Interest Rates and Inflation in Nigeria: Empirical Evidence from the
Autoregressive Distributed Lag Model
OLUFEMI C. ADEMOLA1, YIMKA S. A. ALALADE1, PETER I. OGBEBOR1,
OLALEKAN B. AWORINDE2
1Department of Finance,
Babcock University,
Ilishan-Remo, Ogun State,
NIGERIA
2Department of Economics,
Pan-Atlantic University,
Lekki, Lagos State,
NIGERIA
Abstract: - Policymakers and scholars continue to have extensive conversations about the relationship between
interest rates and inflation in Nigeria. This is because, despite the efforts of Nigerian policymakers and
regulatory authorities to achieve a high level of sustainable growth, the economy continued to witness stunted
growth over the years, primarily due to double-digit inflation that continuously erodes value. In light of this,
this study looked at how interest rates have affected Nigeria's inflation rate over the last 16 years.
The research design for this study is ex-post facto, using time series data for 68 quarters between Q1, 2006
to Q4, 2022. Data were obtained from the databases of the Central Bank of Nigeria (CBN), the National Bureau
of Statistics (NBS), and the World Development Indicator (WDI). The study utilized the Autoregressive
Distributed Lag (ARDL) model to analyze the effect of interest rates on inflation in Nigeria, while the
Augmented Dickey-Fuller (ADF) and Phillip-Perron were employed for the stationarity test.
The results of the analysis showed that interest rates have a long-run significant cointegrating relationship
with the inflation rate (Adj R2 = 0.48; F-stat (4, 63) = 19.61 p < 0.05). The study therefore recommends that the
CBN could alternate its approach to managing inflation in Nigeria by regulating the amount of money in
circulation in addition to solely utilizing the interest rates through the MPR's operation. Furthermore, since the
CBN has little control over the other elements, monetary policy by itself is unable to reduce inflation in
Nigeria. To guarantee the elimination of all barriers to reducing inflation in Nigeria, the report recommends that
the monetary authority work in tandem with the fiscal authority and all pertinent ministries, departments, and
agencies (MDAs).
Key-Words: - Interest Rates, Inflation Rate, Money Supply, Monetary Policy Rate, Prime Lending Rate,
Institutional Quality, Infrastructure Deficit.
Received: May 11, 2023. Revised: November 21, 2023. Accepted: December 5, 2023. Published: December 15, 2023.
1 Introduction
The rate of inflation in the economy and the way
monetary impulses are transferred to the real
sectors of the economy are two important topics in
macroeconomics. The unique features of the
channels via which monetary policy and interest
rates are transmitted are of ongoing interest to
scholars and policymakers. Fluctuations in interest
rates have a significant effect on businesses' and
individuals' investment and saving decisions, which
in turn affects the demand side of the economy.
Before receiving their money back from selling
their final goods, businesses rely on borrowings
from banks and other financial intermediaries to
pay for their manufacturing expenses. Monetary
policy also affects the cost side of the economy
because borrowing from financial intermediaries
would come with a cost that is set by the interest
rates. This is commonly known as the working
capital channel of monetary transmission because it
is predicated on the notion that companies require
working capital to conduct their operations. Given
the possibility that monetary tightening raises the
short-term interest rates, higher interest rates
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inevitably lead to higher costs for working capital
and higher inflation.
Most countries aim to attain both low and
steady inflation and strong economic growth
through their macroeconomic policies, [1], [2], [3].
Inflation is the general increase in the level of
prices for goods and services in any economy.
Many empirical studies have been devoted to the
beneficial and consequential impact that inflation
has revealed on the overall economy. This has led
to intense disputes in the literature on economics
and finance, [4]. Every economy should prioritize
achieving commodity price stability since it is
widely acknowledged to be a necessary condition
for sustained growth and development. "Inflation"
is the barrier preventing this from happening. As a
result of inflation's detrimental effects on savings,
investment, and price stability, as well as its
negative social and economic ramifications, the
main objective of any monetary policy should be to
achieve low inflation rather than raise output or
lower unemployment, [5]). Consequently, it is
imperative to conduct a detailed analysis of
inflation as it is a very intricate economic
phenomenon, with a particular focus on the
mechanisms via which inflationary impulses enter
the economy.
