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Economics and Finance Review Vol. 1(12) pp.

42 61, February, 2012 ISSN: 2047 - 0401


Available online at http://www.businessjournalz.org/efr

42

An Empirical Analysis of the Relationship between Unemployment and Inflation
in Nigeria from 1977-2009

AMINU UMARU
Lecturer, Department of Economics,
School of Management and Information Technology,
Modibbo Adama University of Technology, YOLA,Adamawa State, Nigeria.
E-Mail: aminu_umaru2007@yahoo.com.

&

ANONO ABDULRAHAMAN ZUBAIRU
Lecturer, Department of Management Technology,
School of Management and Information Technology,
Modibbo Adama University of Technology,YOLA,Adamawa State,Nigeria.
E-Mail: abdlrahmananono@yahoo.com


ABSTRACTS

This paper investigates the relationship between unemployment and inflation in the Nigerian economy between
1977 and 2009 through the application of Augmented Dickey-Fuller techniques to examine the unit root
property of the series after which Granger causality test was conducted to determine causation between
unemployment and inflation, then cointegration test was conducted through the application of Johansen
cointegration technique to examine the long-run relationship between the two phenomenon, lastly ARCH and
GARCH technique was conducted to examine the existence of volatility in the series. The results indicate that
inflation impacted negatively on unemployment. The causality test reveals that there is no causation between
unemployment and inflation in Nigeria during the period of study and a long-run relationship exists between
them as confirmed by the cointegration test.ARCH and GARCH results reveals that the time series data for the
period under review exhibit a high volatility clustering. The paper recommends the use of
inflation/unemployment theory that is drawn from data sourced within the country and also improvement in the
existing theories in order to ensure their applicability in the Nigerian context, so as to achieve a desire
reduction in unemployment and inflation which in turn boost economic growth and development.

Key words: unemployment, inflation and Phillips curve.


1.0 INTRODUCTION
Unemployment and inflation are two intricately linked economic concepts. Over the years there have been a
number of economists trying to interpret the relationship between the concepts of inflation and unemployment.
There are two possible explanations of this relationship one in the short term and another in the long term. In
the short term there is an inverse correlation between the two. As per this relation, when the unemployment is
on the higher side, inflation is on the lower side and the inverse is true as well.

This relationship has presented the regulators with a number of problems. The relationship between
unemployment and inflation is also known as the Phillips curve. In the short term the Phillips curve happens to
be a declining curve. The Phillips curve in the long term is separate from the Phillips curve in the short term. It
has been observed by the economists that the longrun the concepts of unemployment and inflation are not
related.

As per the classical view of inflation, inflation is caused by the alterations in the supply of money. When the
money supply goes up the price level of various commodities goes up as well. The increase in the level of
prices is known as inflation. According to the classical economists there is a natural rate of unemployment,
which may also be called the equilibrium level of unemployment in a particular economy. This is known as the
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
Available online at http://www.businessjournalz.org/efr

43
long term Phillips curve. The long term Phillips curve is basically vertical as inflation is not meant to have any
relationship with unemployment in the long term.

It is therefore assumed that unemployment would stay at a fixed point irrespective of the status of inflation.
Generally speaking if the rate of unemployment is lower than natural rate, then the rate of inflation exceeds the
limits of expectations and in case the unemployment is higher than what is the permissible limit then the rate of
inflation would be lower than the expected levels.

The Keynesians have a different point of view compared to the Classics. The Keynesians regard inflation to be
an aftermath of money supply that keeps on increasing. They deal primarily with the institutional crises that are
encountered by people when they increase their price levels. As per their argument the owners of the companies
keep on increasing the salaries of their employees in order to appease them. They make their profit by increasing
the prices of the services that are provided by them. This means there has to be an increase in the money supply
so that the economy may keep on functioning. In order to meet this demand the government keeps on providing
more money so that it can keep up with the rate of inflation.

Unemployment and Inflation are issues that are central to the social and economic life of every country. The
existing literature refers to inflation and unemployment as constituting a vicious circle that explains the endemic
nature of poverty in developing countries. And it has been argued that continuous improvement in productivity
is the surest way to breaking this vicious circle. Growth in productivity provides a significant basis for adequate
supply of goods and services thereby improving the welfare of the people and enhancing social progress.

Unemployment has been categorised as one of the serious impediments to social progress. Apart from
representing a colossal waste of a countrys manpower resources, it generates welfare loss in terms of lower
output thereby leading to lower income and well-being (Raheem, 1993). Unemployment is a very serious issue
in Africa (Bello, 2003) and particularly in Nigeria (Oladeji, 1994 and Umo, 1996). The need to avert the
negative effects of unemployment has made the tackling of unemployment problems to feature very prominently
in the development objectives of many developing countries.

The problem of inflation surely is not a new phenomenon. It has been a major problem in the country over the
years. Inflation is defined as a generalised increase in the level of price sustained over a long period in an
economy (Adebayo, 1997). Inflation is a household word in many market oriented economics. Although several
people, producers, consumers, professionals, non-professionals, trade unionists, workers and the likes, talk
frequently about inflation particularly if the malady has assumed a chronic character, yet only selected few
knows or even bother to know about the mechanics and consequences of inflation.

