An Empirical Assessment of the Relationship between Inflation and Investment in Nigeria

Transcription

1 IOSR Journal of Economics and Finance (IOSR-JEF) e-issn: , p-issn: Volume 1, Issue 3 (Sep. Oc. 2013), PP An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria Olufunke Bosede Olufemi, Adeleke Omolade and Obasuyi, F.O.T Deparmen of Economics, College of Educaion, Ikere-Ekii, Nigeria Absrac: This sudy examined empirically he impac of inflaionary rae on he level of invesmen in a developing economy a case sudy of Nigerian Economy The sudy adoped co-inegraion and error correcion model as he esimaing echniques. The empirical resuls showed ha here is a long run relaionship beween inflaionary rae and invesmen in Nigeria. Unlike some developed naions where inflaion has direc relaionship wih he invesmen, in Nigeria, low rae of inflaion and increased naional income would promoe invesmen. The policy recommendaion is ha Nigeria governmen should srive o curail inflaion o he minimum while acceleraing he growh of he naional income in her ques o boos invesmen. Key Words: Inflaion Rae, Invesmen, Developing Economy. I. Inroducion Generally, inflaion symbolizes a siuaion of rapid persisen and unaccepable high rise in he general price level in an economy resuling in he loss of purchasing power of he counry s currency. The high rae of inflaion, which Nigeria has been experiencing since he 1970s has is origin in he economic measure and conrol ha were enaced during he Nigeria civil war of Prior o he war, Nigeria praciced he open marke economic policy wih very lile governmen conrol. Invesmen on he oher hand is known o consiue he main engine of growh in any economy. Infac, Odoko (2003) describes i as he major caalys for economic developmen. Invesmen is financed from savings (domesic or foreign), bu as a resul of insufficien domesic savings in he developing economy like Nigeria due o low income and inefficien financial sysem, foreign saving is required o supplemen domesic savings in finace of invesmen. Osakwe (1982) poins ou ha inflaion reduces he volume of savings and he more persisen and sronger he inflaion, he lower is he level of saving and invesmen. There are basically hree major approaches used in measuring inflaion he deflaion of he gross naional produc (GNP), which implicily measures inflaion, he consumers price index (CPI) and he wholesale price index (WPI). In Nigeria he mos widely used measure of inflaion is he consumer price index because i is readily available on monhly, quarerly and annual basis. In he classicalis heory of moneary ransmission mechanism, increased money sock only leads o an inflaionary pressure on he economy hereby leaving he real secor where invesmen belongs unaffeced. According o Rosow, (1934) inflaion has been imporan for several indusrial ake off. Bu hen, here is a level of inflaion ha can be considered conducive for economic growh. i.e ha will promoe growh hrough increase in invesmen. The problem herefore lies in deermining he inflaion rae consisen wih developmen and idenifying he price ha reflec a conducive inflaionary pressure on he economy. I is herefore imperaive ha here have been some argumens surrounding he relaionship beween inflaionary rae and economic developmen. While he classical economis believe ha inflaionary rae doesn affec he real secor where invesmen belong, economis like Rosow is of he opininon ha inflaion plays a majpor role in indusrial ake off i.e i has he endency of promoing capial accumulaion. Lieraure Review and Theoreical Framework There have been several sudies on inflaion relaed ioissues in differen journal and publicaions boh local and inernaional. For insance, Bhaia (1960) and Ecksein (1958) aemped o review ha Rosow s hesis did no compleely show ha he ake off sages of economic developmen has ypically been associaed wih inflaion. Looking a he hisorical relaion beween inflaion and economic growh in five counries, Bhaia find no evidence ha ake off in Sweden, Japan and Canada was assocaied wih inflaion He concluded ha relaion beween inflaion and growh has been on he