Several developing nations lack a
comprehensive grasp of inflation, whereas
industrialized nations are better aware of how
inflation affects economic growth, what variables
influence inflation, and the optimal level of
inflation to promote growth, [6]. According to
empirical research, inflation has a detrimental
impact on economic growth in the medium and
long term, [7], [8]. Hence, [9] noted that rising
inflation has not been embraced by any school of
thought due to its negative distribution and social
effects. However, the fact that a particular amount
of inflation is necessary for achieving economic
progress and ensuring its sustainability, however,
serves as evidence in favor of inflation. For this
reason, [8] pointed out that there are several
potentially positive channels via which inflation
affects economic growth.
2 Review of the Literature
2.1 Statement of the Problem
Several important variables are important drivers of
inflation, including the money supply, interest rate,
national output, exchange rate, wage rate, trade
openness, and expectations, [10], [11]. However,
the exact extent of the relationship between interest
rates and the inflation rate in Nigeria has generated
diverse opinions in the empirical literature and
several studies have shown conflicting results. This
study therefore established the level and direction
of the interaction between interest rates (proxied by
prime lending rate, monetary policy rate, money
supply growth, and institutional quality) on the one
side and inflation rate on the other hand. The study
also examined how changes in the proxies for
interest rates affect the dynamics of the inflation
rate in Nigeria.
The research advances knowledge on previous
studies firstly by the adoption of the Autoregressive
Distributed Lag (ARDL) model to compare the data
used for the analysis. While earlier contributions to
the literature evaluated the empirical fit of forward-
looking models for inflation using the GMM
(generalized method of moments) estimator, this
study employed the ARDL as an alternate model
that avoids some of the issues that GMM estimates
face. Secondly, the study introduced Money Supply
Growth and Institutional Quality as control
variables of interest rates to account for the role of
money supply and institutional quality in
controlling inflation in Nigeria.
2.2 Empirical Review
Several studies have looked into the relationship
between interest rates and inflation rates in recent
times. [12], investigated the correlation between
Nigeria's interest rate and inflation rate between
2007 and 2019. For the empirical analysis, the unit
root and Johansen co-integration tests were used in
the study. To ensure robustness, the study's
independent variable, interest rate, was substituted
with the monetary policy rate, maximum lending
rate, and deposit rate. Then, the inflation rate's
responses to each of the interest rate proxies were
determined. The study discovered that while the
inflation rate did not react strongly to interest rates
in the short term, it did so in the long term. Put
another way, it was discovered that while interest
rates were not remarkably effective at controlling
inflation in the near term, they were likely to
become important and relevant in the long run.
According to, [13], monetary policy has no
appreciable long-term effect on Nigeria's ability to
control inflation. According to the study, money
supply has a negative and insignificant impact on
Nigeria's ability to control inflation in the short-
and long-terms, while the Treasury bill rate has a
short-term negative and significant impact and a
long-term positive but insignificant impact.
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From a different methodological angle, [14],
examined the Fisher effect for the UK. The
nonlinear Autoregressive Distributed Lag (ARDL)
model, recently created by [15], was used to
achieve this goal for the periods of 1995M1–
2008M9, and 2008M10–2018M1. The model
created two new scenarios, that is, increases and
decreases in the inflation rate from the changes in
the original inflation rates. This allowed the
researchers to investigate the Fisher effect
concerning inflation spikes and drops
independently. Only in the first scenario do the
empirical results suggest asymmetrically partial
Fisher effects for the UK in the long run.
Furthermore, for the first time, the study attempted
to define and present an alternative interpretation of
the partial effect idea for the UK.
In, [16], the authors applied the VAR Granger
Causality test on time series data of United
Kingdom (UK) annual interest rates and inflation
rates from 1989 to 2017 and found that there is a
bilateral causality between the two variables.
In, [17], the researchers examined the
relationships among monetary policy, economic
growth, and inflation in the Ghanaian economy for
the period of 1982-2017. Employing the ARDL
cointegration model, the study's results
demonstrated that interest rates have a substantial
long-term impact on economic growth, albeit a
negative one. This suggests that higher interest
rates tend to stifle inflationary pressures and
economic growth.
Using panel data covering the years 2006 to 2013,
[18], concentrated on assessing the causal
relationship between interest rate and inflation rate
in the economies of the South Asian Association
for Regional Cooperation (SAARC). Two scenarios
were chosen to evaluate this relationship. The first
scenario empirically evaluated the causal
relationship between changes in inflation rate and
loan interest rates, while the second scenario
examined the relationship between real interest
rates and inflation rates. The outcomes of the first
scenario demonstrated that there is no correlation
between changes in lending rates and changes in
the rate of inflation. In contrast, the second scenario
demonstrated a clear cause-and-effect link between
the inflation rate and the real interest rate.
