Inflation and Unemployment - The Looming Economic Trap

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Saturday, August 21, 2021 / 08:54 PM / By FDC / Header Image Credit: NPR

 

Over 7 million Nigerians lost their jobs due to inflationary pressures in 2020, taking the total number of poor people in the country to over 83 million (40% of the total population). Inflation hit a four-year peak in March. Driven by the effects of COVID-19, it rose to 18.17%, up 4.85% from February. As of July 2021, Nigeria's headline inflation stood at 17.38%. Nigeria is expected to have the fifth-highest inflation rate on the continent by the end of 2021, behind only Zimbabwe, Zambia, South Sudan, and Angola. The high inflation has compounded the financial pressure on households already faced with a shrinking labor market, stagnant economic growth, and increasing levels of insecurity.

 

Nigeria is experiencing cost-push inflation, where prices of goods and services are driven up by the high price of inputs, wages and production resources, most specifically, imports. Although Nigeria has experienced a downturn in its inflation in the past four months, the inflation rate could increase again due to the likely increase in energy costs (PMS price).

 

Inflation is the biggest driver of poverty because of its impact on households, businesses and overall security. Rising prices erode real incomes and purchasing power of consumers, heightens pressure on operating costs, increases production costs, and reduces real returns on investment. Businesses struggle to survive as it is not always possible for producers to transfer additional cost to consumers, and employment suffers as a result. Rising unemployment, in turn, will push more Nigerians into criminal activity to support their livelihood and make up for lost earnings. A surge in insecurity over the last few years has slowed economic growth further and left more people displaced and unemployed, leading to a vicious cycle of violence.

 

However, the problem is not easily solved. The combination of rising inflation and unemployment rates creates a unique set of challenges for policy makers. Policies that boost economic output and reduce unemployment, such as a reduction in taxes and an increase in government spending, would worsen inflation because these policies tend to increase the supply of money in the economy.

 

Policies that would reduce inflation, such as increasing the interest rate, could exacerbate unemployment. When the CBN increases its monetary policy rate, commercial banks have to increase their interest rates, which discourages borrowing and reduces the supply of money in the country. In a country like Nigeria, a significant rise in the interest rate could have devastating effects on the economy. Borrowing becomes more expensive, leading to a decline in the already sluggish economic growth.

 

Instead, the current situation presents yet another reason for the Nigerian government to focus on economic diversification in general, and specifically a reduction in the country's dependence on imports. Excessive importation strains the already depleted foreign reserves, increases exposure to imported inflation and as a result increases the price of goods available in the economy.4 An example of this was banning the use of foreign exchange to import rice and other popular imports that could be grown or manufactured locally. This initially led to an increase in local production, but inadequate supply of the commodities ultimately led to a surge in prices.

 

The current macroeconomic conditions of Nigeria in terms of its current inflation and un-employment rates, reiterates the need for adequate import substitution, export promotion strategies and also the need for a stable exchange rate.


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