increase in he Unied Kingdom, Germany and Japan and significanly posiive only in Sweden. Ecksein (1958), carrying ou a es on he effec of inflaion on economic growh for eigh indusrialized counries. He concluded ha period of rapid economic growh occurred wihou inflaion showing ha here is no hisorical relaionship beween inflaion and economic growh, bu his he said i occurred up o a criical rae of inflaion afer i will decline. Thirallich (1974) in a cross-secion sudy of fory-hree counries over he period of ( ) finds inflaion o be negaively relaed wih growh. His sudy concludes ha depressing effec of inflaion on economic growh works hrough he worsening of he economic disribuion and he cos of invesmen. Also, in a sudy conduced by Durance (1975) in he 8 Page

2 An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria relaionship beween inflaion, growh and he level of per capial income was examined. He suggesed ha in asiuaion where growh rise wih he rae of inflaion up o a poin and hen begins o decline and in a siuaion where growh rise wih level of per capial income and hen declines we should expec he evidence o conform o a mild inflaion as growh rises. However, he relaionship beween invesmen and inflaion has been seen by various economiss using differen economies in diverse perspecives. While some see i o be posiive some see i o be negaive. This sudy herefore aemps o sudy he relaionship by focusing on he impac of inflaionary rae on invesmen using Nigeria Economy as case sudy. Theoreical Framework Demand and pure Cos Push Theories The demand-pull heory ascribe rising prices o excess demand. In he goods marke, prices rise because he claiming on a sociey s resources from invesors and consumers in money when erms exceed he economy s real producive poenial. Thus, his ype of inflaion occurs when aggregae demand rises faser han aggregaed suplly. In he arely 1960s, Nigeria experienced a mild inflaion or single digi inflaion, which is said o be consisen wih he process of economic growh. I would herefore be unrealisic o ascribe he inflaion during he early sages of developmen in Nigeria o demand pull forces. The pure cos model of inflaionary process indicaed ha inflaion arise from increases in he cos of producion, especially rising wage emanaing from rade union acions. According o Iyoha (1975), Inflaion in Nigeria can be aribued o boh demand and supply phenomena as well as he openness of he Nigerian economy and jus one relaed facor. The Monearis Theory of Inflaion From he monearis perspecive, inflaion is always and everywhere a moneary phenomenon and mainains a policy of moneary and physical sabiliy is a basic prerequisie for rapid economic developmen. The monearis heory of inflaion is linked wih Friedman and Schwarz. Accordingly, hey believe ha inflaion is a moneary phenomenon and as such can only be viewed in erms of increase in he sock of money in he economy. Monearis see he arrow of causaion in he equaion of exchange (MV=PY) as going from lef of prices. This direc cavsaion was suppored by he empirical work of Micron Friedman (1968) and Schwarz (1973) Schwarz like Friedman carried ou his empirical sudy by means of simple daa conumely forh counries covering he period ( ). The resul showed a high posiive correlaion beween money supply and prices which is consulan wih a Friedman (1968) saemen ha he level of he rae of growh of money supplies wheher domesic or global deermines he prices level. The monearis herefore view money supply as exogenously deermined and such can be conrolled only by he moneary auhoriies. The Classical Theory of Invesmen The classical heory sae ha planned invesmen will equal planned savings and he equilibraing facor is he ineres rae. They argued ha S=f(r),F 1 (r) <0, i= f(r), f 1 (r)<0. Thus, in he classical heory, ineres rae as a very powerful facor, which influence invesmen. Thus, invesmen is ineres elasic. The Keynesian Theory of Invesmen Keynesian aacked he classical heory for he exclusion of income as a fundamenal deerminan of savings. The classicaliss said ha ineres can adjus inermienly owards