In, [19], the authors studied the impact of money
supply on macroeconomic variables in Nigeria
from 1985 to 2016. The study found that real gross
domestic product and inflation are significantly and
positively impacted by limited money supply. On
the other hand, the impact of large money supply
on real gross domestic product and inflation is
insignificant.
To provide fiscal and monetary policies that
can support an effective economy moving forward,
[20], studied the correlation between inflation and
interest rates in Swaziland. The study used a
quantitative and confirmatory methodology to
examine quarterly secondary data on interest rates
and inflation rates from 2010 to 2014, obtained
from the Central Statistical Department of
Swaziland, the Swaziland National Library, and the
Central Bank of Swaziland. The study used
Microsoft Excel and a descriptive analysis
technique to examine the data and found that
interest rates and inflation rates had a positive and
significant link in Swaziland.
3 Methodology
3.1 Research Design
The study used an ex-post facto research design to
examine the effect of interest rates on inflation in
Nigeria. The use of the research design is supported
by proven theoretical links between inflation and
interest rates, as well as by the application of these
correlations in earlier studies and the availability of
useful data. Some previous studies have also
employed this research design, [21], [22], [23].
3.2 Statement of Hypotheses
The objective of the study is to analyze the effect of
interest rates on the inflation rate in Nigeria. Hence
the testable hypotheses are:
H01: Interest rates have no significant effect on
inflation in Nigeria.
Ha1: Interest rates have a significant effect on
inflation in Nigeria.
3.3 Method of Data Analysis
This study examined how interest rates affect
Nigerian inflation. The study employed both
descriptive and inferential statistics to evaluate time
series data. Statistical metrics including mean,
minimum, maximum, and standard deviation were
used to do the descriptive analysis. To assess the
degree of correlation and identify any issues with
multicollinearity among the explanatory variables,
Pearson's Product Moment Correlation and
Variance Inflation Factor (VIF) were utilized.
The time series properties of the variables were
investigated using the unit root tests of the Phillip-
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Perron test, and the Augmented Dickey-Fuller test
before the regression analysis was estimated. To
estimate the time series regression, the study
employed the linear Autoregressive Distributed Lag
(ARDL) model. The following rationales support
this econometric technique: firstly, variables with
varying orders of cointegration can be employed
with the ARDL approach, [24]. This happens, for
instance, when variables have a mixed order of I(0)
and I (1). Secondly, small, or finite sample sizes
can be employed with the ARDL technique, [25].
Thirdly, simultaneous calculations are made for the
long-run and short-run parameters. Finally, the
technique can take time series data structural breaks
into account.
3.4 Model Specification
The Quantity Theory of Money addresses the
indirect relationship between interest and inflation
through the amount of money in circulation, and
this theory served as the foundation for the model
used to calculate the effect of interest rates on
inflation rates. For this reason, the study used and
modified the empirical models based on the earlier
research of, [26], and, [9], to create the functional
relationship shown in equation (1) below:
INF=f(PLR, MPR, MS, INSTQ) (1)
Where INF is the inflation rate, PLR is the prime
lending rate, MPR is the monetary policy rate,
MSG is money supply growth, and INSTQ is
institutional quality.
The estimable form of equation (1) is specified in
equation (2).
(2)
Where the variables INF, PLR, MPR, MSG, and
INSTQ are as explained earlier in equation (1).
β0 is the constant term and μt is the disturbance
term. The parameters βi(I = 1, 2 . . , 4) are the
coefficients of the respective variables.
The ARDL model for inflation is shown below:
(3)
The study expected an increase in prime
lending rate to have a negative effect on inflation.
This may be the result of rising lending rate trends,
which are linked to high borrowing costs and tend
to discourage people from borrowing money from
banks to boost investment and consumption.
Inflation was also expected to be negatively
correlated with high monetary policy rates and to
rise in response to an expansion of the money
supply. Finally, it was anticipated that lower
inflation would result from higher institutional
quality.
4 Result & Analysis
4.1 Descriptive Statistics and Correlation
4.1.1 Descriptive Statistics
Table 1. Descriptive Statistics of Interest Rates and
Inflation
Variables
Mean
Maximum
Minimum
Std. Dev.
