Project Materials

EXAMINE THE RELATIONSHIP BETWEEN THE UNEMPLOYMENT RATE AND INFLATION IN NIGERIA, TESTING PHILIPS CURVE

Abstract

This study looked at the relationship between unemployment and inflation in Nigeria from 1980 to 2012. The model defined unemployment as a function of inflation, money supply percentage of GDP, and total government spending percentage of GDP. The statistical tests utilised were the causality test, VECM test, and cointegration test. Based on the foregoing tests, the study discovered that: (i) Inflation had a significant long-term and short-term impact on unemployment in Nigeria during the study period. (ii) There is a substantial causal relationship between the variables in the model. Based on the findings, the report proposed that the government implement discretionary policies to alleviate unemployment by increasing government spending while maintaining monetary stability.

Chapter one

INTRODUCTION

Background of the study

Undoubtedly, the government’s macroeconomic aims include maintaining a stable domestic price level and full employment. Macroeconomic performance is measured using three main measures: unemployment rate, inflation rate, and output growth rate (Ugwuanyi, 2004).

Unemployment has been identified as one of the most important barriers to societal progress. Raheem (1993) argues that not only does it waste a country’s labour resources, but it also leads to decreased output and income, resulting in a loss of welfare.

In contrast, inflation has been a serious problem in the country for many years. Inflation is a common term in many market-oriented economies.

Although various people, producers, customers, professionals, non-professionals, trade unionists, workers and the likes, talk regularly about inflation particularly if the situation has assumed

a chronic character, however only selected few know or even bother to know about the mechanisms and repercussions of inflation.

Prior to the introduction of the unemployment and inflation trade-off, also known as the Phillips curve, in 1958, unemployment and inflation were considered and treated separately in economics. For example, Keynes defined inflation as the excess of expenditure over income at full employment.

He contended that as aggregate expenditure increases, so does the inflationary gap and the rate of inflation. Keynesian economists believe that an increase in unemployment reduces income, which in turn affects spending and aggregate output. As a result, increasing consumption or investment can help to boost employment.

Monetarists, on the other hand, explained inflation as an excessive increase in the money supply relative to real output. Their opinion on unemployment is based on Milton Friedman’s perpetual income hypothesis. According to the Permanent Income Hypothesis (PIH), a decrease in employment and current receipts only affects output if the expected income falls.

Each school of thought proposed their own policy remedies. There were, however, no major attempts to investigate inflation and unemployment concurrently.

In 1958, Phillip’s curve was introduced.

A.W. Phillips, that classical economics began to evaluate unemployment and inflation concurrently, so postulating a trade-off between inflation and unemployment: a lower inflation rate must be ready to tolerate a higher degree of unemployment, and vice versa.

Economists like Milton Friedman and Edmund Phelps challenged the Phillips curve thesis, arguing that the trade-off between unemployment and inflation only existed in the short term and that the Phillips curve is vertical in the long run. This resulted in the formulation of the Natural Rate Hypothesis.

Furthermore, empirical investigation conducted by other economists over the years has disproved the genuineness of Phillips’ trade-off argument.

Both high inflation rates and high unemployment rates were discovered to co-exist, giving rise to what has come to be known as stagflation. These twin concerns are currently essential parts of most Less Developed Countries‟ economic crisis.

Unemployment and inflation are concerns that affect both the social and economic lives of every country. The present literature describes unemployment and inflation as a vicious spiral that explains the prevalence of poverty in developing countries.

It has been stated that constant productivity increase, which results in an adequate supply of goods and services, is the most effective strategy to break the vicious circle.

The Nigerian experience of the unemployment and inflation crises was postponed until the early to mid-1980s, when oil prices collapsed, on which the economy had become dangerously dependent.

Prior to the 1980s, previous records showed that the Nigerian economy could provide jobs for its growing population while also absorbing significant imported labour in the scientific sectors.

The wage rate compared favourably to international standards, inflation was moderate, and most industry subgroups experienced relative industrial peace.

The oil boom in the 1970s led to the mass migration of youths into the urban area, seeking to get work. However, following the recession of the 1980s, the available data revealed that the problem of unemployment began to manifest, precipitating the implementation of the Structural Adjustment Programme (SAP), the rapid depreciation of the naira exchange rate, and the inability of most industries to import the raw materials required to maintain output levels.

A major consequence of the naira’s rapid depreciation was a sharp rise in the general price level (inflation), which resulted in a significant drop in real wages. The low salaries in turn generated a deteriorating purchasing power of wage earners and a drop in the aggregate demand.

Consequently, industries started to accumulate unintended inventories and, as a rational economic agent, the manufacturing firms started to rationalize their market prices.

With the simultaneous rapid expansion in the educational sector, new entrants into the labour market increased beyond absorptive capacity of the economy. The government’s goal of achieving “full employment” failed.

The purpose of this research is to determine whether the trade-off thesis is applicable in Nigeria.