equilibrium bu he Keynesians said his is no realisic ha here will be moneary and fiscal policies o decide wha he rae of ineres will be. In he Keynesian model. I=i(r), owever, since a equilibrium, saving equals invesmen, we have S=I,(y) =I (y, r), (y) > 0, (r)<0 The Acceleraor Principle The acceleraor principles ake wo differen forms. The simple acceleraor principle and he flexible acceleraor oherwise called he capial sock adjusmen principles. J.N. Clarke (1963) in business acceleraor and he law of demand developed simple acceleraor. The heory saes ha he rae of invesmen expendiure depends on upon changes in he levels of oupu. Tha is increase in oupu pus pressure on exising producion capaciy, which necessiaes an expansion of he capial sock and in urn necessiaes a higher rae of invesmen expendiure. Symbolically, Le K = Capial Sock, = Level of oupu, = K/Y Capaciy oupu raios, = acceleraor, f W =K/Y, =WY, K=WΔY This is he acceleraor principle. As oupu change (Δk ) changes he same direcion, e K = capial sock of period. = oupu level a period. K = capial sock a he previous period, I = oupu level a previous period. W = Δ K/ Δ Y. Acceleraor. 9 Page

3 An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria J.W Clark made use of poenial oupu in his analysis. The flexible acceleraor heory removes one of he major. Weakness of he simple acceleraor principle ha he capial sock is opimally adjused any ime lag. In he flexible acceleraor principle, here are lags in he adjusmen process beween he level of oupu and he level of capial sock. This is also known as he capial adjusmen model II. Mehodology Model Specificaion Following he various heories especially he Rowsow heory and Bahia (1960) sudy where invesmen was expressed as a funcion of inflaionary rae. A model showing he relaionship beween inflaion and invesmen is specified hus INV =F(Infl, In, RGDP, Ms, D/Y, Infl - I..(1) i.e Rinv = β 0 +β 1 Infl +β 2 In + β 3 RGDP + β 4 Ms + β 5 D/Y + β 6 INFl -1 + U..(2) Where ; Rinv = Real Invesmen (Proxy by Real capial formaion), INFL = Inflaion rae, in = Ineres rae, RGDP = real income, Ms = money sock, D/Y =deb income raio (proxy deb) overhang), NFL -1 = lagged inflaionary rae A priori Expecaion: β 1 >0; β 2 ; β 0 >0 β 4 >0; β 5 <0; β>0 Mehod of Daa Analysis To be able o esablish a dynamic relaionship beween invesmen and inflaionary dynamics in Nigeria, co-inegraion and error correcion model esimaing echnique is adoped using Johansen procedure. The co-inegraion will be preceded by he uni-roo es using he argumen dicker fuller (ADF) es. This will be also used for he residual saionary es before he error correcion Model (ECM). Esimaing Technique The firs sep is o examine wheher he ime series conained in he equaion has a uni roo. In he coinegraion lieraure, he more frequenly used ess for a uni roo are he Augmened Dickey-Fuller (1979 and 1981) Philips Perron (1988) and Perron (1986 and 1988) es. These ess agreed in heir reamen o he inercep parameer. Thus, he null hypohesis model o es for uni roo has he following form: X ax 1 E...(3) And he model under he alernaive hypohesis: The esimaing echnique adoped for his sudy is coinegraion and error connecion model. According o Engle and Granger mehodology, T X ) ax E...(4) ( 2 1 When X is he of he ime series, and under he null hypohesis; a 1 and 0. T represens he number of observaions. In his paper, we use he Augmened Dickey-Fuller (ADF) o es for he saionariy of he ime series. The ADF es can be obained by applying OLS o esimae he coefficiens of he following relaion: X X n 1 i X 1 ui...(5) 1 n is chosen o eliminae he auocorrelaion. If a uni roo exiss, hen y a 1 would no be saisically differen from zero. The ADF es can be conduced by comparing he -value on he coefficien of X 1 wih criical values. The Granger represenaion indicaes ha if X and are inegraed; hey will have an error correlaion represenaion as follow: a( i a0 ( y ai X) b( c( E...(6) Where a (, b( and c( are sable and inveriible polynomials, respecively. Such models provide a more aracive way of presening and modeling coinegraing series. The error correcion models combine he long run ( y ax ) and he shor run dynamics. The second sep of Engle and Granger mehodology consis o esimae he following regression: y a a y X bec...(7) j Where A denoes he firs difference and he EC represens he error erm. The esimaed error erm coefficien mus have saisically significan negaive sign. This coefficien indicaes he percenage of he disequilibrium 10 Page