Obs
INF
12.122
21.340
4.100
3.845
68
PLR
16.027
19.420
11.200
2.010
68
MPR
11.504
16.170
6.000
2.484
68
MSG
4.031
27.691
-7.269
5.289
68
INSTQ
0.011
0.427
-0.402
0.248
68
Source: Researcher’s Computation 2023
Notes: Table 1 shows the mean, maximum, minimum,
and standard deviation of the variables. The dependent
variable is inflation (INF). The regressors are Prime
Lending Rates (PLR), Monetary Policy Rate (MPR),
Money Supply Growth (MSG), and Institutional Quality
(INSTQ). The sample period is from 2006Q1-2022Q4
representing 68 quarterly observations. The estimation
process was facilitated using EVIEWS 12.
Table 1 above shows the descriptive statistics of the
variables used for the study. From the table,
inflation has a mean value of 12.12 and a standard
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deviation of 3.85. The high standard deviation of
3.85 is an indication that inflation levels in Nigeria
are highly susceptible to changes during the period.
The minimum value of 4.10 and maximum value of
21.34 also indicated that Nigeria had very volatile
inflation rates between 2006Q1 and 2022Q4.
The prime lending rate has a mean value of
16.03 and a standard deviation of 2.01. The
relatively low standard deviation of 2.01 indicates
that the prime lending interest rate was less
susceptible to changes during the period while the
minimum value of 11.2 and maximum value of
19.42 indicate that Nigeria has different levels of
prime lending rate during the study period.
The monetary policy rate has a mean value of
11.50 and a standard deviation of 2.48. The
relatively low standard deviation of 2.48 is an
indication that the monetary policy rate was less
susceptible to changes between 2006Q1 and
2022Q4 while the minimum value of 6.00 and
maximum value of 16.17 indicated that Nigeria has
varying levels of monetary policy rate during the
period.
Money supply growth has a mean value of 4.03
and a standard deviation of 5.29. The relatively
high standard deviation of 5.29 indicated that
money supply growth is highly susceptible to
changes between the period of 2006Q1 and
2022Q4. The minimum value of -7.27 and
maximum value of 27.69 indicated that Nigeria has
very volatile levels of money supply growth and
that both positive and negative money supply
growths were recorded during the review period.
Institutional quality has a mean value of 0.011
and a standard deviation of 0.248. The standard
deviation of 0.248 is relatively low, indicating that
there exist weak institutions in Nigeria between the
period the first quarter of 2006 and the fourth
quarter of 2022. The minimum value of -0.402 and
maximum value of 0.427 also indicated that,
although very tight, Nigeria has different levels of
institutional quality and that both positive and
negative institutional quality were recorded during
the review period.
4.1.2 Pearson Correlation Analysis
This section discusses the relationship between the
interest rate variables and the inflation rate in
Nigeria. The study emphasizes the extent of the
relationship between Monetary Policy Rate (MPR),
Prime Lending Rates (PLR), Money Supply
Growth (MSG), and Institutional Quality (INSTQ)
on the one hand, and Inflation Rate (INF) on the
other hand for the period between 2006Q1 and
2022Q4.
Table 2. Correlation Matrix for Interest Rates and
Inflation Rate
Variables
INF
PLR
MPR
MSG
INSTQ
VIF
INF
1.000
N/A
PLR
-0.442
1.000
1.108
MPR
0.188
-0.236
1.000
2.517
MSG
0.177
-0.089
-0.110
1.000
1.040
INSTQ
0.293
-0.058
0.752
-0.170
1.000
2.415
Source: Researcher’s Computation 2023
Notes: Table 2 displays the Pearson pairwise correlation
matrix. The dependent variable is the Inflation Rate
(INF). The regressors are the Prime Lending Rate
(PLR), Monetary Policy Rate (MPR), Money Supply
Growth (MSG), and Institutional Quality (INSTQ). The
sample period is from 2006Q1-2022Q4 representing 68
quarterly observations. The estimation process was
facilitated using EVIEWS 12. The correlations are below
the major diagonal and the last row titled VIF is the test
for multicollinearity.
