“Inflation level of prices for goods and services

 

“Inflation
is the rate at which the general level of prices for goods and services is rising
and, consequently, the purchasing power of
currency is falling. Central banks attempt
to limit inflation, and avoid deflation, in
order to keep the economy running
smoothly.” (Investopedia)

Introduction

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To answer the question stated above, “IS AN
INCREASE IN PETROLEUM PRODUCT PRICE IN NIGERIA A SIGNAL OF INFLATION?” If ‘yes’ (which it is), then state the
various ways in which an increase in petroleum product price determines
inflation. What then is the relationship between oil and inflation before
delving into the examples. Firstly, does an increase in petroleum product price
in the world a signal of inflation. The answer is yes.

“Numerous empirical studies have been
conducted on the determinants of inflation and inflationary process in many
countries, both developed and developing, including Nigeria.

Durevall (1998) investigated the
inflationary process in Brazil for the period 1968 to 1985. The author showed
that the degree of inertia, as indicated by the coefficient value of lagged
inflation, was 0.41. Furthermore, he found that an increase in money growth or
oil-price inflation, increases overall inflation. Also, inflation increases
when the rate of devaluation of the exchange rate increases, while it decreases
when output growth goes up.”

The Relationship between
Oil Prices and Inflation; what it is all about.

The price of oil and inflation are often seen as being connected in a
cause and effect relationship. As oil prices move up or down, inflation follows
in the same direction. The reason this happens is that oil is a major input in
the economy – it is used in critical activities such as fueling transportation
and heating homes – and if input costs rise, so should the cost of end
products. This is otherwise known as cost-push inflation. For example, if the
price of oil rises, then it will cost more to make plastic, and a plastics
company will then pass on some or all of this cost to the consumer, through
raises in prices and thus inflation.

 

Importance of Oil in the Nigerian Economy

Now we want to discuss the importance of oil in the Nigerian economy,
its disadvantages and advantages, how the prices of oil affect other product
prices and how the prices of oil affect the economy.

However,
the persistent instability of crude oil prices in the global market has been
revealed to have adversely affected macroeconomic performance of the Nigerian
economy owing to the fact that Nigeria is a monoculture economy which is
heavily dependent on crude oil export for its foreign earnings. Crude oil price
instability has been found to affect production cost of foreign firms and since
Nigeria is import dependent, an increase in crude oil prices makes imported
goods to be very expensive which is in turn transmitted to domestic prices by
raising the general price level (Mba-Afolabi, 1999; Labys, 2006; Nwosu, 2009;
Arinze, 2011; Runl, 2011; Bobai, 2012).

 

From
the quote above, we can see the effect of increasing crude oil costs on price
levels through inflation. Nigeria, as an economy that produces crude oil and imports
consumer products, suffers inflation via increasing cost of production in other
countries.

Some scholars
actually believe that Nigeria reacts more to changing oil prices than most
other countries do (suggesting that oil
prices might not just be a signal of inflation, but a determinant):

Nigeria
also exhibits higher sensitivity to oil price volatility. Using the ARDL
methodology in the ‘Phillips curve framework,’ the authors estimate that 1%
increase in oil prices lead to 0.04 percent increase in domestic inflation in
the short run and 0.06 percent rise in the long run (Adeniyi and others, 2012).

Raymond
(2010), which looked at the effect of price changes of petroleum products in
the short and long run and the factors responsible for the changes itself also
found that petroleum products prices have significant effect on the economy in
the long run.

 

 

 

Effect
of price changes of petroleum products in the different market period on the
economy & the Government’s effort to curb such Negative Effects

 

Arinze
(2011) focused on the impact of oil price on the Nigerian economy. The study
contends that upward adjustments of petroleum products prices have resulted in
inflation, high cost of living, and inequitable income distribution in Nigeria
between 1978 and 2007. It also found that the various Nigerian regimes
increased fuel prices a total of 18 times within this period with most of the
increase occurring between 1990 and 2007 where prices were adjusted, twice a
year, sometimes. The study revealed that petroleum price increase spur
inflation rate to increase also. It therefore recommended diversification of
the Nigerian economy to curb macroeconomic instability which may arise from
over-dependence on crude oil.

Bobai
(2012) analysed the relationship between petroleum prices and inflation in
Nigeria. It focused on the impact of petroleum product price increase on the
Nigerian economy from 1990 to 2011. Employing the empirical econometric
analysis approach and using variables like inflation rate and petroleum prices,
the results shows that positive relationship exists between PMS, AGO and
inflation. It however found PMS to exert higher effect on inflation than AGO, while
negative relationship exists between inflation and DPK. The overall effect
clearly indicates that increase in petroleum product price contributes significantly
to the rate of inflation in Nigeria.

 

A
study was conducted to first understand the relationship between PMS, AGO and
DPK. Using various models and analysis tools to understand we are able to
answer the question directly by saying: “Yes, an increase in petroleum product
prices in Nigeria is a signal of inflation.”