4 An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria in he dependen variable ha would be adjused from period o anoher. I is widely recognizable ha Engle and Granger es for coinegraion would be enough if we wan o examine he effec of error correcion mechanism on he dependen variable for wo sequences periods such as and 1. The maximum Likelihood procedure (Johansen s es), suggesed by Johansen (1988 and 1991) is paricularly preferable when he number of variables in he sudy exceeds wo variables due o he possibiliy of exisence of muliple coinegraing vecors. The advanage of Johansen s es is no only limied o mulivariae case, bu i is also preferable han Engle-Granger approach even wih a wo-variable-model (Gonzalo, 1990). To deermine he number of coinegraing vecors, (Johansen, 1988 and 1991) and Johansen and Juselius (1990) suggesed wo saisic ess. The firs one is he race es ( race ). I ess he null hypohesis, ha he number of disinc coinegraing vecors is less han or equal o (q) agains a general unresriced alernaive (q = r). The second saisical es is he maximal eigenvalue es ( max ). This es concerns a es of he null hypohesis ha here is ( r) of coinegraing vecors agains he alernaive ha here is (r + 1) coinegraing vecors. Source of Daa Daa on all he variables used in he empirical analysis were all sourced from he CBN saisical Bullein 2006 ediion. III. Resuls And Discussion This secion begins by examine he ime series properly of he variables used in he model. This was done hrough he es for saionariy. Table 1. UNIT ROOT TEST RESULT Variable ADF Saisic Order of Inegraion RINV I(1) RGDP I(1) INFL I(0) INT I(1) MS I(0) INFL(-1) I(0) DEBT I(2) Noe: ADF criical value a 5% is Source: auhor s compuaion The ADF es in his sudy shows ha only MS and INFL (-1) are saionary a he level while RINV, RGDP and INT are only saionary a he firs difference while deb could no be found o saionary a boh levels bu only saionary of he second difference. I could herefore be argued ha equilibrium does no exis in he shor run and herefore he need o know wheher equilibrium exis in he long run. As a resul of his, he es for coinegraion was performed using he Johansen (1991, 1995) maximum likelihood esimaion approach. TABLE 2: CO-INTEGRATION TEST Engel Value Likelihood Radio Criical Values 5% Criical Value 1% Hypohesized No of CE (5) None** A mos 1** A mos 2** A mos A mos A mos 5 *(**) denoed rejecion of he hypohesis a 5% (1%) significance level L.R. Tes indicaes 3 co-inegraion equaion(s) a 5% significance level Source: auhor s compuaion Table 2 showed ha here are hree (3) co-inegraing vecor in he invesmen funcion. This means ha here is a long erm equilibrium relaionship beween he invesmen and variable capured in he model. To be able o correc for he error beween he shor run and long period he error correcion mechanism was used. Bu before hen he co-inegraion regression resul is as follows: 11 Page

5 An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria Table 3 Repressors Coefficiens T-Raio C RGDP INFL INT MS INFL(-1) Deb. D/Y R 2 = 0.97 F-sa = D:w = 1.76 RINV = infl RGDP MS INT infl(-1) D/Y Source: Auhor Compuaion From able 3, resul shows ha here is a posiive relaionship beween and real income (RGDP) and real invesmen in Nigeria. Tha is a uni increase in real income in Nigeria should lead o abou 77.9% increase in he level of invesmen in he economy. There is an inverse relaionship beween rae and invesmen. This is in line wih he Apriori expecaion. Form he resul a percen increase in inflaion will lead o a reducion in invesmen o he une of 29.7%. he implicaion of his is ha governmen mus make sure ha inflaion rae in he counry mus be oally curailed. One