PROJECT TOPIC- EFFECT OF INTEREST RATE ON THE CONTROLE OF INFLATION IN NIGERIA FROM 1980 TO 2012
1.1 Background of the Study
In every fact of life and to any nation, inflation has assumed to be one of the major threat to their wellbeing. Because of these the government of any nation is concerned with the responsibility of maintaining a stable price level through her plans, programs and policies to avoid unprecedented galloping inflation. Every sector of the economy like capital market and the real manufacturing firms requires a stable macroeconomic environment in order to make an effective and reliable forecast. So, these made it clearer the need to study inflation and its control so as to build a timeless dependent model to checkmate its tendency (Taiwo 2010).
Inflation refers to persistent increase in general prices. The rate of inflation has far reaching implications for the performance of the economy. For instance, higher rates of inflation will reduce aggregate demand, production, unemployment, trade deficits, and balance of payment to mention just few. On the other hand, a low and moderate inflation will encourage economic activity, particularly production. This in turn will raise gross domestic product (GDP), reduce unemployment, and eases the balance of payment problems. Its effect and causes are many, very and well treated in some literatures. See Okpara and Nwoha (2010), Fullerton and Ikhide (1998), Odusunya and Atanda (2010), Egwaikhide et al (1994), Jhingan (2004), Batini (2004), Owoye (2007), Asogu (1999) among others.
In the world inflation has become a household word, hence some school of thought like the fiscal and the monetarist who believes that the use of budgeting instrument and monetary indicators is the best to control inflation respectively, exist. However, this work is going to focus on the effect of interest rate on the control of inflation in Nigeria from 1980 to 2012.
Interest rate then refers to the price a borrower pays for temporary usage of capital. It also means the returns a lender expects by postponing and parting with his/her liquidity. The interest rate is a double-hedge sword in that if it is high, holders of surplus funds will part with some since they expect high returns in the future. On the other hand, higher interest rates discourage borrowing. In a state of equilibrium, interest rate equates demand (investment) and supply (saving) in the capital market (Duetsche Bundesbank, 2001).
Real interest rate is an important determinant of saving and investment behaviour of households and businesses, and therefore crucial in the growth and development of an economy (Duetsche Bundesbank, 2001). Both households and firms are mainly concerned with the real returns (interest) on their assets holding. Even though they know the nominal return (interest) on their assets holding, they are not certain about the direction of inflation in the current period (Hakan and Kamuran, 1999). Given their expectations about the future real interest rates, they decide which assets to hold. If the uncertainty surrounding expected inflation is very high, they will expect the return on their investment to be higher.
The existence of fisher hypothesis has continued to generate series of debate among economists. Fisher (1930) asserted that a percentage increase in the expected rate of inflation would lead to a percentage increase in the nominal interest rates. But Jens Weidmann (1997) opined that full fisher effect applies only to economies without taxes. However, Tobin (1965) argued that real interest rate decreases with inflation, while Darby (1975) believed that interest rate changes by more than one for a unit change in inflation rate, due to the tax effect on interest rate. On his part, Mishkin (1984) emphasized that due to the negative correlation between interest rates and inflation, full fisher effect may not hold. Besides, Dutt and Ghosh (1995), Evans (1998), Junttila (2001), and Tillmann (2004) did not believe that the fisher hypothesis holds because they could not confirm any relationship between interest rates and inflation.
Historical Trend of Inflation and Interest Rate in Nigeria
The Nigerian economy has witnessed unprecedented increase in the general price level in the past four decades. The inflation rate was 13.6 per cent in 1970, which increased to 33.9 per cent in 1975 and later dropped to a level as low as 9.9 per cent 1980. By 1984, the rate of inflation jumped to 39.6 per cent and further increased to 40.9 per cent in 1989. In order to address this ugly trend, there was a shift in government policy in 1986 when the Nigeria’s government dropped regulated policy and adopted a deregulated one.
