ABSTRACT

The purpose of this paper is to evaluate the short-run and long-run impact of financial deepening on inflation in Nigeria from 1980 to 2012 using open economy model. Data was collected from Central Bank of Nigeria Statistical Bulletin (2012) and United Nations Conference on Trade and Development (UNCTAD) Volume index. The study employed the use of Auto-regressive Distributed Lag Model (coefficient Diagnostic Wald test and Variance Decomposition Test), to enable us achieve our objectives. The result shows that import volume index (IMPV) and exchange rate (EXCR) in lags 1 & 2 respectively are significant to explain variations in the consumer price index (CPI) in the short-run while all other variable have no significant impact on CPI. Also the short –run result indicates that financial deepening variables; MS2/GDP ratio (Fd1) and PSC/GDP ratio (Fd2) have no significant impact on consumer price index. While in the long-run, import volume index (impv), prime lending rate (prim) and exchange rate (excr) are significant with P-values of 0.0002, 0.0017 and 0.0010 respectively. The coefficients of FD1(-1) and FD2(-1) designated with C(16) and C(17) was tested together using Wald Coefficient Diagnostic Test to see the impact of financial depth on the price level, and the result indicates a positive and significant impact of financial deepening on Consumer Price Index (CPI). Meaning that, increase in money supply to GDP ratio (MS2/GDP) and private sector credit to GDP ratio (PSC/GDP) together generated consequent increases in price. The variance decomposition test indicates that shocks to FD1 can rarely cause variation in price level while shocks to PSC/GDP ratio (FD2) can cause variations in prices more than any other variable both in the short-run and long – run. Standing on our findings, appropriate monetary and exchange rate policies should be ensured as Nigeria move towards achieving her financial depth goals by the year 2020.

INTRODUCTION

Inflation remains one of the major economic variables that can distort economic activities in both developed and developing countries. Although it has been argue that moderately rising prices (single digit inflation) initially activates the level of economic activities (Adeoye 2002), but persistent inflation is however a distress to producers, investors and consumers in an economy. Thus, understanding the factors driving inflation is very vital for the formulation and implementation of appropriate macroeconomic policies (Adeoye 2002).

In classical macroeconomics, there has been an old standing debate by renowned economists on the actual causes of inflation, Quantity theory of money developed by Iriving Fisher, solemnly believed that the main and the only factor that contributes to inflation are monetary aggregates. According to Jhingan (2002), the Monetarists emphasized the role of money as the principal cause of demand-pull inflation. They contend that inflation is always a monetary phenomenon. Price tends to rise when the rate of increase in the money supply is greater than the rate of increase in real output of goods and services (Johnson, 1973). Keynesian Economics believes on the money demand function as a strong factor of inflation. On the other hand Monetary-disequilibrium theorists states that output, not (or not only) prices and wages, fluctuate with a change in the money supply, while  monetary neutrality theory, affirmed that in the long-run, a one-time percentage rise in the money supply is matched by the same one-time percentage rise in the price level, leaving unchanged the real money supply and all other economic variables such as interest rates. Even till this age the debate on the actual cause of price rise still hold. Many researchers has come up with varied evidences using different models, for example; According to Jose De Gregorio (2004), in the working paper developed for the central Bank of Chile; he explicitly mentioned the factors that can affect inflation in many countries; for example in the case of South African the factors that favours lower inflation and inflation risks are evolution of broad money supply defined as M3. In the other cases such as the Czech Republic, Israeli, and Switzerland, he asserted that the expansion of monetary aggregates has no impact on inflation. Mc Candles and Weber (1995) found that for 110 countries during a 30 year period, inflation and monetary aggregates are positively correlated in the long-run.

You either get what you want or your money back. T&C Apply

Talk to us right now: (+234)906-451-7926 (Call/WhatsApp)

---