Inflation Dynamics and Industrial Output Gap in Nigeria

Abstract :

Rising costs of production in Nigeria in the past few decades has rendered the local industry less competitive than their international counterparts. Rational consumers in Nigeria have intelligently substituted expensive and poor quality made-in-Nigeria products for high quality and lowly priced imported products. A combination of poor patronage, rising cost of doing business and an unstable macroeconomic environment has contributed to a dozen recessions in the industrial sector in the last 30 years. A pertinent economic issue is the high rate of inflation in the country. This paper investigates the relationship between inflation and industry output gap in order to ascertain if the negative output gaps in the industry have been caused by strong inflationary pressures. Secondary data was derived from the CBN Statistical Bulletin 2016 between 1985 and 2016. The study used HP Filter technique to estimate the output gap. The Johansen Co-integration test and Vector Error Correction Model was used to determine the long run relationship between inflation and output gap. The study found that there exist a statistically insignificant long run positive relationship between inflation and output gap. However, up to 78 percent of errors generated in the model due to a shock to inflation in the current period are corrected in the next period. The study recommends that policymakers need not take the rate of inflation into consideration when attempting to forecast changes in the output gap, however in the long run, an unstable inflation can contribute to the output gap, therefore inflation needs to be put in check.