Olusola Dahunsi, PhD, Lecturer, KolaDaisi University

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Subjects of Interest

  • Development Finance
  • Fiscal Policy
  • Public Sector Reform

CBN is fighting inflation instead of stagflation 19 Apr 2024

The Nigerian economic managers today stand between the devil and the deep blue sea. The Central Bank of Nigeria (CBN), which is responsible for monetary policy, faces the challenges of a persistent increase in the general price level of goods and services and rising unemployment rate. Which of the two should policy remedy prioritise? Yet, the central bank faces another formidable challenge, which is slow economic growth.

Traditionally, the relationship between inflation and unemployment is negatively correlated. Lower inflation will cause higher unemployment, and vice versa. But empirical evidence indicates that, in Nigeria, a direct relationship has been existing between inflation and unemployment. Inflation has continued to rise with the unemployment rate.

According to CBN data, inflation surged from 22.79% in June 2023 to 31.70% in February 2024. At the same time, the unemployment rate rose from 4.2% in Q2 2023 to 5.0% in Q3 2023, according to the National Bureau of Statistics (NBS), using its revised methodology for collecting labour market statistics in Nigeria. Given the complexity of the relationship between these two macroeconomic indices, especially the multiplicity of structural and monetary factors driving them in Nigeria, the impact of high inflation on unemployment are difficult to counteract with monetary policy alone.

But fiscal and monetary policies are also often counteractive – if not introduced in the right combination, volume, and in synch. For instance, tight monetary policy to reverse a persistent rise in inflation can aggravate unemployment if fiscal policy is also tight. But using cheap money, i.e. loans with low interest rate, to address unemployment can also worsen inflation. By the same token, adopting dear money, i.e. loans with high interest rate, to tackle inflation can aggravate unemployment, resulting in a slowdown of economic activities.

To be clear, the Nigerian economy is experiencing stagflation, which describes the combination of slow economic growth, high unemployment, and high inflation. Intuitively, the appropriate policies for intervening in this economic condition should seek to stimulate both supply and demand. This is more so under the circumstance of high poverty rate in the country.

But, seemingly counterintuitively, the CBN is sidetracking conventional economic policy wisdom. Between May 2023 and March 2024, the central bank has increased the Monetary Policy Rate (MPR) from 18.5% to 24.75%.

The recent decisions of the Monetary Policy Committee of the CBN on aggressive interest rate hikes have been rationalized. To fight (imported) inflation, the exchange rate of the naira needs to stabilize. And for this to happen, policy must incentivise foreign exchange inflows – for all practical purposes foreign portfolio investments – to boost foreign exchange supply. Thus, the CBN is leaving no stone unturned in fighting inflation. But it is arguably not trying to grapple with the urgency of fighting stagflation.

Of course, there have been successes that the recent monetary decisions of the CBN have achieved, including helping to narrow the gap in the official and parallel markets exchange rates and attract foreign portfolio investments. But there are trade-offs with regard to the delay in fighting poverty, unemployment, and catalysing economic growth.

As long as general economic weaknesses persist, confidence in the CBN policies will generally remain weak although they have roused sections of the financial market – especially investors in government bonds and CBN’s open market operation. A more general enthusiasm should have seen domestic savings, which create a larger pool of investable funds, significantly rising. But a slow-moving domestic savings trend has witnessed a weak growth from 20.70% as a percentage of GDP in 2022 to 20.78% in 2023. Conversely, the immediate impact of rising interest rates is more on borrowing costs for businesses, as loans become more expensive, potentially discouraging investment in new projects and/or expansion plans.

Stagflation is a complex economic problem. It is better prevented. Fighting it is tough. Raising the interest rate – especially when it is already in double digits – could depress economic growth while bringing down the general price level. By making credit to the private sector more expensive and less affordable, interest rate hikes can also further hurt employment. When central banks – especially those in the advanced economies are on a tightening cycle – fiscal policy tends to offset the shortfall in credit supply by enacting stimulus programmes. The programmes essentially try to stimulate demand and support continued capital investment.

Such supportive fiscal measures have been ineffective in Nigeria. Corruption and political patronage have seen funds for such programmes mis-directed to unproductive beneficiaries. For instance, a major scandal in the current administration has been associated with the misappropriation of funding under the social investment programme. The same scandal occurred under the previous administration. This lack of complementarity between fiscal and monetary policy will likely continue to prolong stagflation in the Nigeria economy.

One factor that can compensate for production losses to unemployment and boost economic output growth is productivity growth. Productivity growth, which describes the efficiency with which inputs are converted into outputs, has remained relatively low in Nigeria compared to other emerging economies. For instance, Nigeria’s labour productivity growth averaged around 1.5% per annum in the last decade, as per data from the NBS.

The current state of productivity in the country is due to inadequate skills development, inefficiencies in the labour market, outdated farming/production techniques, high production costs, and inadequate infrastructure, just to mention a few. Generally, fixing the productivity gap requires investments with a long-term horizon for a country like Nigeria that has low technological knowhow, weak R&D system, and that has yet to prioritise human capital development. For years, the organised private sector has tried to pick up the slack in human capital development. But it employs only a fraction of the workforce, majority of which operates the informal economy.

The CBN has to recognise the breadth of the challenges it faces, based on its mandates for price stability, economic growth, and full employment. If it isolates the issues, the other problems will undermine its isolated success – for instance the appreciation in the value of the naira in the last few weeks. As has been argued elsewhere in this publication, a high exchange rate is inherently neither good nor bad. It depends on the growth agenda and external competitiveness of an economy. An export-dependent economy would be better served if its currency is relatively weak than strong, making its exports cheap. But an import-reliant economy like Nigeria’s surely needs a strong currency, except that its exchange rate will dissuade domestic production and its exports will be price uncompetitive.

The CBN has to embrace its broad mandate. Low inflation is not more important than full employment or high economic growth. Based on the extant economic situation, low inflation – i.e. one-digit inflation – would be unachievable without a dramatic increase in domestic output growth and a drastic reduction in the national unemployment rate.

Olusola Dahunsi, PhD, who is a chartered accountant, is a lecturer and researcher.