In the last unit, we
examined the control of financial institutions and the consequent role that the
various
supervisory and
regulatory authorities play in the determination of money supply. In this unit,
we shall review
inflation.
The economic spectre
of the Nigerian Inter Civil War period was the demoralising level of
unemployment.
The implementation of
economic policies following the war allowed over 30 years of unemployment
problems.
The worry of
unemployment has given way to a concern over inflation, the condition of
generally rising
prices and the bulk
of post-war Nigerian economic policies may be seen as a continuing fight to
restrain price
increases and the
distortions created by them.
In a very general
sort of way, inflation simply means rising prices. Although prices do not
always change
together, the
interdependence of different parts of the economy does tend to punch up all
prices together.
The main purpose of
this chapter is to examine some of the causes/theories of inflation and to see
if they are
applicable in
Nigerian situation. In earlier units, the causes of inflation have already been
considered implicitly.
Firstly, an excess of
aggregate demand over aggregate supply when output cannot increase will cause a
rise in prices. This
sort of inflation is called “demand inflation” (sometimes also demand-pull-for
some obvious
reasons). For these
reasons inflation is usually an important element in an excess demand
situation. The
second type of
inflation already considered is what might be called “monetary inflation”, that
is rising prices
caused by increases
in the money supply.
Meaning/Definitions of Inflation
Inflation has become
a household word in Nigeria. It is no longer a strange economic jargon to any
student.
There is hardly any
Nigerian citizen who does not worry about rising prices and the high cost of
living.
In the ordinary
sense, inflation is seen as an increase in the average level of prices. In
economics, it is
defined as a
condition in which supply persistently fails to keep pace with the expansion of
demand. It is a
state of
disequilibrium in which too much money is chasing too few goods.
The literature is
full of plethora of definitions of inflation. Selow (1979) for instance, see
inflation as going
on when one needs
more and more money to buy some representative bundle of goods and services or
a
sustained fall in the
purchasing power of money. As Johnson (1972) units, and for most purposes,
inflation is
generally and
conveniently defined as a sustained rising trend in the general price level.
Inflation is a period
of general increases in the price of goods and services in an economy.
Inflation can be
measured using the following methods.
(a) Consumer Price
Index - It measures inflation at the price where goods are consumed.
(b) Wholesale
Price Index - In this, inflation is measured at the wholesale stage.
(c) Gross
Development Product Deflator - More often this is used to measure
variations in the computation
of economic activity
in developing countries.
None of these indices
will give an unbiased result because at any point in time, there is a new
product being
introduced in the
economy.
Types of Inflation
(a) Demand-Pull
Inflation: This is induced by excessive demand not matched with increase in
supply.
Here, too much money
is chasing too few goods. Give a fixed stock of goods, any increase in demand
brought about by
increase in people’s disposable income will force prices up in the market. This
was the
situation during the
Biafran-Nigerian War and after the Udoji Salary Awards in 1974 when wages
extensively
increased. Higher wages increased the purchasing power of consumers thus
leading to
increased demand. The
pressure on commodities therefore led to increase in their prices.
(b) Cost-Push
Inflation: This is induced by rising cost of production, particularly
rising wages. If we take
the four factor rewards/wages, profit, interest and rent, we
would unit that only wages could be influenced considerably
by human factors. The trade union could be very vocal and militant and this may
lead to increase in wages without corresponding increase in productivity. This
wage-price spiral inflation is such that the increase in wage, which is a
production cost will lead to price rise and the price rise is another argument
by labor unions for higher wages and therefore, higher prices will once again
set in and so on. The problem is more pronounced when such wage increase is
well anticipated by sellers such that prices may actually rise in anticipation
of pay rise. In fact, the cycle continues and prices continue to rise, hence
the name wage-price spiral.
(c) Hyper-Inflation: This occurs
when the level rises at a very rapid rate. In this case, money loses
itsfunction as a store of value and its medium of exchange function may be
affected if people are unwillingto receive it, preferring trade by barter. This
was the situation in Germany after World War II in 1945when people preferred
cigarette to money. The main cause of hyper-inflation is an enormous expansion
of the money supply.
