Is there a Trade off between Inflation and Unemployment in Nigeria? Implications for Monetary Policy

By

Chimere Iheonu

Date Published

July 3, 2024

Category

Political Economy

Introduction

The Central Bank of Nigeria (CBN) recently announced that prioritizing price stability is at the detriment of employment, revealing that a trade-off exists between inflation and unemployment in Nigeria. The CBN also revealed that it had decided to focus on achieving price stability, consistent with the principles of the traditional Phillips Curve. But is there truly a trade-off between inflation and unemployment in Nigeria? 

According to the Phillips Curve, a trade-off exists between inflation and unemployment, at least in the short term. This nexus has been key to the implementation of monetary policy in many countries, including Nigeria, and the mechanism that underpins this nexus is changes in aggregate demand. Traditionally, inflation indicates that the demand for goods and services is strong. Businesses would respond to this by increasing production and hiring more workers, thereby reducing unemployment. When inflation falls, it reflects weaker demand, prompting businesses to cut back on production and reduce the workforce.

However, the Nigerian economy presents unique complexities that may challenge the validity of this relationship, casting doubt on the CBN's path towards price stability. In this article, I argue that the Nigerian government can implement policies that simultaneously reduce both inflation and unemployment, as there is currently no inherent trade-off between the two in Nigeria.

There is no tradeoff

The United States economy, as early as the 1970s, disproved the Phillips Curve when both inflation and unemployment rose simultaneously. Many economists have also argued that the Phillips Curve cannot be universally applied over time, as various factors can influence the behavior of both inflation and unemployment.

The definition of the Phillips curve has a key feature. The feature emphasizes that there is strong demand for goods and services in the economy. However, this cannot be said of the Nigerian economy. The economy has witnessed a number of firm closures due to low demand and high operational costs.

Nigeria, over the last few years, has had both a high inflation rate and a high unemployment rate, doubting the validity of the Phillips curve and the stance of the CBN. This positive nexus between inflation and unemployment is known as stagflation, and is an indicator that a reduction in inflation is possible without raising unemployment. In fact, reducing inflation can help improve employment in times of stagflation.

The positive nexus between inflation and unemployment also reveals that aggregate demand may not be the determining factor that influences inflation in Nigeria and that the CBN and the government must look towards the supply side of the economy. The Phillips curve equation puts this into better perspective that monetary policy is only effective in combating inflation if it emanates from the demand side of the economy. The equation also reveals that in times of supply shocks, there is little monetary policy can do to slow down the rate of inflation.

Nigeria’s inflation, as has been revealed at various policy discussions, is largely a supply-side issue. As a matter of fact, when inflation and unemployment rise together, it often signifies that inflation is emanating from the supply side of the economy. The CBN and the government would have to understand this if they were to combat inflation.

Conclusion

The idea that a trade-off exists between inflation and unemployment in Nigeria is untrue, given the kind of inflation that exists today. However, this may be one reason why the CBN has continued to pursue contractionary monetary policy in its fight against inflation. If the CBN thinks a trade-off exists, then it most likely thinks inflation is demand pulled.

However, given that Nigeria’s inflation and unemployment are on the high side, it should signal to the CBN that no trade-off actually exists. This should be a pointer that inflation is a supply-side issue, and consistently employing demand-side measures could be counterproductive.

Inflation and unemployment can be reduced simultaneously by improving aggregate productivity/supply. Increasing productivity helps stabilize prices by closing the gap between demand and supply, and it reduces unemployment as businesses expand production.

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Disclaimer: This information in this article is NOT investment advice. It is intended for information and entertainment purposes only.

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