Nigeria’s persistent inflation: Looking beyond Monetary Policy Rate

Introduction

Milton Friedman’s assertion that “inflation is always and everywhere a monetary phenomenon” is being rigorously tested in the global economy. Since the 2008 financial crisis, central banks have struggled to control inflation, with the COVID-19 pandemic and geopolitical tensions, particularly the war in Ukraine, further complicating these efforts. In Nigeria, these global inflationary pressures are compounded by unique local factors, resulting in severe macroeconomic uncertainty. The Central Bank of Nigeria (CBN) has responded with aggressive monetary tightening, raising the benchmark monetary policy rate (MPR) to a record of 26.75 percent as of August 2024. Despite these efforts, inflation has continued to surge, reaching an all-time high of 34.19 percent. However, these issues are not unique to Nigeria; the global economic outlook has deteriorated, with the World Bank warning of potential recessions in emerging markets and developed economies due to sustained inflationary pressures.

There is a school of thought that argues that the reliance on MPR hikes has been insufficient in curbing inflation in Nigeria due to a combination of structural economic issues, such as soaring commodity and energy prices, and the recent twin policy changes of fuel subsidy removal and the abolition of the multi-currency regime. These factors have eroded real incomes, exacerbated the cost-of-living crisis, and imposed the limitations of monetary policy as a tool for inflation control in Nigeria. The sections that follow provide the foundation for understanding the complexities of inflation management in today’s interconnected world, why MPR has failed to curb inflation in Nigeria, the broader implications for the economy, and potential alternative policy measures to address these challenges.

“However, these issues are not unique to Nigeria; the global economic outlook has deteriorated, with the World Bank warning of potential recessions in emerging markets and developed economies due to sustained inflationary pressures.”

Inflation trends and global trajectory

Inflation, defined as a persistent increase in the general price level of goods and services and a key measure of the cost of living, affects economies differently based on their stages of development. However, inflation manifests in two forms: demand-pull and cost-push. Demand-pull inflation occurs when excess demand outweighs supply, often driven by increased consumer spending due to higher wages or government spending. In contrast, cost-push results from rising production costs leading producers to raise prices. Over the years, advanced economies such as the United States (US), United Kingdom (UK), and Eurozone have experienced inflationary pressures post-pandemic, though at varying rates. For instance, the US inflation rate hit a new 40-year high of 9.1 percent in June 2022, which later moderated due to an aggressive hawkish stance by the Federal Reserve. Similarly, UK inflation clocked the highest rate since 1982 at 10.1 percent in 2022 and has declined amicably amid the Bank of England’s hawkish stance. Additionally, emerging markets such as Brazil, India, and Ghana have faced high inflation rates due to macroeconomic headwinds, with Ghana’s inflation rate peaking at 54 percent in December 2022 due to the economic and financial crisis.

Nigeria’s inflationary experience, however, diverges from these examples due to the unique structural and macroeconomic challenges facing the country. While advanced economies have seen some success in moderating inflation through monetary tightening, Nigeria’s inflation has consistently remained high despite similar measures by the CBN’s hawkish stance. The CBN raised the MPR year-on-year from 18.5 percent in June 2023 to 26.75 percent in August 2024, an increase of 800 basis points, to control inflation, which has been exacerbated by factors such as macroeconomic uncertainties, weak supply chains, and import reliance. Unlike in advanced economies, where inflationary pressures are largely demand-driven, Nigeria’s inflation is predominantly cost-push, driven by supply-side constraints such as high energy costs, insecurity, poor infrastructure, low productivity, consumer sentiments, and currency depreciation.

Global factors, such as the COVID-19 pandemic and geopolitical tensions, have compounded Nigeria’s inflationary pressures. The pandemic led to a significant decline in productivity globally; however, in Nigeria, this was further aggravated by structural issues such as dependency on imported goods and a weakened naira, making the country more vulnerable to external shocks. Additionally, geopolitical tensions, particularly in oil-producing regions, have led to volatility in oil prices, further impacting Nigeria’s foreign exchange earnings and contributing to inflation. These unique challenges make Nigeria’s inflation more resistant to traditional monetary policy tools like the MPC’s hawkish stance, as the root cause of inflation is not solely monetary but structural. As a result, while other countries may see a more direct impact of monetary policy on inflation, Nigeria requires a more pragmatic approach that addresses both monetary and structural issues to effectively curb inflation.

