THE IMPACT OF INFLATION ON GOVERNMENT SPENDING IN NIGERIA ECONOMY

CHAPTER ONE

1.1 BACKGROUND TO THE STUDY

Inflation is an inevitable property of any economy in the world. It influences every country, negatively as well as positively, whether it is developed or developing country as well. Anyanwu (2011) stated that inflation is an important factor leading to social and economic instability and disorder. It is one of the most largely observed and tested economic variables both theoretically and empirically. Its causes, impacts on other economic variables, and cost to the overall economy are well known and understood.Nigeria, being a developing country, could not overcome the continuously year to year climbing up inflation, and also its causes and consequences. After remaining relatively low for quite a long time, the inflation rate in Nigeria started to accelerate in late 2003.

The role of money supply appears significant in influencing food price inflation in Nigeria (Anyanwu, 2011).which disturbed family budget as well as consumer’s purchasing power. People struggled in order to maintain their living standard but it slumped down gradually. Many authors have written on the impacts of inflation and cost of living on the Nigerian economy, but the authors have different views, nevertheless, one common thing is that all the authors agree that inflation and cost of living have various impacts on the economy of Nigeria.The problem created by the rising prices of goods and services leading to higher cost of living has become too difficult for the government to solve. During inflationary period, fixed amounts of money buy less quantity of goods and services. The real value of money is drastically reduced i.e the purchasing power of consumers are reduced. Government spending also referred to as government expenditure relationship between inflation has continued series of debate among scholars. Keynes (1936) argues that the solution to economic depression is to induce the firms to invest through some combination of reduction in interest rates and government capital investment including infrastructure.

This claim that increasing government expenditure promotes economic development is not supported by all scholars. A number of prominent authors especially of the neoclassical school argue that increased government expenditure may slow down the aggregate performance of the economy because in an attempt to finance raising expenditure, government may have to increase taxes and or borrowing. The higher income tax may discourage or may be a disincentive to additional work which in turn may reduce income and aggregate demand. In the same manner, high corporate tax leads to increase in production costs and reduce profitability of firms and their capital to incur investment expenditure. On the other hand, increased government borrowing (from the banks) required to finance its expenditure may compete and crowds-out private sector and this reduce private investment in the economy. Sachs (2006) argues that among the developed countries, those with high rates of taxation and high social welfare spending perform better on most measures of economic performance compared with countries with low tax low rates of taxation and low social services spending. According to the Revenue Mobilization Allocation and Fiscal Commission – RMFC (2011) the federal government of Nigeria spends 52.2% of total government revenues. The remaining revenues are shared among the Federating States and Local Government Areas (LGAs) on the basis of detailed sharing formula.