Academic journal article Journal of Financial Management & Analysis

The N.a.F.T.A. Evidence on Testing the Kumara Swamy Theorem of Inflationary Gap

Academic journal article Journal of Financial Management & Analysis

The N.a.F.T.A. Evidence on Testing the Kumara Swamy Theorem of Inflationary Gap

Article excerpt

Introduction

In 1978, Professor M.R Kumara Swamy proposed the unique and well-researched Kumara Swamy Theorem of Inflationary Gap during the convocation lecture on 'Inflation and Economic Development of Nigeria' delivered at the Institute of Management and Technology, Enugu, Nigeria on March 3, 1978, which states.

The growth of the money supply in a country must be twice the growth of real output to maintain price stability. Thus the difference between money supply and real output is the actual inflationary gap, while the permissible inflationary gap is the difference between real output and double (permissible) money supply. The excess of the actual gap over the permissible gap is referred to as the excess inflationary gap caused by non-economic development factors like maintenance of unproductive enterprises (non-performing assets) and we may add corruption and fraud premiums. (Swamy1)

Prelude

Financial economists have long postulated about the relationship between various economic variables, such as the level of economic activity (often as evidenced by growth in G.N. P. or one of its ancillary measures such as G.N. I.), growth of the money supply and, of course, the most persistent problem that has plagued many economies since the 1960s, inflation. Not only had Professor Swamy proposed this Theorem but he had successfully tested the theorem for the Nigerian economy as recounted in "A Financial Management Analysis of Nigerian Economic Situation: Problems and Solutions" in the Nigerian Journal of Financial Management (December 1982)2and "Empirical Testing of the Kumara Swamy Theorem of Inflation Gap: Nigerian Economy in Perspective" in the Journal of Financial Management and Analysis (July-December : 2009).

Lazaridis and Livanis tested the Theorem outside the developing world in two countries in Europe- -, Greece and Cyprus, while Bauer and Faseruk examined in the perspective of Canada. Both studies utilized databases over time periods that included the ongoing international financial crisis, precipitated by the sub-prime crisis in the U.S.A. and the continuing Euro-zone crisis which was particularly severe in the P.I.G.S. nations (Portugal, Italy, Greece and Spain). The lingering recession of 2008 and its aftermath were not as severe in Canada as they were in Greece and Cyprus as demonstrated by Bauer and Faseruk. The Euro-zone economies are expected to grow at significantly lower rates over the foreseeable future, given the non-resolution of significant economic events that are expected to persist beyond 2012.

Despite the recession, inflation as a global phenomenon has continued to increase internationally due to the persistence of high oil (petroleum) prices and increases in food prices. Food prices increased as a result of both oil prices and shortages of foodstuffs due to growth in population, increased consumption by emerging middle classes in China and India, and drought conditions in Africa and North America during 2012. Lazaridis and Livanis investigated the Kumara Swamy Theorem of Inflationary Gap for the Cypriot and Greek economies over the period 2004-2009 and found favorable results for the Kumara Swamy Theorem of Inflationary Gap. The results of the testing for Canada by Bauer and Faseruk did not demonstrate as pronounced results. In all cases, however, the money supply increased at a rate which was more than double the permissible postulated in the Theorem. While double seems to be an appropriate lower bound, it is not as clear if doubling should be either a point estimate or a lower bound. The current study also examines the Kumara Swamy Theorem of Inflationary Gap as a long-term average and demonstrates that the results can be very robust in the short-term often exhibiting significant swings before returning to the long-term average amounts.

Cypriot and Greece : Strongly Inter-related Economies

While the Cypriot and Greek economies are strongly interrelated and both are members of the European Union, only Greece is a member of the 34 countries within the Organization for Economic Cooperation and Development (O. …

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