An Evaluation of the Optimal Inflation Target for Economic Growth in Nigeria

Abstract

This study uses the threshold regression method to determine the optimal inflation threshold for economic growth in Nigeria. There is evidence that establish that setting an inflation target as a nominal anchor that constrains price movements to a particular point or within a pre-agreed range is indispensable for economic growth. Application of the Bai-Perron structural breakpoints test to the data detected two breaks dated 1999 and 2011. The Lee-Strazicich Unit Root Test showed that the data were cointegrated. The threshold estimation for optimal inflation values in the 5% to 25% band revealed that the residual sums of squares, RSS, is minimized and the R2 is maximized at an optimal inflation threshold of 18% with a statistically significant regression model, suggesting that the optimal inflation target for economic growth in Nigeria is 18%. The Autoregressive Distributed Lag model (ARDL) estimate shows that a 1% increase in inflation leads to an increase of 0.017% GDP growth in Nigeria in the long-run. The estimation of the ARDL model indicate that the coefficients of exchange rate, trade openness and population growth present mixed signaling in relation to GDP growth in the long- and short-run. Our results indicate that the implementation of the inflation targeting framework in a credible, transparent and accountable way could help to anchor inflation expectations, rein in inflation and improve economic growth in Nigeria.