Causes of Inflation in Nigeria
Generally, the
following could be said to be the causes of inflation.
(1) Excessive Money
Supply: Excessive money supply through poor monetary policy or other
methods
invariably lead to
inflation in Nigeria, the 1974 Udoji Salary Award and the 1981 Minimum Wage Act
injected a lot of
money in the economy thus causing inflation. Expansionary monetary policy is
also a
contributory factor.
(2) Fall in the
Supply of Goods and Services: Agriculture is virtually abandoned in
Nigeria. It is only left
to the aged in the
remote villages who practice subsistent farming using out-dated or archaic
methods.
This shortage of
commodities has been one of the most influential causes of inflation in Nigeria
today.
Rising wages also
increase production costs. This, thus, leads to decreased supply of commodities
thereby causing rise
in prices.
There were marked shortages
in the supply of essential commodities. This became particularly noticeable
when the country
could not obtain necessary foreign exchange to pay for the expanding imports.
Thus, the prices of
few commodities that found their ways into the country and those produced
locally
were soaring.
(3) Budget Deficits or Government
Expenditure Programme: Almost all the governments of West
African countries
have been experiencing budget deficits since the 1970s. There is also enormous
increase in
government expenditure on development programme and other capital projects or
expenditures.
These have
contributed greatly to inflationary trends.
(4) Imported
Inflation: Almost all our manufactured goods in Nigeria are imported from
the advanced
nations of the world
who are currently experiencing inflation. This means a direct importation of
these
higher prices to West
African nations. Importation of goods from countries suffering from inflation
could lead to
imported inflation into the country which also increase domestic price.
(5) Rural-Urban
Drift/Migration: The mass drift to urban areas has left the Agricultural
sector unattended
to. Moreover, the
little goods and services in the urban areas are grossly inadequate hence
inflation results.
(6) Increase in
population Explosion: There is enormous increase in the population of West
African
nations in particular
and the whole world in general. For Nigeria, her estimated population increased
from about 55m in
1963 to more than 88.5m in 1991. The situation is worsened by the fact that
majority
of the population are
children who fall under the unproductive sector of the society. They are,
therefore,
dependent on the
working population hence they put pressure on the little goods and services
available.
(7) Activities of
Middlemen and Monopolistic Tendencies: There are too many middlemen in the
chain of distribution
of goods and services in Nigeria. These people are very exploitative hence they
hoard available goods
in order to sell at higher prices in “Black Markets”. Many others who have the
influence from
government quarters monopolise the supply of certain essential commodities
thereby
charging higher
prices than hitherto or what ought to be. Therefore, large scale hoarding in
the hands of
the major and minor
distribution, particularly the lucky few that had access to import license
contributed
in a very large way
to the severity of inflation in Nigeria.
(8) Excessive
Demand by Consumers: Increase in the purchasing power of consumers leads to
higher
demands and thus
inflation. This is the case in Nigeria due to higher wages resulting from
frequent
upward salary
adjustments and revisions.
The inflation we have
in Nigeria can be rightly described as demand-pull because there has been an
upward trend in
demand for goods and services for the past thirty years which may be the result
of a
rising standard of
living of many Nigerians. The oil boom further increased and aggregated demand
with no corresponding
increase in supply most especially essential goods and food stuffs, hence persistent
rise in their prices.
(9) Higher
Production Costs: Higher wages, as is the case in Nigeria are higher costs
of production.
They may hinder
increased productivity, thereby resulting to inflation or the higher production
costs are
passed onto consumers
in the form of higher prices on commodities.
(10) War-Caused
Inflation: During wars like Nigerian/Biafran War, efforts were directed to
production of
war equipment or
armaments. Labor which could have produced foods was deployed to the war
fronts. Hence, demand
could not equate supply. Inflation therefore resulted.
(11) Wage Increase
Unrelated to Production: Since there have been general wage increases, the
most
notorious was the
Udoji wage review reports, the implementation of which almost troubled the wage
levels of most of the
working groups. The most recent of this wage increase in the country is the SAP
relief and 45% wage
increase. These wage increases were unrelated to increases in productivity of
workers. Hence high
wages means high prices.