Undoubtedly, parts of the macroeconomic goals which the government strives to achieve are the maintenance of
stable domestic price level and full-employment. These goals are pursued in order to avoid cost of inflation or
unemployment and the uncertainty that follows where there is price instability or high rate of unemployment.
The effects of inflation and unemployment on economic growth will be examined bearing in mind that a country
(Nigeria for instance) will grow faster in real terms if inflation and unemployment are reduced to a barest
minimum. Perhaps it should be mentioned here that inflation is not incompatable with growth.

The early theories of the relationship between unemployment and inflation are postulated on the basis of data
sourced from the developed western world, especially USA and Britain (United Kingdom) whose economies is
developed and open. Major economic variables are determined within the country unlike Nigeria and the rest of
the developing economies of the world whose major economic variables are determine by forces outside the
economy. The Philips postulate of the negative relationship between unemployment and inflation, the
Friedmans long-run vertical relationship between the two variables, the Keynesians postulate of change in one
variable (unemployment or inflation) as a result of shocks in an economy which may change one without
affecting the other for instance around 1973 in USA when Dollars value depreciated, there is an increase in
OPEC oil prices and massive demand for Wheat that forces prices of goods and services to increase (inflation)
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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44
U
L

A
O
1 dp
P dt



































U
O

Unemployment
U
H

without a corresponding decrease in unemployment. There is also a massive flow of teenagers and women in
labour force which lead to increase in unemployment without corresponding decrease in inflation. Keynes
postulate therefore shift in Philips curve, the recent positive hypotheses which depicted the coexistence of
unemployment and inflation in the economy especially in the developing nations which Nigeria happen to be
inclusive, was based on data and information from the western world which may have little or no applicability in
Nigeria. This therefore provide the basis for the study of the relationship between unemployment and inflation
base on data source within the Nigerian economy so as to formulate a theory that can best explain the Nigerian
unemployment and inflation situation. The study would address the above problem in Nigerian way with the aim
of finding lasting solution to unemployment and inflation in country.

2.0 THEORETICAL REVIEW/FRAMEWORK
Here some of the theories of the relationship between unemployment and inflation were reviewed. The Milton
Friedman Nobel memorial lecture (1976), the Phillips curve is categorised into four theories namely: the
negative, the natural hypotheses, and the positive hypotheses. Keynes is left with the explanation of the Phillips
curve and postulated a shift in Phillips curve.

2.1 Negatively sloping Philips curve
Professional analysis of the relation between inflation and unemployment has gone through two stages since the
end of World War II and is now entering a third. The first stage was the acceptance of a hypothesis associated
with the Rate of price change















Fig. 1 Simple Philips Curve

name of A.W Philips that there is a stable negative relation between the level of unemployment and the rate of
change of wages-high levels of unemployment being accompanied by falling wages, low levels of
unemployment by rising wages. The wage change in turn was linked to price change by allowing for the secular
increase in productivity and treating the excess of price over wage cost as given by a roughly constant mark-up
factor.

Fig. 1 illustrates this hypothesis where Friedman had followed the standard practice of relating unemployment
directly to price change, short-circuiting the intermediate step through wages.

This relation was widely interpreted as a causal relation that offered a stable trade-off to policy markers. They
could choose a low unemployment target; such as U
L
. In that case they would have to accept an inflation rate of
A. There would remain the problem of choosing the measure (monetary fiscal, perhaps other) that would
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
Available online at http://www.businessjournalz.org/efr

45
produce the level of aggregate nominal demand required to achieve U
L
, but if that were done, there need be no
concern about maintaining that combination of unemployment and inflation. Alternatively, the policy makers
could choose a low inflation rate or even deflation as their target. In that case they would have to reconcile
themselves to higher unemployment U
O,
for zero inflation, U
H
, for deflation.

Economics then busied themselves with trying to extract the relation depicted in Fig. 1 from evidence for
different countries and periods, to eliminate the effect of extraneous disturbances, to clarify the relation between
wage change and price change, and so on. In addition, they explored social gains and losses from inflation on
the other, in order to facilitate the choice of the right trade-off.

Unfortunately for this hypothesis, additional evidence failed to conform with it. Empirical estimates of the
Philips curve relation were unsatisfactory. More important, the inflation rate that appeared to be consistent with
a specified level of unemployment did not remain fixed: in the circumstances of the post-World War II period,
when governments everywhere were seeking to promote full employment, it tended in any one country to rise
over time and to vary sharply among countries. Looked at the other way, rates of inflation that had earlier been
associated with low levels of unemployment were experienced along with high levels of unemployment. The
phenomenon of simultaneous high inflation and high unemployment increasingly forced itself on public and
professional notice, receiving the unlovely label of stagflation.

Some of us were skeptical from the outset about the validity of a stable Philips curve, primarily on theoretical
rather than empirical grounds. What mattered for employment, we agreed was not wages in dollars or pounds or
kronor but real wages- what the wages would buy in goods and services. Low unemployment would, indeed
mean pressure for a higher real wage-but real wages could be higher even if nominal wages were lower,
provided that prices were still lower. Similarly, high unemployment would, indeed, mean pressure for a lower
real wages could be lower, even if nominal wages were higher, provided prices were still higher.

