Modelling the inflation process in Nigeria

This paper analyses the main sources of fluctuations in inflation, and builds an econometric model that explains the inflation process in Nigeria. In doing so, the paper addresses the following questions:

• can the shifts in the Nigerian inflation process over time be identified?
• what are the key determinants of inflation in Nigeria?
• what are the types of shocks that cause inflationary impulses and what is the nature of the propagation mechanisms?

The paper systematically chronicles Nigeria’s inflation experience with a look at inflation episodes, exchange rate changes, oil prices and other factors. The paper also surveys the theoretical literature and empirical studies of inflation in general and for Nigeria in particular. The analysis of the sources of fluctuation using the framework of error correction mechanism, found that the lagged Consumer Price Index (CPI), expected inflation, petroleum prices and real exchange rate significantly propagate the dynamics of inflationary process in Nigeria. The level of output was found to be insignificant in the parsimonious error correction model. Surprisingly, the coefficient of the lagged value of money supply was found to be negative and significant only at the 10% level. One of the major implications of this result is that efforts of the monetary regulating authorities to stabilize the domestic prices would continuously be disrupted by volatility in the international price of crude oil.

This paper argues that inflation entails sizeable economic and social costs, and controlling it is one of the prerequisites for achieving a sustainable economic growth. The paper concludes that, exploring relationships among oil revenue, money expansion and fiscal deficits, and experimenting with the differential between the parallel exchange rate and the official exchange rate as regressors, are future research areas that have the potential to continuously improve the understanding of the dynamics of inflation in Nigeria.