By this new policy, direct monetary policy changed to indirect one as the market forces are allowed to determine the key interest rates in the economy. The expectation is that the interest rates under this regime will be appropriate to curtail the upward trend in the general price level. However, interest rate moved in the same direction, interest rate increased from 1975 and further to 13 percent 1984. Interest rate continued to rise, getting up to 31.2 percent and 36.09 percent in 1992 and 1993 respectively.
In 1995 inflation rate rose to a very disturbing level, which inflation rate was 72.9 percent. Up to date while interest rate is still high, inflation rate has continued on the double digit side. This study will be of much importance because it’s going to elucidate the effect of interest rate on inflation in Nigeria and ease the continued worry for both government and policy makers.
PROJECT TOPIC- EFFECT OF INTEREST RATE ON THE CONTROLE OF INFLATION IN NIGERIA FROM 1980 TO 2012
1.2 STATEMENT OF THE PROBLEM
An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general levels of prices rise, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, those segments in society which own physical assets, such as property, stock and so on benefit from the price/value of their holdings going up, while those who seek to acquire them will need to pay more for them. Their ability to do so will depend on the degree to which their income is fixed. For example, increases in payments to workers and pensioners often lag behind inflation, and for some peoples income is fixed. Also, individuals or institutions with cash assets will experience a decline in the purchasing power of the cash. Increases in the price level (inflation) erode the real value of money (the functional currency) and other items with an underlying monetary nature.
Debtors who have debts with a fixed nominal rate of interest will see a reduction in the “real” interest rate as the inflation rate rises. The real interest on a loan is the nominal rate minus the inflation rate. The formula R = N-I approximates the correct answer as long as both the nominal interest rate and the inflation rate are small. The correct equation is r = n/i where r, n and i are expressed as ratios (e.g. 1.2 for +20%, 0.8 for −20%). As an example, when the inflation rate is 3%, a loan with a nominal interest rate of 5% would have a real interest rate of approximately 2%. Any unexpected increase in the inflation rate would decrease the real interest rate. Banks and other lenders adjust for this inflation risk either by including an inflation risk premium to fixed interest rate loans, or lending at an adjustable rate.
1.3 RESEARCH QUESTIONS
From the existing historical trends on inflation and interest rates in Nigeria, a lot of arguments among researchers had been generated. Some are of the opinion; from their research work that interest rate does not have any relationship with interest rate in the developing countries. While some said that there exist a relationship between interest rate and inflation in the developed economies. Hence, from the above mentioned trends we ask the following questions:
- Does interest rate has effect on inflation rate in Nigeria?
2. Does interest rate policy has long run relationship with inflation in Nigeria?
1.4 OBJECTIVES OF THE STUDY
In order to give sound answers to the research questions. This work is geared towards achieving the following objectives:
- To investigate the effect of interest rate on inflation in Nigeria.
- To investigate if interest rate policy has a long run relationship with inflation in Nigeria.
1.5 HYPOTHESIS OF THE SUDY
The objectives of this study are tested on the following hypothesis as listed below:
- Interest rate does not significantly affect the level of inflation in Nigeria.
- Interest rate policy does not have a long run relationship with inflation in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
This work was done with detail and accuracy in such a way that it will be relevant to any institution of higher learning and to students who are still pursuing their first degree. This work will be of much importance to researchers who may wish to further this research work. The work is done in such a way that it will be resourceful material to developed and developing nations. It is equally an invaluable material to the Nigeria government, our policy makers and non-governmental organizations.
1.7 SCOPE AND LIMITATIONS
The period which this research works or study covered is from the year 1980 to 2012. The scope of this work will cover the entire country (Nigeria) and has also been narrowed down to monetary sector. This study looks into the effect of interest rate on inflation in Nigeria considering the following variables like interest rate and inflation rate.
More so, these are constraints or limitation or challenges encountered during the course of the project. The authenticity of data and the late publication of the data needed for the work and also the availability of the data and accessibility of it. Most times this data are estimated average.