Continuous printing of the naira pushes up inflation

The recent report by the World Bank and the European Intelligence Unit (EIU) that the Federal Government of Nigeria is printing money to augment the monthly allocation to the three tiers of government and to meet other financial needs is very disturbing. If not stopped immediately, the action could heighten inflation with dire consequences for the country’s exchange rate and industrial development.

How do we explain a situation where at a time other central banks around the world are tightening their monetary policies with the primary goal of curtailing money supply our own central bank of Nigeria is tightening monetary policy and at the same time pumping more money into the system through deficit financing and development finance initiatives?

According to the EIU report, “The CBN has continued to print money for the Federal Government, whose overdraft facility with the CBN reached N19 trillion ($46bn) in April 2022, up from N17.4 trillion at end of 2021. The CBN is also operating a range of direct lending schemes for the agricultural, manufacturing and energy sectors, currently total about N3.6 trillion ($9bn).”

The EIU says the ability of the CBN to tame Nigeria’s inflation through raising rates is being undermined by its continued direct financing of the budget deficit. “Building credibility in the target rate (of inflation) has not been a priority in recent years. The continued printing of money at the same time as tightening policy would prevent effective control of the price level,” according to the EIU.

Irrespective of government’s position on this matter, the fact remains that printing more money doesn’t increase economic output, it only increases the amount of cash circulating in the economy

Nigeria has rules that limit how much lending the central bank should offer the government and there are statutes that forbid the government from reckless borrowing. But it could be inferred from the EIU report that these rules have been contravened repeatedly.

While in May 2022, the CBN tightened monetary policy with a 150-basis point hike supposedly to attain its 9 percent inflation target at the same time, the bank continued to directly finance government deficit in an unbridled manner.

“All prudential rules on the government borrowing through the (CBN’s) overdraft facility have long been broken. It seems highly plausible that the CBN will continue financing a widening budget deficit through the overdraft facility.

“If the overdraft gets larger, it would be a clear sign that the CBN is politically unable or unwilling to take a clear stance on inflation and the anchoring of expectations,” the EIU stated.

Irrespective of government’s position on this matter, the fact remains that printing more money doesn’t increase economic output, it only increases the amount of cash circulating in the economy. If more money is printed, consumers are able to demand for more goods, but if firms still have the same quantity of goods, they will respond by putting up prices. In a simplified model, printing money will cause inflation.

Suppose an economy produces N10 million worth of goods; e.g. 1 million pens at N10 each. At this time the money supply will be N10 million. If the government doubles the money supply, we would still have 1 million pens, but people would have more money. Demand for pens would rise, and in response to higher demand, firms would push up prices.

The most likely scenario is that if the money supply were doubled, we would have 1 million pens sold at N20. The economy is now worth N20 million rather than N10 million. But, the number of goods is exactly the same.

In this simple model, printing more money has made goods more expensive, but hasn’t changed the quantity of goods. And this is what the CBN is currently doing; a major reason for the May 2022 hike in inflation rate which the National Bureau of Statistics (NBS) said rose to 17.71 percent with 1.78 percent increase over April 2022 rate.

There are several challenges associated with inflation. First is fall in value of savings. Second, is menu cost. If inflation is very high, it then becomes harder to make transactions. Prices frequently change as firms had to spend more on changing price lists. In the hyperinflation of Germany for instance, prices rose so rapidly that workers were paid twice a day. Thirdly, is uncertainty and confusion. High inflation creates uncertainty. Periods of high inflation discourage firms from investing and can lead to lower economic growth.

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Rather than print money, there are other options the CBN can explore to meet government’s financial needs. All over the world, governments borrow by selling bonds/gilts to the private sector. Bonds are a form of saving. People buy government bonds because they assume a government bond is a safe investment. However, this assumes that inflation will remain low. If government prints money to pay off the national debt, inflation could rise. This increase in inflation would reduce the value of bonds. If inflation increases, people will not want to hold bonds because the value will fall. Therefore, the government will find it difficult to sell bonds to finance the national debt and would have to pay higher interest rates to attract investors.

If Federal Government prints too much money and inflation gets out of hand, investors will not trust the government and it will be hard for her to borrow anything at all. Therefore, printing money could create more problems than it was meant to solve.

Agreed, there have been arguments on the merits of printing money with the proponents contending that in a recession, with periods of deflation, it was possible to increase the money supply without causing inflation. This they say is because the money supply depends not just on the monetary base, but also the velocity of circulation. For example, if there is a sharp fall in transactions (velocity of circulation) then it may be necessary to print money to avoid deflation.

They often refer to the liquidity trap of 2008-2012 when the Bank of England pursued quantitative easing (increasing the monetary base). But that action only had a minimal impact on underlying inflation because, although banks saw an increase in their reserves, they were reluctant to increase bank lending.

Hence, if the central bank of Nigeria decides to pursue quantitative easing (increasing the money supply) during a normal period of economic activity, as we have today, it would definitely cause inflation.