 

“The study
examined the impact of increase of petroleum prices in the Nigerian economy.
The methodology is empirical econometric analysis approach. Variable used for
analysis were inflation rate and petroleum prices in Nigeria. These variables
were considered appropriate indicators of petroleum products and inflation rate
responses. The main tool of analysis was a multiple regression model which
examines the relationship between petroleum prices and inflation in Nigeria
from 1990-2011. Data on the variables were used to estimate parameters of the
model through the OLS techniques … The results shows positive relationship
exists between PMS, AGO and inflation. PMS had more effect on inflation, while
negative relationship exists between inflation and DPK. However, the overall
effect showed increase in petroleum product price increase the rate of
inflation in Nigeria.”

Table
A: Empirical
Econometric Analysis Data Inflation rate (INF), Premium Motor Spirit (PMS),
Automotive Gas Oil (AGO) and Dual Purpose Kerosene (DPK).

 

 

Year

INF

PMS

AGO

DPK

1990

7.5

0.6

0.5

0.4

1991

12.7

0.7

0.5

0.5

1992

44.81

0.7

0.55

0.5

1993

57.17

3.25

3

2.75

1994

53.03

11

9

6

1995

72.81

11

9

6

1996

29.29

11

9

6

1997

10.67

11

9

6

1998

7.86

11

9

6

1999

6.62

20

19

17

2000

6.94

22

21

17

2001

18.87

22

21

17

2002

12.89

26

26

24

2003

14.03

40

38

38

2004

15.01

49

48

48

2005

17.85

65

60

50

2006

8.24

65

60

50

2007

5.38

65

60

50

2008

11.6

65

60

50

2009

11.5

65

145

50

2010

11.9

65

145

50

2011

12.6

65

145

50

 

The
table above shows the relationship between inflation and petroleum prices in
Nigeria. The inflation rate as at 1990 was 7.5 percent. 1995 being the year
with the highest rate of inflation was 72.81 percent; it seriously declined to
6.62 percent in 1999. In 2005 it was 17.5 percent as at the end of 2011 the
inflation rate was 12.6 percent. While the prices of PMS, AGO and DPK per litre
for each product in 1990 were 0.60 kobo, 0.50 kobo and 0.40 kobo as at 2011 the
prices of the same product per litre were N65:00, N145:00 and N50:00.

 

Conclusion
& Summary

Is
the increase petroleum products price in Nigeria a signal of inflation?

   The simplified answer to this is yes! This
is caused by a combination and the interplay of different factors. To clearly
discuss this, a clear definition of inflation is given. Inflation refers to the
general level at which monetary cost of commodities in an economy rises and,
subsequently, the value of the currency of the economy in question falls i.e.
the value of the currency depreciates. According to dictionary.com, a signal
“anything that serves to indicate, warn, direct, command, or the like, as a
light, a gesture, an act, etc.” 

   Nigeria relies heavily on crude oil, so
heavily that it accounts for over 70% of Nigeria’s export earnings. This is
highly impractical as the over-dependence of Nigeria on oil has led to other
lucrative and promising sectors being over-looked and under-developed. Nigeria
is a mono-product economy, with the mono-product being crude oil which is
ironic as Nigeria imports over 80% of her petroleum products.

   Nigeria imports such a large volume of
petroleum products because of the poor state of her refineries. Several
refineries in Nigeria are in great need of repair and maintenance. They also
face the problem of obsolete technology and underutilization. The obvious
solution to this is to properly utilize and maintain Nigeria’s refineries
or/and build new ones but due to lack of funding, the complexity and intricacy
of the refining process and the underlying problem of corruption, all efforts
at so doing are frustrated as soon as they begin.

   Due to the negative effect of the methods of
extraction of crude oil on the environment, alternatives to the use of crude
oil are being researched upon and developed. This, coupled with an increase in
suppliers and domestic production of oil has lead to an increase in the supply
of oil that has not been met with an equal increase in demand. In addition to
this, the relatively high price of extraction of crude oil has led to a
decrease in the gains from oil, Nigeria’s one product in her mono-product
economy. As Nigeria’s main source of foreign exchange is crude oil this leads
to deprecation of the Nigerian currency, the Naira, and thus inflation.

   However, this is not specific to Nigeria.
Petroleum is still, to a large extent, a necessity good with relatively
inelastic demand. Owing to this, an increase in the price of crude oil will
lead to an increase in the price of all commodities as fossil fuels are, in a
sense, the backbone of the industrial age. Fossil fuels to a high degree
facilitate the needs of man including transportation and energy production and
so an increase in the cost of fossil fuels will subsequently lead to an
increase in the cost of production of most, if not all commodities and a
decline in the value of the currency being used.

   What makes Nigeria a little more unique in
relation to how petroleum products relate to inflation is that the price of
crude oil, be it high or low, affects the Nigerian Economy negatively. In the
case of a decrease in the price of crude oil, this is Nigeria’s main source of
revenue and foreign exchange earnings and less will be supplied according to
the law of supply. This also means the revenue obtained decreases, thus
decreasing Nigeria’s foreign exchange earnings and the purchasing power of her
currency thus leading to inflation. Alternate to this, an increase in the price
of crude oil also increases the cost of refined oil products which is a main
import of Nigeria. This leads to an increase in her foreign exchange expenditure
and a decrease in the value of her currency. It is an unfortunate paradox.