4.1.2.1 Interpretation
The results of the correlation analysis in Table 2
show that monetary policy rate, money supply
growth, and institutional quality have positive
relationships with inflation in Nigeria. This implies
that increases in monetary policy rate, money
supply growth, and institutional quality will lead to
an increase in the level of inflation. The results also
provided evidence that the prime lending rate has a
negative relationship with the inflation rate in
Nigeria. Thus, an increase in the prime lending rate
will lead to a fall in the inflation rate. The test for
multicollinearity was conducted and the variance
inflation factor (VIF) for each of the explanatory
variables was less than 10. The VIF were 1.108,
2.517, 1.040, and 2.415 for monetary policy rate,
prime lending interest rate, money supply growth,
and institutional quality, respectively. Therefore.
the four regressors used in the estimated model
were found to be uncorrelated with one another.
4.1.3 Result of the Stationarity Test
Stationarity tests were conducted to examine the
time series properties of the variables over the
study period. Specifically, the Augmented Dickey-
Fuller (ADF) and the Phillip-Perron (PP) unit root
tests were used to evaluate for stationarity in the
series and the result is presented in Table 3.
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Table 3. Result of the Unit Root Test
Variables
ADF
PP
Remarks
INF
-2.448
-2.181
ΔINF
-7.367***
-7.347***
I(1)
PLR
-2.001
-2.318
ΔPLR
-6.871***
-6.861***
I(1)
MPR
-2.261
-2.443
ΔMPR
-4.694***
-4.766***
I(0)
MSG
-5.847***
-8.547***
ΔMSG
-10.634***
-37.186***
I(1)
INSTQ
-2.241
-2.139
ΔINSTQ
-3.721***
-3.567***
I(1)
Source: Researcher’s Computation 2023
Notes: Table 3 presents the unit root test. The dependent
variable is the Inflation Rate (INF). The regressors are
the Prime Lending Rate (PLR), Monetary Policy Rate
(MPR), Money Supply Growth (MSG), and Institutional
Quality (INSTQ). The sample period is from 2006Q1-
2022Q4 representing 68 quarterly observations. The
estimation process was facilitated using EVIEWS 12.
The critical value at 5% for intercept and trend is -3.50
and for intercept alone is -2.93. ** and *** indicate
significance at 5 and 1 percent, respectively.
4.1.3.1 Interpretation
From the unit toot test in Table 3, the stationarity
tests were carried out on the data using ADF and
PP. The test showed evidence that the inflation rate
(INF) was stationary at first difference. This was
because the unit root statistic for the ADF and the
PP unit root tests were more negative than the
critical values at a 5 percent level of significance.
In addition, there was evidence that Prime Lending
Rate (PLR), Money Supply Growth (MSG), and
Institutional Quality (INSTQ) were also stationary
at first difference while Monetary Policy Rate
(MPR) was stationary at the level at the 5 percent
level of significance.
Therefore, due to the different order of
integration of the variables, the Autoregressive
Distributed Lag (ARDL) model approach to
cointegration of Pesaran and Pesaran (2001),
which allows for the combination of levels and first
difference stationary variables was adopted for the
analysis. The adoption of the ARDL approach to
cointegration was also because the short-run and
the long-run dynamics of the specified model were
estimated concurrently.
4.2 Test of Hypotheses
Research Objective: Analyse the effect of Interest
Rates on the Inflation Rate in Nigeria.
Research Question: What is the effect of Interest
Rates on Inflation Rate in the Nigerian economy?
Research Null Hypothesis: Interest rates have no
significant effect on inflation in Nigeria.
Table 4. Interest Rates and Inflation
Panel A: Long Run Estimates
Dependent Variable: INF
Variable
Coefficient
S.E
t-stat
Prob
C
66.047
18.743
3.524
0.001
PLR
-2.296
0.751
-3.057
0.004
MPR
-1.553
0.773
-2.009
0.050
MSG
0.456
0.414
1.102
0.276
INSTQ
18.088
7.852
2.304
0.026
Panel B: Short -Run Estimates
Variable
Coefficient
S.E
t-stat
Prob
D(INF(-1))
0.196
0.094
2.081
0.043
D(INF(-2))
0.245
0.095
2.574
0.013
D(PLR)
-0.128
0.091
-1.415
0.163
D(PLR(-1))
-0.115
0.202
-0.567
0.573
D(PLR(-2))
-0.029
0.222
-0.130
0.897
D(PLR(-3))
0.348
0.215
1.618
0.112
D(MPR)
0.765
0.208
3.684
0.001
D(MSG)
0.199
0.193
1.030
0.308
D(INSTQ)
0.025
0.025
0.966
0.339
ECT(-1)
-0.177
0.035
-5.058
0.000
Panel C:
Diagnostic Tests
Statistic
Prob.