surprising resul from he sudy is is posiive relaionship beween ineres rae and invesmen. The reason for his ype of relaionship migh no be unconneced wih wha Anyawu (1995) called he exisence of many risk akers who are invesor in he Nigerian economy his se of invesors migh no be concerned wih ineres rae on loan bu profi and duraion of realizing such profis. The money supply and deb are boh posiively relaed o invesmen. Meaning ha a percenage change in money supply and also in deb will bring abou change in invesmen o he urn of 17.5% and 14% respecively. Bu he carry-over effec of he inflaionary rae from he previous year exhibied a direc relaionship. The effec of his migh have been soaked by economic aciviies in he previous period before reaching he curren period. The value of he R 2 is 0.97 indicaing ha he explanaory variable explains abou 97% of he sysemic variaion in he invesmen. Despie he inverse relaionship beween inflaion and invesmen, he value of he T. raio showed ha inflaionary rae alone does no have significan impac on he level of invesmen in Nigeria. Likewise oher variables in he model excep he real income i.e. RGDP. The F saisic shows ha he overall regression is saisically significan. However he resul reveals ha here is no problem of auocorrelaion as he Durbin-Wason is 1.76 Table 4 Error Correcion Parsimonious Model Explanaory Elasiciies. Value Consan ΔLOG (RGDP) ΔLOG (INF ΔLOG (INT) ΔLOG (Ms) ΔLOG (INFL(-1)) ΔLOG (DEBT) ΔECM (-1) R 2 = F-Sa = D:w =1.68 Source: Auhor s Compuaion The resul in able 5 analyses he shor run dynamics among he variables. This is furher eviden in he value of he ECM which is correcly signed i.e. negaive. This means ha he ECM is able o correc any deviaion from he long run equilibrium relaionship beween invesmen and is pas values of inflaionary rae. IV. Conclusion and Recommendaion Some conclusion can be drawn from he findings in his sudy. Firsly, he sudy has revealed ha inflaionary rae does no have posiive impac on he level of invesmen in Nigeria. Again he empirical findings have shown ha increase in GDP will posiively influence he level of invesmen. The policy recommendaion is ha Nigeria governmen should puruse vigorously, policy ha will dreasically reduce he curren high rae of inflaion in he counry while rying o boos domesic producion so as o increase he GDP. Generally, his sudy has herefore, shown ha low inflaion and growing real income are cenral o massive 12 Page

6 An Empirical Assessmen of he Relaionship beween Inflaion and Invesmen in Nigeria capial formulaion. I is herefore imporan ha policies ha will creae condiions for his o happen should be of grea concern o policy makers. References [1] Anyawu, J.C. and Oaikhenan, H.E (1995) The Modern Macro Economic Theory and Applicaion in Nigeria Jonnane Educaional Publishers Limied, Onisha, Pp [2] Arunwarlds W.C. (1951) Depreciaion as cause of inflaion in African Counries: an Empirical Analysis. [3] Bhaia R.J. (1960). Inflaion, Deflaion and Economic Developmen IMF Saff Papers [4] Clarke J.N (1936) Acceleraion Principles and is Applicaion. American Economic Review. [5] Durnace, J. (1975) The Impac of exchange rae uncerainy on he level of invesmen economic Journal 109, C55-C67 [6] Ecksein. C (1958), Foced Invesmen Decisions in UK manufacuring: he imporance of Tobins Q Oupu and Deb, European Economic Review, 39, [7] Friedman M. (1958), Wha price Guild Poss in Shuz G. and Alber RZ (Eds) guidelines, informal conrols and he marke place, Universiy of Chicago Press, Chicago, [8] Iyoha, M.A (1975) Inflaion and Openness In less Developmen Economics, A cross Counry Analysis Economic Developmen and Culural Change Vol. 22, No. 1, Ocober [9] Odoko F. O (2003). Conemporary Economic Policy Issues CBN Publicaion. [10] Osakwe e al (1982), Nigeria and he IMF, Heinmann Books Nigeria. Ibadan [11] Rowsow, R.E (1934), Conflic, Inflaion and Money Cambridge Formal of Economics, 1, [12] Schwarz, G. R. (1973), A world of Inflaion, (New York Barnes and Noble) [13] Thirwall A.P. (1974) Inflaion, Saving and Growh in Developing Economics Macmillan, London. 13 Page