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EFFECT OF FISCAL POLICY ON STRUCTURAL INFLATION IN NIGERIA

Thesis, Project Topic: Effect of Fiscal Policy on Structural Inflation in Nigeria  


CHAPTER ONE

1.0     Introduction

1.1     The background of the study

One of the macroeconomic problems facing Nigeria is the problem of inflation. Since the 1970s, there has been a continuous increase in inflation rate. It is a malady which has eaten deep into the fabrics of the country’s economy. Its effect on the economy is so devastating that the real GDP of the country over the years has not been growing.

However, for a better understanding, inflation is the continuous and persistent increase in the general price levels of goods and services. There are two major categories of inflation: Demand pull inflation and cost push inflation which is otherwise called supply-side inflation. A demand pull inflation is said be a traditional and the most common type. It takes place when aggregate demand is rising while the variable supply is diminishing. This situation is generally called “Too much money chasing too few goods”. Renowned economist, John Maynard Keynes believed that increase in demand not matched by supply is the actual cause of this type of inflation. Iyioha (2004) in support of this theory emphasizes that when the aggregate demand exceeds the aggregate supply at full employment level, the result is a gap which is called an inflationary gap. The more the gap the more rapid the inflation rate. The second category or type of inflation which is cost-push inflation is of the view that inflation is caused by wage increases enforced by unions and profit increases by producers or employers.

This is why it can equally called wage inflation, producers’ inflation or the supply side inflation. It a common place in most developing countries including Nigeria because of the structural rigidities associated with developing countries trying to develop. The structural rigidities may arise in the form of non-availability of raw materials for industries which are necessary for production in which case, the only alternative is “importation” of such raw materials that in turn raises the price of the produced goods and services at home as the producers try to make profit. At this point, the unions come in, in agitation for wage increase because their real wage or income is reduced with respect to the increase in the prices of goods and services. The rigidities may also arise because of the fact that most developing country depend on primary products from agriculture which is susceptible to fluctuation in weather conditions or climatic changes. This may lead to the activities of the hoarders hoarding most of the available but meagre resources in anticipation of higher price. This in turn reduces supply to the barest minimum against the demand of such products which may be constantly at an increase.

However, in order that the workers or the wage earners may be better off, the union keep pressing for higher pay even though that the productivity of labour has not increased which means increase in wage earning or money wage without actual increase in supply. As mentioned above, these are the supply bottlenecks suffered by the developing countries including Nigeria which the structuralist school of thought termed structural inflation. Notwithstanding, the government of Nigeria over the years has not folded its hands. It has been searching for an effective policy measures to counteract this menace. In this regard, it has followed the theory of John Maynard Keynes which proposed the use of fiscal policy to plumate inflation in an economy. It would be mostly in place at this point therefore, to define the term “Fiscal Policy”, to know its components and how it works for the economy.

Fiscal policy is the government’s management of the economy through the manipulation of its income and spending power to actualise some desired macroeconomic objectives amongst which are price stability and economic growth. It is a deliberate alteration of the government spending and taxation to help achieve desired macroeconomic objectives as said above by changing the level and composition of aggregate demand (AD). This simply means that it works through taxation (government revenue) and expenditure. Fiscal policy can equally work through the manipulation of subsidies, exchange rate, checks on the external reserve, borrowings which may be used to finance deficits where the projected expenditure is above revenue. However, there are two major types of fiscal policy and they include: Discretionary and Automatic fiscal policies. Discretionary fiscal policy refers to the policies which are decided and implemented by one-off policy changes while Automatic stabilization is where the economy can be stabilised by the processes of fiscal drag and fiscal boost. Moreover, for the sake of this work, the researcher’s concentration is basically on the discretionary fiscal policy because this is where the deliberate manipulation of the government of the economy manifests most. Discretionary fiscal policy is made up of Expansionary and contractionary fiscal policies. Expansionary fiscal policy is when the government expenditure exceeds its tax revenue and it is mostly recommended during economic recession. Contractionary fiscal policy on the other hand occurs when the government’s spending is lower than its tax revenue and this is used by the government to curtail the excess in the aggregate demand within an economy. For either type, the government uses its initiative to determine which serves the economy best at a particular point in time, that is, depending on the situation at hand.

The government of Nigeria has applied this type of fiscal policy since its realisation of independence through its budgetary allocations in order to curb its structural inflation (wage or supply inflation). It has done this through granting of subsidies, tax holidays for production firms or companies, different types of incentives and above all, it has continued to employ deficit budgeting which is expansionary in nature. Despite all these measures, the real effect on the economy of the country is yet to be discovered. That is why this research work has been primarily focused to investigate the effect of fiscal policy on the structural inflation in Nigeria.

1.2      Statement of Problem

The government of Nigeria has really worked had in the area of inflation control since the inception of the country’s independence through the use of fiscal policy instruments. It has applied virtually all the instruments of this policy measure but still the problem has been at an increase. For instance, the Central Bank of Nigeria (CBN) estimated the rates of inflation at 10.3 minimum and 12.9 maximum between the periods of December, 2011 and November, 2012 respectively which means that despite the government’s position in this regard, it still seems nothing has actually been done. Therefore, in order that the real impact of fiscal policy measures might be known, effort has been made to look into the result of the previous analysis of the trend of inflation in Nigeria which indicates that the country’s type of inflation is far from the traditional demand pull type but is the supply-side type which is termed structural inflation. The link now is between this particular supply-side inflation and fiscal policy. It is for this reason that this study is meant to investigate the effect of fiscal policy on structural inflation in Nigeria from the periods of 1970 to 2011.

1.3    Research Question

The above problem presents the following research questions:

  1. i) Is there any significant relationship between the fiscal policy measures and the rate of supply/producers’ inflation in Nigeria?
  2. ii) To what extent has the government’s fiscal policy affected the rate of inflation in Nigeria?

1.4     Objective of the study

In carrying out this study, the following objectives will be met.

  1. i) To find out if there exist any significant relationship between fiscal policy measure and the rate of producers’ inflation in Nigeria for the period under investigation.
  2. ii) To ascertain how much fiscal policy has contributed to the control of inflation in Nigeria.

1.5     Significance of the Study

The benefit and significance of this study lies on the fact that the federal government of Nigeria will be helped with the findings of the study in discovering the loopholes and solution to the problem of price level stability administration in the country. It will also be of great importance to the lovers of knowledge as it will be serving as a source of enlightenment. More so, it will be of great help to any researcher who might wish to carry out more studies on this area as it will provide a good focus to such a person. Similarly, the importance of price stability to the nation’s economy can never be over emphasized given its important position in the determination of the level of investment and general economic growth, hence the benefit justification of this study.

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