(12) Bad Management of Resources: The
large-scale fraud and corruption which has started since the
oil boom era of early
1970s has been increasing the tempo of inflation in Nigeria. Contracts most of
which were not
executed, were unbelievably inflated. Large sum of money were siphoned into
private
pockets, some
particular individuals become richer than the states. Thus, money lost its
traditional
value. In pursuit of
Naira, most people abandoned productive employment to become sales agents,
contractors,
importers and exporters. The effects of all these were the disappearance of
many essential
and other goods from
the Nigerian Market, coupled with usually rising prices.
Effects of Inflation (Problems)
(i)
Distributive Injustice: Inflation imposes a lot of distributive
injustice on the society by re-distributing
income in favor of
one group to the disadvantage of the other groups. Examples are discussed
below:
(a)
People on fixed income suffer: Such people like pensioners,
fixed salary earners etc, because
there is no in-built
flexibility in their income to make their income adjust in line with the
continuous
rise in the prices of
goods and services they buy. Thus the quantity of good and services that their
money income can buy
will be diminishing progressively until they succeed in improving their lot
through bargaining
for higher wages. On the other hand, those whose income are flexible will
benefit from
inflation because they can always increase their income ahead of price
increase.
Business men and
other profit earners thus benefit from inflation
(b)
Inflation imposes adverse effects on savings: This
is because real value of savings cannot be
maintained. By
discouraging savings, inflation could be perpetuated because people will want
to
keep their wealth in
real assets as opposed to money. The Central Bank can, however, maintain
the real level of
savings by adjusting interest rates but this will be an extra cost to the
economy.
(c) Inflation
Reverses the Position of Debtors and Creditors: Debtors gain while creditor
lose.
The only way which
the creditor could be saved is by imposing an interest rate which should
reflect the inflation
rate; otherwise he will get cheap money back for dear money lent out.
(ii)
Loss of Confidence in Money: At the extreme case of
Hyper-inflation, there would be economic
depression such that
business men may not know what to charge for their products like the 1930s
inflation in Germany
when a packet of cigarette sold for millions of German marks and buyers too
will
not know what to pay.
In such severe cases, money virtually become worthless. Suppliers of productive
factors want to be
paid in kind and not in cash, and creditors will keep away from debtors as they
do not
want to obtain such
cheap money from debtors. Money will be deprived of its functions as an
exchange
medium and as a
standard for deferred payment. We have seen above that because of inflation,
savings
will fall thus money
will cease to be a store of value. As a measure of value or unit of account,
money
will also fail
because the instability of its own value will make it difficult for it to
measure other values.
With all these
developments, money will become virtually useless and this may bring a tendency
for the
society to go back to
barter exchange and subsistent production.
(iii)
Expectation Effects: As a buyer, if I expect that price will rise tomorrow, I will want
to buy today so
as to avoid paying
higher price tomorrow whereas as a seller, I would wish to withhold stock until
the
price rises tomorrow.
A situation of scarcity
will, therefore, arise today and the current high demand will create inflation
today. This makes
economist believe that “inflation will occur if people expect it to occur”.
(iv)
Wrong Investment Priorities: Inflation will precipitate
wrong investment because it is only those
items whose prices
are rising that people will concentrate production upon whereas they may not be
actually important.
It follows in real life that ostentatious goods and such goods like beer will
attract
more attention than
essential items like agricultural products.
(v)
Inefficiency and Poor Quality: In an inflationary period,
goods will no longer be of the required
standard because of
the haste to make profit. Emergency contractors and innumerable unskilled
people
will go into contract
jobs and such jobs as distributorship, increasing distribution cost which is an
aid of
inflation.
(vi)
Distortion of Government Development Plans: the costs of major
investments are disturbed by
inflation such that
government development plans are severely distorted. This may lead to
re-appraisal
and deficit financing
and some projects might be dropped out of the plan for reason of prohibitive
cost.
During inflation, new
plans become difficult to formulate because the planner will not know the
prices
to use.
