• Thursday, March 28, 2024
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Deflating the inflated Nigerian economy

Driving economic growth through legal innovations

With 2022 economic realities fast unfolding, it is essential to illuminate how best policies and practices can help deflate an already inflated Nigerian economy.

The Central Bank of Nigeria (CBN) focuses on increased growth within a controlled inflation target. Even with Philips (1958) arguments that an exploitable trade-off between output and price elasticity exists, the consensus about inflation and growth in terms of their match for policy reconciliation remains dimly discerned. The downward rigidity of prices will most likely ossify the structure of relative prices, impeding adjustment to real shocks. Therefore, little inflation might help to “grease” the economy.

On the other hand, high inflation rates, by confounding relative price signals and making efficient resource allocation more difficult, could result in more sluggish economic growth. But whether these or other negative effects begin at single-digit inflation rates, or only at much higher rates, remains a controversial question. Moreover, it is not clear that a rise in inflation causes a proportional worsening of the country’s growth performance: it might be that once chaotic inflation rates have been reached, relative prices cease to have much meaning anyway, making further increases in inflation less important

In a multivariate context, the inflation-growth relationship becomes yet more complicated. Obviously, the growth-inflation relationship must include other plausible determinants of growth.

Several issues then arise. First, the inflation-growth relationship may not be robust once “conditioning” factors are included in the debate of how growth-inducing inflation can be monitored. The conditioning factors may themselves be functions of the inflation rate. For instance, investment affects GDP growth, but may itself be affected by inflation. To the extent that inflation influences growth through such indirect effects, the inclusion of these factors in a growth model reduces the apparent effect of inflation.

Read also: Inflationary pressures still stretching wallets of Nigerians says FBNQuest

There may be rich and important interactions between inflation and the other determinants of growth. For example, the marginal effect of inflation on growth may differ according to the level of physical and human capital in the country. With growth having many possible determinants, it may be difficult to model such interactions, especially since theory provides little guidance on the appropriate specification. Inflation is not under direct policy control; especially in the short run, it is affected by shocks that can influence both inflation and growth, possibly resulting in spurious relations. Finally, even if low inflation is generally associated with faster growth, it does not necessarily follow that disinflation is always good for growth.

A major determinant of the distribution of income in a country is traditionally assumed to be the level of development: as predicted by the so-called Kuznets hypothesis (Kuznets 1955) countries shift from relative equality to inequality and back to greater equality as they move through the development stages.

The effect of inflation on income inequality might depend on the initial level of inflation: when initial inflation is high, reducing inflation might decrease inequality; when initial inflation is low, instead, reducing inflation might come at the cost of higher inequality. This would explain why inflation seems progressive only in reports, concerning low-inflation countries, while is found regressive in most cross-country including high-inflation developing economies.

Rapid disinflation may result in lower growth, at least in the short run. It is rather surprising, therefore, that a consensus about the relationship between these two variables is yet to emerge.

Central bankers and most other observers view price stability as a worthy objective because they think that inflation is costly. Some of these costs involve the average rate of inflation, and others relate to the variability and uncertainty of inflation. But the general idea is that businesses and households are thought to perform poorly when inflation is high and unpredictable. These considerations suggest that, if a relationship between inflation and GDP growth exists, it is not likely to be a simple one. The bivariate relationship will not be straightforward, let alone proportional; there may be important interaction effects between inflation and the other determinants of growth, and the correlation between disinflation and growth may be quite different from the steady-state inflation-growth relationship.

Perhaps the lack of a consensus about the effects of inflation on growth is not so surprising after all.