There is no need to assume a stable Philips curve in order to explain the apparent tendency for an acceleration of
inflation to reduce unemployment. That can be explained by the impact of unanticipated changes in nominal
demand on markers characterized by (implicit or explicit) long-term commitments with respect to both capital
and labour. Long-term labor commitments can be explained by the cost of acquiring information by employers
about employees and by employees about alternative employment opportunities plus the specific human capital
that makes an employees value to a particular employer grow over time and exceed his value to other potential
employers.

Only surprises matter, if everyone anticipation would be embodied in future say, 20% rate of inflation to be
associated with a different level of unemployment than a zero rate. An unanticipated change is very different
especially in the presence of long-term commitment themselves partly a result of the imperfect knowledge
whose effect they enhance and spread over time. Long-term commitment mean, first that there is not
instantaneous market clearing (as in markets for perishable foods) but only a lagged adjustment of both prices
and quantity of changes in demand or supply (as in the house rental market); second that commitment entered
into depend not only on current observable prices, but also on the prices expected to prevail throughout the term
of the commitment.

2.2 THE SHIFTING PHILLIPS CURVE
The shifting Phillips curve was postulated by Keynes in his attempt to explain the Phillips curve. To him
(Keynes) there is bound to be shocks in an economy whereby one of unemployment or inflation would be
affected without necessarily affecting the other. He cited examples with what happen in U.S around 1973 when
Dollar value depreciate, there was increase in OPEC oil prices and massive demand for Wheat that forces prices
of goods and services to increase (inflation increase) without a corresponding decrease in unemployment. There
was also a possibility of having increase in unemployment rate without a corresponding decrease in the rate of
inflation. For example, 20 years back there was massive flow of teenagers and women in the labour force which
lead to increase in unemployment without a corresponding increase in prices (inflation)
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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46
I dp
P dt
U
N

U
L

B
A
E
G
I dp *
P dt = A
I dp *
P dt = B
2.3 NATURAL RATE OF UNEMPLOYMENT HYPOTHESIS
Proceeding along these lines, E.S. Phelps and Friedman developed an alternative hypothesis that distinguished
between the short-run and long-run effects of unanticipated changes in aggregate nominal demand. Start from
some initial stable position and let there be, for example, an anticipated acceleration of aggregate nominal
demand. This will come to each producer as an unexpectedly favourable demand for his product. In an
environment in which changes are always occurring in the relative demand for different goods, he will not know
whether this change is special to him or pervasive. It will be rational for him to interpret it as at least partly
special and to react to it, by seeking to produce more to sell at what he now perceives to be a higher than
expected market price for future output. He will be willing to pay higher nominal wages than he had been
willing to pay before in order to attract additional workers. The real wage that matters to him is the wage in
terms of the price of his product, and he perceives that price as higher than before. A higher nominal wage can
therefore mean a lower real wage as perceived by him.

To workers the situation is different: what matters to them is the purchasing power of wages not over the
particular good they produce but over all goods in general. Both they and their employers are likely to adjust
more slowly their perception of prices in general-because it is more costly to acquire information about that
than their perception of the price of the particular good they produce.





















Fig.
2






Expectations adjusted Philips Curve

As a result, rise nominal wages are perceived by workers as a rise in real wages and hence call forth an
increased supply, at the same time that it is perceived by employers as a fall in real ages and hence calls forth an
increased offer of jobs. Expressed in terms of the average of perceived future prices, real wages are higher.

Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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But this situation is temporary: let the higher rate of growth of aggregate nominal demand and of prices
continue, and perceptions will adjust to reality. When they do, the initial effect will disappear, and then even be
reversed for a time as workers and employers find themselves locked into inappropriate contracts. Ultimately,
employment will be back at the level that prevailed before the assumed unanticipated acceleration in aggregate
nominal demand. This alternative hypothesis is depicted in Fig. 2 each negatively sloping curve is a Philips
curve like that in Fig. 1 expect that it is for a particular anticipated or perceived rate of inflation, defined as the
perceived average rate of price change, not the average of perceived rates of individual price change (the order
of the curves would be reversed for the second concept). Start from point E and let the rate of inflation for
whatever reason move from A to B and stay there. Unemployment would initially decline to UL, at point F,
moving along the curve defined for an anticipated rate of inflation of A. As anticipations adjusted, the short-run
curve would move upward, ultimately to the curve defined for an anticipated inflation rate B. concurrently
unemployment would move gradually over from F to G.

This analysis is, of course there is a continuing stream of unanticipated changes; it does not deal explicitly with
lags, or with overshooting, or with the process or formation of anticipations. But it does highlights the key
points: what matters is not inflation per se, but unanticipated inflation; there is no stable trade-off between
inflation and unemployment; there is a natural rate of unemployment (U
N
), which is consistent with the real
forces and with accurate perceptions; unemployment can be kept blow that level only by an accelerating
inflation; or above it, only by accelerating deflation.

The natural rate of unemployment, a term I introduced to parallel Knut Wicksells natural rate of interest is
not a numerical constant but depends on real as opposed to monetary factors the effectiveness of the labor
market, the extent of competition or monopoly, the barriers or encouragement to working in various occupations
and so on.

