Is Nigeria’s inflation rate challenge a “demand-pull” or “cost-push” inflation?

Key highlights

• Nigeria’s inflation rate rose to 21.91% in February, its highest level in 17 years, due to cost-push factors such as high production costs and currency depreciation.
• The Central Bank of Nigeria has raised interest rates by 650 basis points in the past eight months to combat inflation, but it has failed to reduce inflation numbers.
• Experts argue that Nigeria’s inflation problem is more cost-push than demand-pull and suggest that the CBN should consider alternative measures to address the issue, such as managing currency swap and improving monetary policy coordination.

Nigeria’s headline inflation rate rose to a fresh 17-year high of 21.91% in February 2023. A 0.09%-point increase from 21.82% was recorded in the previous month.  

In a bid to curb the rising inflation, the Central Bank of Nigeria has increased its benchmark interest rate by a cumulative 650 basis points in the last eight months to a record of 18%. By continuing to raise rates, it opines that galloping inflation is created by too much money in circulation 

However, inflation has remained unabated, despite the contractionary monetary policy stance adopted by the apex bank. This has raised questions amongst analysts and economic experts about the rationale behind the continuous use of monetary tools to fight inflation despite the increasing numbers. 

So why is the CBN’s action failing to bring down inflation? Is it taking the wrong medicine based on a poor diagnosis of the issue? 

The inflation rate is usually caused by either “demand-pull” or “cost-push” inflation.  

Demand-pull inflation occurs when there is an increase in aggregate demand (i.e., total demand for goods and services in the economy) that outpaces the economy’s capacity to produce these goods and services. 

• In other words, inflation rises when demand for goods and services outpaces the economy’s capacity to meet it. 
• Demand-pull inflation can be attributed to some variables. One of the most frequent is a rise in consumer spending, which may be stimulated by elements like low-interest rates, growing earnings, and easier access to credit. 
• Other factors can include government spending on infrastructure projects or other initiatives that stimulate demand. To combat demand-pull inflation, central banks often raise interest rates to reduce consumer and business borrowing, which in turn can decrease aggregate demand. 

Cost-push inflation occurs when there is a decrease in aggregate supply (i.e., the total amount of goods and services that the economy can produce) due to an increase in the cost of production. 

• To retain their profit margins, manufacturers increase the prices of their goods and services when the cost of production goes up, which raises the economy’s total price level. 
• Cost-push inflation can be attributed to some variables. One of the most frequent is a rise in the price of labour or raw materials, which may be brought on by elements like rising energy prices, problems with the supply chain, or wage increases. 
• Governments have some instruments at their disposal to fight cost-push inflation. One strategy is to minimize corporate taxes and regulations, which can lower production costs and lessen the need to raise prices. 

Contributors of Nigeria’s inflation: A breakdown of Nigeria’s inflation numbers for February 2022 showed that bread and cereal led the list of highest contributions with 21.7%, followed by rent with 7.74% and tubers with 6.06%. 

• According to the NBS, some of the factors contributing to Nigeria’s rising inflation rate include an increase in the cost of production as a result of energy costs, as well as an increase in the cost of importation, rising from the persistent currency depreciation. 
• The CBN in its recent MPC briefing alluded to rising energy prices, a surge in the price of grains, and exchange rate pressures associated with the capital flows to high-yield US-dollar-denominated assets as factors contributing to the rise in inflationary pressure.  
• Following the Russia-Ukraine war in February 2022, which saw the price of crude oil hit a record high, resulting in a global energy crisis, as most world economies had to deal with unprecedented level inflation rate. 

The rising cost of energy and the resultant effect of the FX crisis led to a surge in business operational costs, hereby impacting their margins. 

However, in a bid to keep profit elevated, businesses increased their selling price, causing further inflation, where some other consumer goods manufacturers resulted in the schematization of their products. 

As established by the apex bank and the NBS, Nigeria’s inflation is more cost-push, rather than demand-pull, the CBN continues to combat the rising inflation using monetary tools, which could have a ripple effect on the level of economic activities in the country. 

The MPC last week raised the benchmark interest rate to 18%, representing the sixth consecutive rate hike by the CBN, which is yet to change the uptrend in the inflation numbers. 

Expert opinion: Ezekiel Gomos, an Economist at Jos Business School, maintained that Nigeria’s inflationary problem is more of a cost-push rather than a demand-pull. 

• “The hawkish move by the CBN confirms my fears that the hawks in the MPC do not seem to understand that our inflation rate in Nigeria is not driven by interest rates but by diverse factors, amongst which is poor monetary policy coordination and implementation, supply chain disruptions, non-availability of economic lubricants like fuel, agric inputs resulting in cost-push price increases,” he said. 
• “The current inflationary problem is not driven by too much money!!! Where is the money?? With inflation at 21.9% and rising to 22% – we will get there next month- it shows the need to seek other instruments to curtail inflation and not interest rates hike. The failure to manage the currency swap and the attendant economic disruption was itself a major culprit.” 
• “This has led to the erosion of nearly N20bn off GDP in 60 days. These should be the major focus of the MPC because more disruption is coming in the second quarter resulting from post-election challenges,” he added.