Bound Test
7.869
0.000
Adjusted R-square
0.480
F-Statistic
19.607
0.000
Serial Correlation
0.972
0.386
Heteroscedasticity
0.615
0.839
Linearity Test
1.458
0.151
Normality
1.719
0.423
CUSUM
CUSUMSQ
Stability Test
Stable
Stable
Source: Researcher’s Computation 2023
Notes: Table 4 reports the long-run estimates, short-run
estimates, and the diagnostic tests for the relationship
between interest rates and inflation rates. The dependent
variable is the Inflation Rate (INF) and the regressors
are the Prime Lending Rate (PLR), Monetary Policy
Rate (MPR), Money Supply Growth (MSG), and
Institutional Quality (INSTQ).
4.3 Interpretation
4.3.1 Bound Test
The bound test was used to ascertain the possibility
of a long-run relationship with the results showing
that the bound test statistics of 7.869 is statistically
significant at a 5 percent significant level. The
result implies the possibility that the variables have
a long-run cointegrating relationship. Therefore,
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based on the possibility of a long-run relationship
between interest rates and inflation rate, the study
estimates the long-run and the short-run elasticity.
The empirical results for the model for the effects
of interest rates and inflation rate, in the short and
long runs, are reported in Table 4.
4.3.2 The Long-Run Dynamics
Panel A of Table 4 displays the ARDL model's
estimated long-run coefficients. Long-term data
suggested that the prime lending rate and inflation
rate have a negative connection, meaning that a rise
in the prime lending rate would cause Nigeria's
inflation rate to decline. In other words, the
inflation rate would drop by 2.269 percent for every
1% increase in the prime lending rate. The findings
additionally demonstrated a substantial correlation
between the prime lending rate and Nigerian
inflation (PLR = -2.296, t-test = -3.057, p < 0.05).
This suggests that the prime lending rate plays a
major role in influencing variations in Nigeria's
inflation rate.
The findings also indicated that there is a
negative correlation between the inflation rate and
the monetary policy rate, suggesting that raising the
monetary policy rate would cause the inflation rate
to decrease. As a result, a one percent increase in
inflation will result in a 1.553 percent drop. The
results also showed a substantial correlation
between the monetary policy rate and Nigeria's
inflation rate (MPR = -1.553, t-test = -2.009, p <
0.05), suggesting that the monetary policy rate is a
major factor influencing fluctuations in Nigeria's
inflation rate.
The findings also demonstrated a positive
correlation between the money supply and the
inflation rate, i.e., an increase in the money supply
will result in a rise in inflation. That example, a one
percent increase in the money supply will result in
an inflation rate increase of 0.456 percent.
Additionally, the results showed that there is no
significant correlation between the growth of the
money supply and the rate of inflation in Nigeria
(MSG = 0.456, t-test = 1.102, p > 0.05). This
suggests that variations in the level of inflation in
Nigeria are not significantly influenced by the
expansion of the money supply.
The outcome demonstrated evidence of a
positive association between institutional quality
and inflation rate, suggesting that rising
institutional quality will inevitably result in rising
inflation rates. Therefore, an increase in
institutional quality of 1% will increase inflation of
18.088 percent. The results showed a significant
association between the inflation rate in Nigeria and
institutional quality (INSTQ = 18.088, t-test =
2.304, p < 0.05). This suggests that institutional
quality has a substantial role in influencing changes
in the inflation rate in Nigeria.
4.3.3 Short-run Dynamics
This subsection serves a dual function. To
determine the degree of adjustment back to
equilibrium using the error correction term, the first
step is to determine if changes and the statistical
significance observed in the long run also exist in
the short-run model. The error correction term
(ECTt-1) measures the short-run adjustment
process, which demonstrates how soon variables
recover from a shock and reach balance. To ensure
stability, the coefficient of ECTt-1 needs to be
statistically significant and have a negative sign.
The outcome of the regression analysis
demonstrated that there is a brief and negligible
correlation between the prime lending rate and the
rate of inflation. This outcome is consistent with the
long-term negative link, suggesting that the
relationship between the prime lending rate and
Nigeria's inflation rate is both a short- and long-
term phenomenon. Furthermore, data indicates a
positive and substantial short-term link between the
inflation rate and the monetary policy rate. The
varying outcomes over the long and short terms
indicate that raising the policy rate by the monetary
policy authority will worsen inflation in the short
term but have a negative long-term effect on the
rate of inflation. Additionally, the results showed
that, but not significantly, the money supply and
institutional quality had a favorable short-term
association with the inflation rate.