For example, the natural rate has clearly been rising in the United States for two major reasons. First, women,
teenagers and part-time workers have constituted a growing fraction of the labor force. These groups are more
mobile in employment than other workers, entering and leaving the labor market, shifting more frequently
between jobs. As a result, they tend to experience higher average rates of unemployment. Second,
unemployment insurance and other forms of assistance to unemployed persons have been made available to
more categories of workers, and have become more generous in duration and amount. Workers who lose their
jobs are under less pressure to look for other work, will tend to wait longer in the hope, generally fulfilled of
being recalled to their former employment, and can be more selective in the alternatives they consider. Further,
the availability of unemployment insurance makes it more attractive to enter the labor force in the first place,
and so may itself have stimulated the growth that has occurred in the labor force as a percentage of the
population and also its changing composition.

The determinants of the natural rate of unemployment deserve much fuller analysis for both the United States
and other countries. So also do the meaning of the recorded unemployment figures and the relation between the
recorded figures and the natural rate. These issues are all of the utmost important for public policy. However,
they are side issues for my present limited purpose.

The connection between the state of employment and the level of efficiency or productivity of an economy is
another topic that is of fundamental importance for public policy but is a issue for my present purpose. There is
a tendency to take it for granted that a high level of recorded unemployment is evidence of inefficient use of
resources and conversely. This view is seriously in error. A low level of unemployment may be a sign of a
forced draft economy that is using its resources inefficiently and is inducing workers to sacrifice leisure for
goods that they value less highly than the leisure under the mistaken belief that their real wages will be higher
than they prove to be. Or a low natural rate of unemployment may reflect institutional arrangements that inhibit
change. A highly static rigid economy may have a fixed place of everyone whereas a dynamic, highly
progressive economy, which offers ever-changing opportunities and fosters flexibility, may have a high natural
rate of unemployment. To illustrate how the same rate may correspond to very different conditions; both Japan
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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48
and the United Kingdom had low average rates of unemployment from, say 1950 to 1970, but Japan experienced
rapid growth, the U.K stagnation.

The natural rate or accelerationist or expectations-adjusted Philips curve hypothesis-as it has been
variously designated is by now widely accepted by economist, though by no means universally. A few still
cling to the original Philips curve, more recognize the difference between short-run and long-run curve but
regard even the long-run curve as negatively sloped, though more steeply so than the short-run curves; some
substitute a stable relation between the acceleration of inflation and unemployment for a stable relation between
inflation and unemployment-aware of but not concerned about the possibility that the same logic that drove
them to a second derivative will drive them to ever higher derivatives.

Much current economic research is devoted to exploring various aspects of this second stage-the dynamic of the
process, the formation of expectations, and the kind of systematic policy, if any that can have a predictable
effect on real magnitudes. We can expect rapid progress on these issues, (Special mention should be made of the
work on rational expectations, especially the seminal contributions of John Muth, Robert Lucas, and Thomas
Sargent). [Gordon (9).]

2.4 A POSITIVELY SLOPED PHILIPS CURVE
Although the second stage is far from having been fully explored let alone fully absorbed into the economic
literature, the course of events is already producing a move to a third stage. In recent years, higher inflation has
often been accompanied by higher not lower unemployment, especially for periods of several years in length. A
simple statistical Philips curve for such periods seems to be positively sloped, not vertical. The third stage is
directed at accommodating this apparent empirical phenomenon. To do so, Friedman suspect that it will have to
include in the analysis the interdependence of economic experience and political developments. It will have to
treat at least some political phenomena not as independent variables as exogenous variables in econometric
jargon-but as themselves determined by economic events as endogenous variables [Gordon (8)]. The second
stage was greatly influenced by two major developments in economic theory of the past few decades one the
analysis of imperfect information and of the cost of acquiring information, pioneered by George Stigler; the
other, the role of human capital in determining the form of labour contracts, pioneered by Gary Becker. The
third stage will, he believe, the greatly influenced by a third major development the application of economic
analysis to political behaviour, a field in which pioneering work has also been done by Stigler and Becker as
well as by Kenneth Arrow, Duncan Black, Anthony Downs. James Buchanan, Gordon Tullock and others.

The apparent positive relation between inflation and unemployment has been a source of great concern to
government policy makers. Friedman quoted from a recent speech by Prime Minister Callaghan of Great
Britain:

We used to think that you could just spend your way out of a recession and increase employment by cutting
taxes and boosting Government spending. I tell you, in all candour, that that option no longer exists and that
insofar as it ever did exist, it only worked by injecting bigger doses of inflation into the economy followed by
higher levels, of unemployment as the next step. That is the history of the past 20years (speech to Labour Party
Conference, 28 September, 1976).

The same view is expressed in a Canadian government white paper: continuing inflation, particularly in North
America, has been accompanied by an increase in measured unemployment rates (The Way Ahead: A
Framework for Discussion, Government of Canada Working Paper. October, 1976).

These are remarkable statements, running as they do directly counter to the policies adopted by almost every
Western government throughout the post-war period.


Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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49
2.5 GRAPHICAL PRESENTATION OF UNEMPLOYMENT AND INFLATION IN NIGERIA FROM
1977-2009

FIGURE i. A LINE GRAPH
0
10
20
30
40
50
60
70
80
1980 1985 1990 1995 2000 2005
UNEMPL INFLA

The graph above reveals that the relationship between unemployment and inflation in Nigeria is neither negative
throughout nor positive. The graph shows trade-off in 2000 through to 2009, inflation is more stable while
unemployment is volatile.

3.0 EMPIRICAL REVIEW/ FRAMEWORK
Here empirical review of other peoples work on the relationship between unemployment and inflation is done.
Onwioduokit (2006) investigated the relationship between unemployment and inflation in Nigeria and found
that there is negative relationship between unemployment and inflation with the coefficient of -0.412, this
validates the Philips hypotheses; however, the results of the causality test indicate no causality between
unemployment and inflation in Nigeria. Stock and Watson (1999) used the conventional Phillips curve
(unemployment rate) to investigate forecasts of U.S. inflation at the 12-month horizon. The authors focused on
three questions. First, has the U.S. Phillips curve been stable? If not, what are the implications of the instability
for forecasting future inflation? Second, would an alternative Phillips curve provide better forecasts of inflation
than unemployment rate Phillips curve? Third, how do inflation forecasts from Phillips curve stack up against
time series forecasts made using interest rate, money, and other series? They found that inflation forecasts
produced by Phillips curve generally had been more accurate than forecasts based on other macroeconomic
variables, including interest rates, money and commodity prices but relying on it to the exclusion of other
forecasts was a mistake. Forecasting relations based on other measures of aggregate activity could perform as
well or better than those based on unemployment, and combining these forecasts would produce optimal
forecasts. Williams and Adedeji (2004) examined price dynamics in the Dominican Republic by exploring the
joint effects of distortions in the money and traded-goods markets on inflation, holding other potential
influences constant. The study captured the remarkable macroeconomic stability and growth for period 1991 to
2002. Using a parsimonious and empirically stable error-correction model, the paper found that the major
determinants of inflation were changes in monetary aggregates, real output, foreign inflation, and the exchange
rate. However, there was an incomplete pass-through of depreciation from the exchange rate to inflation. The
authors established a long-run relationship in the money and traded-goods markets, observing that inflation was
influenced only by disequilibrium in the money market.

In recent years, many emerging-market countries have experienced dramatic decline in inflation as a result of a
combination of relatively benign external factors and the adoption of sound domestic policies (Bailliu, et al
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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50
2002). Applying existing inflation models that have worked well in industrialized countries to Mexico, the
performance of these models was compared to a mark-up model that had been used extensively for the analysis
of inflation in Mexico. Each model was estimated using quarterly data, over the period 1983 to 2001. The
estimation and forecasting results suggest that the evolution of the exchange rate remained a very important
factor for explaining inflation. Indeed, the best performing model, the mark-up model, was the one in which the
exchange rate played the most significant role. The Phillips curve preformed better when using actual values
than forecasted values as explanatory variables. Omoke and Ugwuanyi (2010) tested the relationship between
money, inflation and output by employing cointegration and Granger-causality test analysis. The findings
revealed no existence of a cointegrating vector in the series used. Money supply was seen to Granger cause both
output and inflation. The result suggest that monetary stability can contribute towards price stability in Nigerian
economy since the variation in price level is mainly caused by money supply and also conclude that inflation in
Nigeria is to much extent a monetary phenomenon. They find empirical support in context of the money-price-
output hypothesis for Nigerian economy. M2 appears to have a strong causal effect on the real output as well as
prices.Using Okuns law each percentage point of cyclical unemployment is associated with a loss equal to 2%
of full-employment output; if full-employment output is $10 trillion, each percentage point of unemployment
sustained for one year costs $200 billion. Tejvan (2011) collected data from US and UK and analysed the
relationship between inflation and unemployment. The result revealed some trade-off between inflation and
unemployment in both US and UK as indicated in two graphs below. The data collected for US was from 1978
to 2011 while that of UK was from 1981 to 2011.

Empirical Evidence Behind Trade Off
This graph shows unemployment and inflation rate for the US economy.

There are occasions when you can see a trade off. For example, between 1979 and 1983, he sees inflation (CPI)
fall from 15% to 2.5%. During this period, he sees a rise in unemployment from 5% to 11%.

In 2008, he sees inflation fall from 5% to -2%. During this time, he sees a sharp rise in unemployment from 5%
to over 10%.

This therefore, suggests there can be a trade off between unemployment and inflation.
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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51

UK Evidence Unemployment v Inflation

% annual change in inflation and unemployment.

The graph above reveals that the trade-off in UK is very high compare to US, the trade-off is almost all year
round only in some few cases where the graph shows positive relationship, especially in 2009.

3.0 DATA METHOD OF ANALYSIS
The research work will make use of the econometric procedure in estimating the relationship between the
variables. The ordinary Least Square (OLS) technique will be employed in obtaining the numerical estimates of
the coefficients of the equation, Argumented Dicky-Fuller test of stationarity would be adopted after which
Granger causality test can also be used to determine the causation between inflation and unemployment or short-
run relationship between the variables, after which Johansen cointegration test would be employed to test the
existence of long-run relationship between inflation and unemployment in Nigeria then ARCH and GARCH
technique can be employed to test the volatility of the data because is a time series data. The OLS method is
chosen because it possesses some optimal properties; its computational procedure is fairly simple and it is also
an essential component of most other estimation techniques.

