Orthodox stabilization policies and stagflation: A neo-structuralist analysis of inflation and ouput effects in Nigeria
This study applies a neo-structuralist model of stagflationary monetary restraint and contractionary devaluation in a semi-industrialized economy to the case of Nigeria in 1960-1986. The model is based on the assumption that significant outlays for firms' working-capital needs are financed with short-term credit obtained from the informal (curb) credit market. In this setting, orthodox stabilization policies that increase the marginal interest rate in the curb market may lead to short-term stagflation via their effects on supply. The study is conducted using a model of the Nigerian economy that explicitly incorporates salient "stylized facts" about its financial and real sectors. These stylized facts include credit rationing, inflationary expectations, reliance on curb-market finance, and ex post product-price adjustment. Partial equilibrium in the financial sector is attained quickly through variations in the curb-market rate, Financial-sector disturbances impact real macrovariables via the respective effects of the curb-market rate on aggregate supply and demand. The econometric evidence shows that the necessary conditions for the short-term stagflationary effects of a credit squeeze, a reserve-deposit-ratio increase, or financial liberalization are satisfied in Nigeria. A large stagflationary bias implies that the contractionary demand-side effects of monetary restraint are accompanied by supply-side inflation. The sufficient conditions for stagflation are satisfied for each monetary-policy instrument tested. Given the constraint imposed on working-capital finance by credit rationing, a credit squeeze reduces output growth and increases inflation by a greater proportion than the case without credit rationing. The demand-side adjustments to monetary restraint are borne mostly by investment rather than by consumption with adverse consequences for growth. While interest costs are transmitted quickly into inflation, the deflationary demand-side effects of monetary restraint are slow in coming. Devaluation has contractionary output effects with a small impact on the trade deficit coming from the adjustment of real imports. The concluding chapter proposes a policy plan for Nigeria that is designed to mitigate both the inflationary and investment-reducing effects of orthodox stabilization policies. The short-run stabilization package includes a reserve-deposit-ratio increase and the expansion of bank credit to firms implemented under a more market-oriented scheme, a gradual naira devaluation, and a reduction in government spending.