Read also: Why food prices remain high despite fall in inflation

Is the Monetary Policy Rate (MPR) an effective tool to curb inflation? The Nigerian context

The CBN plays a significant role in the nation’s monetary policy, aiming to ensure price stability, maintain external reserves to safeguard the naira’s international value, and promote a resilient macroeconomic environment. This role extends beyond monetary policy to fostering economic growth and responding to macroeconomic uncertainties, especially given Nigeria’s history of persistent double-digit inflation.

Fig. 1: Inflation vs. Monetary Policy Rate (MPR)

Figure 1 illustrates the trends of headline inflation in Nigeria and the MPR year-on-year. Despite significant progress by the CBN in increasing the MPR, the effectiveness of this tool in curbing inflation appears limited. The graph revealed that headline inflation has continued to rise, indicating that inflationary pressures in Nigeria are influenced and driven by factors beyond the reach of MPC’s hawkish stance. Contributing factors include rising production costs, increased energy prices, high petrol costs, surges in electricity tariffs, currency depreciation, high food prices from supply chain disruptions, macroeconomic uncertainty, and regional insecurity. Additionally, government policies such as fuel subsidy removal, an increase in value-added tax (VAT), and other taxes have also contributed to inflation in Nigeria.

Read also: Inflation slows to 33.40% on lower food prices

Fig 2: Exchange rate, oil price, and M2 effect on inflation

Figure 2 illustrates how significant weakening of the naira increases import costs, fuelling inflation despite the MPR increase. The graph also revealed that a rising money supply (M2) exacerbates inflationary pressure without corresponding economic growth. Additionally, fluctuating oil prices impact energy costs, further driving inflation, while government policies such as fuel subsidy removal and VAT increases compound these effects. The spiral effect on the economy is evident, indicating the limitations of relying solely on MPR to address inflation in Nigeria.

Broader implication of inflation and the MPR hike on the economy

Despite a seemingly promising GDP growth rate, the spiral effect of inflation indicates that GDP growth rate fell by 0.49 percent in Q1 2024 compared to Q4 2023, indicating an economic slowdown driven by high inflation reducing purchasing power.

The MPR hike, intended to curb inflation by making borrowing more expensive and encouraging savings, has had varying effects across different sectors:

• Agriculture: Agricultural growth dropped from 2.10 percent in Q4 2023 to 0.18 percent in Q1 2024, attributed to high borrowing costs for farmers and a decline in output.
• Industry: Industrial growth fell from 3.86 percent to 2.19 percent, as high MPR increases the cost of financing industrial operations, affecting capital-intensive industries.
• Services: Services grew slightly by 0.34 percent. This slowdown is further supported by consistently negative labour productivity.

Conclusion and recommendations

Given the structural nature of inflation in Nigeria, relying solely on MPR hikes is insufficient. Thus, an alternative measure for combating and addressing inflation in Nigeria requires broad-based policy reforms. For instance, fiscal policy reforms such as targeted subsidies and investment in infrastructure (affordable housing) to lower the costs for businesses and consumers; structural reforms to address the inefficiencies in supply chains; improve resource mobilisation; improve public financial management that enshrines fiscal discipline; and finally, improve monetary and fiscal policy coordination. For instance, despite recording a high inflation rate of 54 percent in December 2022, Ghana’s inflation rate declined to 22.8 percent as of June 2024, largely attributed to a well-designed strategy in their 2023 and 2024 budgets aimed at restoring macroeconomic stability, fiscal consolidation, and sound public finances.

Prof. Joseph Nnanna; Chief Economist Development Bank of Nigeria.
The views expressed in this article are those of the author; they do not necessarily reflect Development Bank of Nigeria policy.