In demonstrating the application of ordinary least square method, the simple linear regression analysis will be
used with the inflation rate and unemployment rate, as the relevant variables. The independent variable is
unemployment rate while the inflation rate will be the dependent variable. Justification for the selection of these
methods is that the data is a time series data and all time series data exhibit a random walk.

MODELS SPECIFICATION
MODEL I(OLS)
UNEMP = a
0
+ a
1
INFL + e

INFL - Inflation rate
UNEMPL - Unemployment rate
a
0
, and a
1
- Parameters
e - Error term (white noise)
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52
MODEL II (ARCH and GARCH)
UNEMP
t
= a
0
+ a
1
UNEMP
t-1
+ e -------------------------(1)
t
2
=
1
+ B
1

t-1
+ B
2 t-1
2
--------------------------------------------(2)
INFL
t
= a
2
+ a
3
INFL
t-1
+ e --------------------------------(3)
t
2
=
2
+ B
3

t-1
+ B
4 t-1
2
--------------------------------------------(4)
Where

INFL - Inflation rate

UNEMP - Unemployment rate

1
and
2
- Constant
B
1,
B
2,
B
3
and B
4
- ARCH and GARCH coefficients
B
1

t-1
- ARCH term
B
2 t-1
2
- GARCH term
e - Error term (white noise)
A PRIORI EXPECTATION

ECONOMIC A PRIORI CRITERIA
This refers to the sign and size of the parameters in economic relationships.
MODEL I
It is expected that a
0
> 0, a
1
< 0 and a
2
< 0
MODEL II
It is expected that B
1
+B
2
<1 and B
3
+B
4
<1
However, if the estimates of the parameter turn up with signs or size not conforming to economic
theory, they should be rejected, unless there is a good reason to believe that in the particular instance, the
principles of economic theory do not hold.

4.0 RESULTS AND FINDINGS
TABLE 2: REGRESSION RESULTS
Dependent Variable: UNEMPL
Method: Least Squares
Date: 03/02/12 Time: 20:18
Sample: 1977 2009
Included observations: 33
Variable Coefficient Std. Error t-Statistic Prob.
C 32.71779 5.425731 6.030117 0.0000
INFLA -1.512065 0.601582 -2.513480 0.0174
R-squared 0.169292 Mean dependent var 21.37273
Adjusted R-squared 0.142495 S.D. dependent var 18.67785
S.E. of regression 17.29598 Akaike info criterion 8.597517
Sum squared resid 9273.675 Schwarz criterion 8.688214
Log likelihood -139.8590 F-statistic 6.317584
Durbin-Watson stat 1.138311 Prob(F-statistic) 0.017364

Table 2 contains bivariate regression results for the relationship between unemployment and inflation. The results indicate that the
coefficient of inflation and the constant are statistically significant. Precisely, the coefficient of inflation is found to be statistically
significant at 5 percent level as indicated by its probability value 0.0174 and rightly signed (negative). This therefore, implies that
1 percent increase in inflation would reduce unemployment by 151.2 percent. The F-statistics value 6.32, which is the measure of
the joint significance of the parameters, is found to be statistically significant at 5 percent level as indicated by the corresponding
probability value 0.0174.

The R
2
value 0.1693 (16.93%) implies that 16.93 percent total variation in unemployment is explained by the regression equation.
Coincidentally, the goodness of fit of the regression remained low after adjusting for degree of freedom as indicated by the
Economics and Finance Review Vol. 1(12) pp. 42 61, February, 2012 ISSN: 2047 - 0401
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53
adjusted R
2
(R
2
= 0.1425 or 14.25%). Durbin Watson statistic 1.14 in table 2 is found to be greater than R
2
value 0.1693 indicating
that the model is not spurious.

TABLE 3: UNIT ROOT TEST
Null Hypothesis: D(UNEMPL) has a unit root
Exogenous: Constant
Lag Length: 1 (Automatic based on SIC, MAXLAG=2)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -5.678275 0.0001
Test critical values: 1% level -3.670170
5% level -2.963972
10% level -2.621007
*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation
Dependent Variable: D(UNEMPL,2)
Method: Least Squares
Date: 03/02/12 Time: 20:13
Sample(adjusted): 1980 2009
Included observations: 30 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
D(UNEMPL(-1)) -1.422372 0.250494 -5.678275 0.0000
D(UNEMPL(-1),2) 0.403134 0.175886 2.292013 0.0299
C -0.190772 3.252724 -0.058650 0.9537
R-squared 0.587316 Mean dependent var 0.083333
Adjusted R-squared 0.556747 S.D. dependent var 26.74832
S.E. of regression 17.80830 Akaike info criterion 8.691845
Sum squared resid 8562.657 Schwarz criterion 8.831965
Log likelihood -127.3777 F-statistic 19.21268
2.169205 Prob(F-statistic) 0.000006

The results of unit root are contained in table 3. The results revealed that all the variables of the model are found
to be stationary at both 1 percent, 5 percent, and 10 percent level with first difference (d(1)), which is indicated
by ADF results at all levels less than the critical values in negative direction. The null hypotheses are rejected at
1 percent significance level.

