson Co-integration test, Vector error co-integration granger causality test(VEC) and Vector Error Correction Model (VECM) where employed to model both the long run and short run relationships between inflation, economic growth, interest rate as (explanatory variables) and private consumption expenditure as (dependent variable). Augmented Dickey- Fuller (ADF) and Phillips–Perron (PP) test were conducted and the results show that all the data are not stationary at a level but after the first difference they become stationary. The Johansson co-integration test indicates that there exists a long run relationship between the variables for the period of study. However, the VEC Granger Causality result shows that inflation is positively granger causes private consumption expenditure for the period of study and there happens to be no causality flowing from inflation to economic growth, neither is there causality from economic growth to inflation in the short run. However, the long-run model result shows a negative impact of inflation on economic growth for the study period. It implies that I per cent increase in inflation will result in 0.69 decreases in economic performance (RGDP). It could therefore be recommended that Government together with the central Bank of Nigeria should develop and pursue prudent monetary and fiscal policies that would aim at reducing and stabilizing both the micro and macroeconomic indicators especially inflation targeting, so as to boast the growth of the economy.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The management of the economy is a major concern of governments all over the world. Governments of countries feel compelled to ensure, through appropriate policies that their economies are managed to achieve desirable macroeconomic objectives. These objectives include: price stability; economic growth; full employment; and balance of payments equilibrium. The achievement of stable prices and attainment of sustainable economic growth had been the central objectives of macroeconomic policies for most countries in the world today. This is so because the achievement of other objectives like full employment and balance of payment equilibrium are also determined by the achievement of price stability and economic growth. (Ohale & Onyema, 2002)

Economic growth is dependent upon the productive effort of a society and investment of resources. An increase in production and investment will lead to economic growth. A country’s rate of growth can be affected by inflation through its effect on investment. An increase in inflation rate reduces the return on investment, both on physical and human capital. Lower returns mean less accumulation and innovation and hence a lower rate of growth. Growth in output of goods and services is a good way of bringing material benefits to the citizens. This is through fostering those developments such as increased investment, technical progress, increase in demand, amongst others, which are conducive to the growth of the economy. Investment is required to maintain output per head in the face of an increase in the size of labour force. Moreover, increase in consumption expenditure makes producers to respond by increasing their capacity and by so doing, promote economic growth. Nevertheless, as the level of economic activities increase, an economy experiences growth (Ohale & Onyema, 2002; and Apere, 2006).

Private consumption expenditure constitutes the largest component of total consumption expenditure in Nigeria and accounts for more than 65% of the Gross Domestic Product, GDP ( National Bureau of Statistics, 2010). Thus, private consumption expenditure is a core component of aggregate demand.