Friday, May 15, 2015 11:17 PM / FDC
Stagflation is a macroeconomic condition in which a country experiences a reduction in real economic growth at the same time as facing an increase in the general level of prices i.e. inflation. It usually occurs at the lower part of a business cycle. The most vivid example was when oil prices spiked by 400% after the Yom Kippur war, following which the US experienced stagflation. The oil crisis was largely responsible for the downturn in the economy just as it was for the UK in the 1970s.
Two main explanations exist for why stagflation occurs. The first is associated with supply shocks for oil importing countries and price decline for oil exporting countries. The second can result from inappropriate macroeconomic policies, such as in the UK when non-monetary policies and devices were used to respond to the economic crisis. Hence, stagflation is usually associated with oil price volatility, but then continues as central banks use excessively stimulative monetary policy to counteract the resulting recession. This sometimes leads to a runaway price-wage spiral. .
Views on Stagflation
None of the economic schools of thought (Keynesian, Neo-Classical, and Monetarist) initially believed or were able to explain the concept of stagflation. This was because prior to the 1960s, many Keynesian economists used the Phillips curve theory which states that inflation and unemployment have a stable and inverse relationship. They ignored the possibility of stagflation. After several years of research, a compelling justification was provided based on the effects of adverse supply shocks on both prices and output.
Is Nigeria in Stagflation?
Nigeria is not in a stagflation state but could be inadvertently moving in that direction. The recent NBS data showed a contraction in economic growth to 3.96% in Q1’15 from 6.21% in the corresponding period of 2014. Also, the inflation numbers released for April showed the 5th consecutive increase to 8.7%. Hence, this is not stagflation but just a recipe or a start of the curve.
In order to stimulate growth, the government is likely to spend more through increased borrowing and advocate for a lower interest rate. This reduces unemployment and boosts growth but is likely to result in a higher level of inflation rate. Nonetheless, if the level of economic growth achieved by the accommodative policy is significant, the impact of a high rate of inflation may be muted.
Likely Monetary Policy Response
Identifying the appropriate policy response to adopt requires an in-depth understanding of the cause of the macro-economic problem.
Some of the key considerations to be deliberated on by the MPC include the following;
1. Stagflation: Low economic growth and high inflation
2. Low level of external reserves inspite of marginal accretion
3. Inherent inflationary pressure
4. Exchange rate stability in all forex market segments
5. Wide divergence between the interbank and the bureau-de-change exchange rates
6. Increasing oil price and its sustainability given the current oil market dynamics
7. New government and its economic and policy agenda.
The current CBN inflation target of 6-9% is unrealistic with the current fundamentals in play. Targeting an inflation band of 10-13% allows the CBN more room to tinker with the interest rates to stimulate growth.
Encouraging bank lending to specific sectors of the economy using subsidized interest rates alongside a more practical inflation target helps to address the looming issue of stagflation.
If policy measures by the new administration are aimed at reviving productivity and improving returns on investment, the real sector will have the incentive to lift capital expenditure. Hence, Nigeria will be on the transition path from stagflation to higher and sustainable real economic growth.
Buhari is obsessed with development and long-term competitiveness of the Nigerian economy, aimed at improving the welfare of Nigerians. He will have to deal with some trade-offs especially allowing for some inflation whilst investing significantly i.e. 10% of GDP in infrastructure to jump start the economy. There are no easy options, there are only hard choices.
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