TABLE 4 : CAUSALITY TEST
Pairwise Granger Causality Tests
Date: 02/08/12 Time: 14:52
Sample: 1977 2009
Lags: 2
Null Hypothesis: Obs F-Statistic Probability
INFLA does not Granger Cause UNEMPL 31 1.27311 0.29684
UNEMPL does not Granger Cause INFLA 1.32802 0.28239
The results of Granger causality are contained in table 4. The results revealed that
there is no causation between unemployment and inflation in Nigeria. The F-statistics
values are all less than 2 which indicate acceptance of the two hypotheses of no
causation between the variables. The probability values also confirmed that given their
high values.
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54

The Johansen cointegration test results contain in table 5 below confirm the existence
of long-run relationship between unemployment and inflation as indicated by the
TRACE- Statistic. The TRACE-Statistic results revealed that there is 1 cointegrating
equation at 5 percent level and also the Max-eigenvalue revealed that there is 1
cointegrating equation at 5 percent level.

TABLE 5 :COINTEGRATION TEST
Date: 02/08/12 Time: 14:46
Sample(adjusted): 1979 2009
Included observations: 31 after adjusting endpoints
Trend assumption: Linear deterministic trend
Series: UNEMPL INFLA
Lags interval (in first differences): 1 to 1

Unrestricted Cointegration Rank Test
Hypothesized Trace 5 Percent 1 Percent
No. of CE(s) Eigenvalue Statistic Critical Value Critical Value
None * 0.439746 18.21338 15.41 20.04
At most 1 0.008131 0.253087 3.76 6.65
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Trace test indicates 1 cointegrating equation(s) at the 5% level
Trace test indicates no cointegration at the 1% level

Hypothesized Max-Eigen 5 Percent 1 Percent
No. of CE(s) Eigenvalue Statistic Critical Value Critical Value
None * 0.439746 17.96029 14.07 18.63
At most 1 0.008131 0.253087 3.76 6.65
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Max-eigenvalue test indicates 1 cointegrating equation(s) at the 5% level
Max-eigenvalue test indicates no cointegration at the 1% level

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I):
UNEMPL INFLA
0.070431 0.131053
-0.000469 0.234523

Unrestricted Adjustment Coefficients (alpha):
D(UNEMPL) -10.33268 0.790288
D(INFLA) -0.907885 -0.240750

1 Cointegrating Equation(s): Log likelihood -202.4224
Normalized cointegrating coefficients (std.err. in parentheses)
UNEMPL INFLA
1.000000 1.860740
(0.72600)

Adjustment coefficients (std.err. in parentheses)
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55
D(UNEMPL) -0.727738
(0.19774)
D(INFLA) -0.063943
(0.03876)


TABLE 6: ARCH and GARCH RESULTS
Dependent Variable: UNEMPL
Method: ML - ARCH (Marquardt)
Date: 03/02/12 Time: 21:14
Sample: 1977 2009
Included observations: 33
Convergence achieved after 129 iterations
Variance backcast: ON
Coefficient Std. Error z-Statistic Prob.
C 24.52172 4.069828 6.025247 0.0000
INFLA -0.825710 0.370758 -2.227083 0.0259
Variance Equation
C 4.979235 27.16191 0.183317 0.8545
ARCH(1) 0.903699 0.789814 1.144193 0.2525
GARCH(1) 0.367203 0.317549 1.156367 0.2475
R-squared 0.106978 Mean dependent var 21.37273
Adjusted R-squared -0.020596 S.D. dependent var 18.67785
S.E. of regression 18.86921 Akaike info criterion 8.340791
Sum squared resid 9969.322 Schwarz criterion 8.567534
Log likelihood -132.6230 F-statistic 0.838557
Durbin-Watson stat 1.029681 Prob(F-statistic) 0.512397

The ARCH and GARCH results contain in table 6 reveals that the time series data under consideration is
volatile. This is indicated by the sum of the ARCH and GARCH coefficient (0.9037 + 0.3672 = 1.2709). This
result shows that there is high volatility clustering in the data.

5.0 CONCLUDING REMARKS
This paper investigates the impact of government expenditure on education and health on economic growth and
development in Nigeria through the application of Augmented Dickey-Fuller technique in testing the unit root
property of the series, the Granger causality test for causation was conducted, Johansen cointegration test of the
existence of long-run relationship of variables in the model and ARCH and GARCH techniques was conducted
to test the presence of volatility in the series. The results of unit root suggest that all the variables in the model
are stationary, the results of causality suggest no causation between unemployment and inflation in Nigeria, the
results of cointegration technique suggest that there is long-run relationship between unemployment and
inflation and ARCH and GARCH results suggest that the data is volatile. The results also revealed that when
inflation is increased by 1 percent unemployment will reduce by 152 percent in inflation. Despite the negative
relationship revealed by the regression results, the applicability of various theories of unemployment and
inflation in Nigeria is minimal. This paper therefore, recommend the use of theories drawn from data sourced
within the country. A major policy implication of this result is that concerted effort should be made by policy
makers to increase the level of usage of unemployment/inflation theory that is base on Nigerian data and
situation (they should stop copying theories from the western world) for they are detrimental to the growth and
development of the Nigerian economy.