The cointegrating term is found to have the
correct sign and is significant as predicted,
according to the short-run results, suggesting that
any deviation from the steady state in Nigeria can
be readily adjusted for. Consequently, Panel B of 4
reports an estimated coefficient for the ECTt-1 that
is negative and statistically significant (ECT= -
0.177, t-test = -5.058 p < 0.05). It can be inferred
that during the next quarter, deviations from the
inflation rate equilibrium path are adjusted by
almost eighteen percent. Stated differently, Nigeria
has a comparatively modest process of adjustment.
Interest rates and inflation rates in Nigeria have a
long-run equilibrium relationship, which is further
supported by the statistical significance of the
ECTt-1.
With an adjusted R-square of 0.480, it can be
inferred that only approximately 48% of the
variations in the inflation rate can be explained by
the prime lending rate, monetary policy rate, money
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supply growth, and institutional quality; the
remaining 52% can be attributed to other factors
that influence inflation rate fluctuations but are not
included in the model. The F-test, which verifies
the null hypothesis that every coefficient in the
model is zero, indicates the overall fit of the model.
The model fits the data well in this instance, as
shown by the F-test's significance at the 5% level.
Alternatively, the prime lending rate, monetary
policy rate, money supply growth, and institutional
quality are all major factors influencing changes in
Nigeria's inflation rate, according to the F-test
statistic of 19.607 with a probability value of 0.000.
As a result, the alternative hypothesis—which holds
that interest rates significantly affect inflation in
Nigeria—was accepted and the null hypothesis—
which holds that interest rates have no substantial
influence on inflation—was rejected.
4.4 Post-Estimation Test
Five distinct kinds of diagnostic tests were
conducted to ensure the reliability and validity of
the parameter estimates and to enable the drawing
of appropriate conclusions from the data. The F-
statistic of 0.972 and a probability value of 39% are
greater than the 5 percent level, indicating that the
successive error terms are not serially associated,
according to the data. Therefore, the results do not
rule out the null hypothesis that the residuals show
no serial connection. According to the study's
findings, there was no correlation between the
subsequent error terms in the estimated model for
Nigeria's inflation and interest rates. This infers that
the homoscedasticity null hypothesis could not be
rejected, the heteroscedasticity results demonstrated
that the F-statistic of 0.615 with a probability value
of 84 percent is not statistically significant at the 5
percent level of significance. There is proof,
therefore, that the error terms' variance is
homoscedastic.
Moreover, the statistical significance of the
Ramsey RESET test for linearity is not established;
its F-statistic is 1.458, and its probability value is
15 percent, higher than the 5 per level. The findings
thus show that there is a linear relationship between
interest rates and the rate of inflation in Nigeria and
that the estimated model is appropriately stated.
Similar to this, the normality test Jarque-Bera
statistic yielded an F-statistic of 1.719 with a
probability statistic of 42%, which is higher than
the significance level of 5%. As a result, the null
hypothesis of normalcy was accepted. Panel C
presents the results of the CUSUM and CUSUMSQ
statistics.
4.5 Discussion of Empirical Findings
The objective of the study was accomplished
through the application of the Autoregressive
Distributed Lag (ARDL) model and the findings
supported the existence of a long-term co-
integrating relationship between interest rates and
inflation rate in Nigeria over the period. The
following outcomes were shown by the long-run
and short-run elasticities in the presence of a long-
run cointegrating relation.
In the long run, there is evidence that the prime
lending rate and monetary policy rate have a
negative relationship with the inflation rate, while
money supply growth and institutional quality have
a positive relationship with the inflation rate in
Nigeria. In addition, there is evidence that prime
lending rate, monetary policy rate, and institutional
quality have long-run significant relationships with
the inflation rate in Nigeria, while money supply
growth has no long-run significant relationship with
the inflation rate in Nigeria. The results of the
hypothesis testing supported the rejection of the
null hypothesis that interest rates have no
significant effect on the inflation rate in Nigeria and
the acceptance of the alternative hypothesis that
interest rates have a significant effect on the
inflation rate in Nigeria.