(vii) Distortions in
Accounting Reports
(viii)
Balance of Payment Effect: Because domestic prices are higher, home
made goods would become
more expensive
relative to those in other countries. The country, therefore, becomes a dumping
ground
for foreign goods, a
good place to sell but a bad place to buy from and this will have significant
impact
on foreign exchange
earnings and on the balance of payment situation.
General Ways of Controlling Inflation in Nigeria
(1)
Price Control Measure: This involves the setting up of Price
Control Board by the government
which fixes maximum
prices charged for certain commodities experiencing inflation. Experience,
however,
has shown that this
system bedeviled with a myriad of problems does not work. The Nigerian case
is typical example.
What usually results are hoarding, profiteering and black-marketing, thus
negating
the initial aims.
(2)
Wage Control or Wage Freeze: Most of governments place
freezes on wage increases as a measure
to combat inflation
but this policy does not work or is ineffective since workers have devised
methods of making the
government or employers of labor dance to their tune. These ways include
goslow,
work-to-rule,
industrial actions, etc. These are most often used in democratic nations/societies.
(3)
Monetary Policy: This involves the use of traditional monetary instruments to
reduce the quantity of
money in circulation.
These include increase in the Bank or Discount Rate, increase in the Liquidity
ratio, use of open
market operation – contractionary monetary policy in this case, sectorial
allocation or
special directives,
etc., however, the experience in the developing world has shown that these
traditional
instruments of
monetary policy have a lot of deficiencies hence their effectiveness.
(4)
Fiscal Policy: A combination of increase in personal income tax and reduction
in government expenditure
may prove effective
especially when inflation is demand-pull in nature. These reduce the purchasing
power of consumers
thus reducing demand and prices of commodities.
(5)
Total Ban on the importation of certain items :
Especially when inflation is imported, the government
is strongly tempted
to place total ban on the importation of certain non-essential items. However,
retaliation by other
nations and political pressure lead to the lifting of the ban no sooner than it
was
placed hence the
ineffectiveness of such a policy.
(6)
Increase in the Production of Goods and Services:
Increase in the production of goods and services
is the most effective
measure to inflation. Increase in the supply of products will naturally force
prices down. In
Nigeria, concrete efforts should be made to increase production of essential
but scarce
commodities.
(7)
Over-hauling of the entire Distribution Network:
Only genuine distributors should be appointed
and any one found
hoarding and profiteering should be prosecuted to serve as a deterrent to
others.
Conclusion
The tendency of
prices to rise and the value of money to fall is known as inflation. One of the
main aims of
government is to
control the rate of inflation because of its undesirable effect on the economy.
For a full
understanding of
inflation, it is important to realise the relationship between the supply of
money and the rate
at which prices are
rising for the supply of money is important consideration in the question of
inflation. This
leads many people to
regard inflation as a condition of excess Aggregate Monetary Demand (AMD) over
Aggregate Supply in
conditions of full employment. The importance of this definition of inflation
lies in the
fact that it draws
attention to Aggregate Monetary Demand and consequently to the supply of money.
While acknowledging
the importance of the money supply to the inflationary process, it is useful to
consider
other powerful forces
which make their contribution to rising prices. The standard distraction is
between
“Cost-Push inflation”
and “demand-pull” inflation. The names indicate the main causes of the
particular
inflation although it
is usual for one kind of inflation to lead to the other kind in a particularly
unpleasant
circle.
Cost-push inflation
occurs when prices rise as a result of the costs of production increasing more
rapidly
than output. When
cost inflation of this kind is widespread, it necessarily leads to demand inflation
as the
recipients of extra
income want to increase their purchases. Once an inflationary atmosphere is
established,
the process is in
danger of becoming not only self-perpetuating but self-accelerating.
While there is a
minority view that a degree of inflation is a necessary stimulant to the
economy slightly
rising prices
encouraging investment, the strenuous efforts of governments to restrain its
pace suggest that it
produces many
undesirable side effects.
Summary
In the unit, we have
successfully defined inflation and were able to recognize the different types of inflation,
analyse the causes
and effects of inflation. Reasonable suggestions on the various ways of
controlling inflation
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