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56
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Appendix
TABLE 1: Unemployment rate and inflation rate from 1977-2009
years unemployment rate inflation rate
1977 21.5 4.3
1978 13.3 4.3
1979 11.6 4.3
1980 10.0 6.4
1981 21.4 6.4
1982 7.2 6.4
1983 23.2 6.4
1984 40.7 6.2
1985 4.7 6.1
1986 5.4 5.3
1987 10.2 7
1988 56.0 5.3
1989 50.5 4.5
1990 7.5 3.5
1991 12.7 3.1
1992 44.8 3.4
1993 57.2 2.7
1994 57.0 2
1995 72.8 1.8
1996 29.3 3.4
1997 10.7 3.2
1998 7.9 3.2
1999 6.6 3
2000 6.9 18.1
2001 18.9 13.7
2002 12.9 12.2
2003 14.0 14.8
2004 15.0 11.8
2005 17.8 11.9
2006 8.2 13.7
2007 5.4 14.6
2008 11.6 14.9
2009 12.4 19.7
Source: CBN Statistical Bulletin, 2009.

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Most systematic evidence for the past two decades is given in Table 1 and figure 3 and
4, which show the rates of inflation and unemployment in seven industrialized countries
over the past two decades. According to the five year averages in Table 1, the rate of
inflation and the level of unemployment moved in opposite directions the expected
simple Philips curve outcome in five out of seven countries between the first two
quinquennia (1956 60, 1961 65); in only four out of seven countries between the
second and third quinquennia (1961-65 and 1966-70); and in only one out of seven
countries between the final two quinquennia (1966-70 and 1970-75). And even the one
exception-Italy is not a real exception. True, unemployment averaged a shade lower
from 1971 to 1975 than in the prior five years, despite a more than tripling of the rate of
inflation. However, since 1973, both inflation and unemployment have risen sharply.

UNIT ROOT TEST
Null Hypothesis: D(UNEMPL) has a unit root
Exogenous: Constant
Lag Length: 1 (Automatic based on SIC, MAXLAG=9)
t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -5.678275 0.0001
Test critical values: 1% level -3.670170
5% level -2.963972
10% level -2.621007
*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation
Dependent Variable: D(UNEMPL,2)
Method: Least Squares
Date: 02/08/12 Time: 15:26
Sample(adjusted): 1980 2009
Included observations: 30 after adjusting endpoints
Variable Coefficient Std. Error t-Statistic Prob.
D(UNEMPL(-1)) -1.422372 0.250494 -5.678275 0.0000
D(UNEMPL(-1),2) 0.403134 0.175886 2.292013 0.0299
C -0.190772 3.252724 -0.058650 0.9537
R-squared 0.587316 Mean dependent var 0.083333
Adjusted R-squared 0.556747 S.D. dependent var 26.74832
S.E. of regression 17.80830 Akaike info criterion 8.691845
Sum squared resid 8562.657 Schwarz criterion 8.831965
Log likelihood -127.3777 F-statistic 19.21268
Durbin-Watson stat 2.169205 Prob(F-statistic) 0.000006

CAUSALITY TEST
Pairwise Granger Causality Tests
Date: 02/08/12 Time: 14:52
Sample: 1977 2009
Lags: 2
Null Hypothesis: Obs F-Statistic Probability
INFLA does not Granger Cause UNEMPL 31 1.27311 0.29684
UNEMPL does not Granger Cause INFLA 1.32802 0.28239

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60
CAUSALITY TEST
Date: 02/08/12 Time: 14:52
Sample(adjusted): 1979 2009
Included observations: 31 after adjusting endpoints
Trend assumption: Linear deterministic trend
Series: UNEMPL INFLA
Lags interval (in first differences): 1 to 1

Unrestricted Cointegration Rank Test
Hypothesized Trace 5 Percent 1 Percent
No. of CE(s) Eigenvalue Statistic Critical Value Critical Value
None * 0.439746 18.21338 15.41 20.04
At most 1 0.008131 0.253087 3.76 6.65
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Trace test indicates 1 cointegrating equation(s) at the 5% level
Trace test indicates no cointegration at the 1% level

Hypothesized Max-Eigen 5 Percent 1 Percent
No. of CE(s) Eigenvalue Statistic Critical Value Critical Value
None * 0.439746 17.96029 14.07 18.63
At most 1 0.008131 0.253087 3.76 6.65
*(**) denotes rejection of the hypothesis at the 5%(1%) level
Max-eigenvalue test indicates 1 cointegrating equation(s) at the 5% level
Max-eigenvalue test indicates no cointegration at the 1% level

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I):
UNEMPL INFLA
0.070431 0.131053
-0.000469 0.234523

Unrestricted Adjustment Coefficients (alpha):
D(UNEMPL) -10.33268 0.790288
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D(INFLA) -0.907885 -0.240750

1 Cointegrating Equation(s): Log likelihood -202.4224
Normalized cointegrating coefficients (std.err. in parentheses)
UNEMPL INFLA
1.000000 1.860740
(0.72600)

Adjustment coefficients (std.err. in parentheses)
D(UNEMPL) -0.727738
(0.19774)
D(INFLA) -0.063943
(0.03876)