The results of this study also relate to the
findings of some existing studies amongst which
are, [12], who examined the interrelationship
between interest rate and inflation rate in Nigeria
for the period 2000-2019 and found 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, [13], who found that
monetary policy has no significant impact on
inflation control in Nigeria both in the short run and
long run, [16], who conducted the VAR Granger
Causality test on time series data of interest rate and
inflation from 1989 to 2017 in the United Kingdom
(UK) and found that there is a bilateral causality
between the two variables and, [18], whose study
focused on the evaluation of the causal relationship
between interest rate and inflation rate in South
Asian Association for Regional Cooperation
(SAARC) economies by using panel data ranging
from the year 2006 to 2013 to (i) empirically test
the causal relationship between lending rate and
changes in inflation rate and (ii) to consider the
causal relationship between real interest rate and
inflation rate. In the first case, the study found that
there was no relationship between changes in the
inflation rate and changes in lending rates in the
SAARC economies while in the second scenario,
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the study found a substantial cause-and-effect link
between real interest rate and inflation rate.
The investigation of the money supply's effect
on macroeconomic variables in Nigeria from 1985
to 2016 by, [19], found that narrow money supply
has a positive and significant impact on inflation,
whereas broad money supply has no significant
impact on inflation while the study by, [20]
investigated the correlation between interest rates
and inflation rate in Swaziland and discovered a
strong and positive relationship between the two
variables.
5 Summary and Conclusion
The study examined the effect of interest rates on
inflation and the empirical analysis and findings
resulting from the analyses revealed mixed results.
In the long run, there is evidence that the prime
lending rate and monetary policy rate have a
negative relationship with the inflation rate, while
money supply growth and institutional quality have
a positive relation with the inflation rate in Nigeria.
In addition, there is evidence that prime lending
rate, monetary policy rate, and institutional quality
have a significant long-run relationship with the
inflation rate in Nigeria, while money supply
growth has no long-run significant relationship with
the inflation rate in Nigeria. The result shows that
in the short run, monetary policy rate, money
supply growth, and institutional quality have a
positive relationship with the inflation rate in
Nigeria, while the prime lending rate, has a
negative relationship with the inflation rate. In
addition, there is evidence that in the short run, only
the monetary policy rate has a significant impact on
the inflation rate in Nigeria, while the prime
lending rate, money supply growth, and
institutional quality have no significant impact on
inflation in Nigeria. Also, the results of the
hypothesis testing support the rejection of the null
hypothesis that interest rates have no significant
effect on the inflation rate in Nigeria and the
acceptance of the alternative hypothesis.
The study found that interest rates are
significant factors influencing inflation in Nigeria.
However, the directions of the effect are mixed.
While the prime lending rate exerts the expected
negative impact on inflation in Nigeria in both the
short and long runs, the monetary policy rate only
has a negative effect in the long run. The study also
found that the effect of the combination of interest
rates, money supply growth, and institutional
quality on inflation in Nigeria is only 48%. This
implies that there are other factors outside of the
purview of the monetary policy mechanism that
account for 52% of inflation in Nigeria.
The study found that interest rates are
significant factors influencing inflation in Nigeria.
However, the directions of the effect are mixed.
While the prime lending rate exerts the expected
negative impact on inflation in Nigeria in both the
short and long runs, the monetary policy rate only
has a negative effect in the long run. The study also
found that the effect of the combination of interest
rates, money supply growth, and institutional
quality on inflation in Nigeria is only 48%. This
implies that there are other factors outside of the
purview of the monetary policy mechanism that
account for 52% of inflation in Nigeria.
The study therefore concluded that interest
rates are significant factors influencing inflation in
Nigeria. Expectedly the relationship between
interest rates and inflation is negative, however, this
is mostly in the long run as shown by the effect of
MPR on inflation. In the short run, the relationship
was found to be positive, which was unexpected
especially since the instrument is the important
short-run instrument to manage inflation.
The study therefore recommends that in
controlling inflation in Nigeria, the CBN should not
focus only on the use of interest rates through the
use operation of the MPR but also alternate by
controlling the quantity of money supply in the
economy as well. In addition, the monetary policy
alone cannot curb inflation in Nigeria as the other
factors are not within the purview of the CBN.
Hence, the study recommends that the monetary
authority collaborates with the fiscal authority and
all relevant ministries, departments, and agencies to
ensure the removal of all impediments to curbing
inflation in Nigeria.
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problem to the final findings and solution.
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Scientific Article or Scientific Article Itself
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Conflict of Interest
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that are relevant to the content of this article.
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