Interest Rates and Inflation Rate Interplay: Impact on Policy Decision in Nigeria Since Year 2000

Musa Samuel Olayinka

doi:10.31436/ijema.v29i1.819

Authors

Musa Samuel Olayinka University of Lagos, Nigeria

DOI:

https://doi.org/10.31436/ijema.v29i1.819

Keywords:

Inflation rate, Interest rates, Shocks, Impulse responses, Nigeria

Abstract

This study examined the interrelationship between interest rate and inflation rate in Nigeria. Interest rate is one of the key policy instruments that can be employed by the central bank to attain inflation targeting. The rate can be adjusted to curb high inflation or to prevent economic depression. The study seeks to find the significance of interest rates in determining inflation rate and also responses of inflation rate to shocks. For over a decade, Nigeria has been challenged to keep the inflation rate low and maintaining single digit rate, but, this has proved unsuccessful. Empirical analysis started with various diagnostic tests such as unit root and Johansen co-integration tests. Coefficient estimates were based on vector error correction and vector auto-regression models. To achieve robustness in the study, interest rate was decomposed into three components: monetary policy rate, maximum lending rate and deposit rate. Responses of inflation rate to each interest rate were obtained. The years under review, 2000-2019, were disaggregated into 2000-2007 and 2009-2019. Findings established that interest rates were weak instruments to curb inflation in the short run but inclined to be significant and relevant instruments in the long run. Moreover, inflation rate responses to interest rates were weak in the short run but proved strong in the long run. The conclusion was not exactly similar to previous authors’ because interest rates gradually proved applicable to inflation targeting in the long run. As the Central Bank of Nigeria (CBN) relies on interest rate to curb inflation rate, it is suggested the apex bank should ensure a smooth transmission channel between inflation rate and interest rates. Like in the United States (US) and other advanced countries, the bank should strive to keep inflation and interest rates lower than the current rates and simultaneously improve on macroeconomic policy management.

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