Post on 08-Jan-2023
MONETARY POLICY IN NIGERIA – THE IMPACT OF MONETARY
POLICY ON NIGERIA’S ECONOMIC GROWTH
Monetary Policy in Nigeria - Developing countries
growth policies are better delivered as full packages
since fiscal and monetary policies are inextricable,
except in terms of the instruments and implementing
authorities. However, monetary policy appears more
potent in correcting short term macroeconomic
maladjustments because of the frequency in applying and
altering the policy tools, relative ease of its
decision process and the sheer nature of the sector
which propagates its effect to the real economy – the
financial system.
The main objective of monetary policy in Nigeria is to ensure
price and monetary stability. This is mainly achieved
by causing savers to avail investors of surplus funds
for investment through appropriate interest rate
structures; stemming wide fluctuations in the exchange
rate of the naira: proper supervision of banks and
related institutions to ensure financial sector
soundness; maintenance efficient payments system;
applying deliberate polices to expand the scope of the
financial system so that interior economics, which a re
largely informal, are financially included. Financial
inclusion is
Particularly important in the sense that the larger it
is larger is the interest rate sensitivity of
production and aggregate demand and so the more
effective monetary policy is.
The economy of Nigeria is faced with unemployment low
investment and high inflation rate and these factors
mitigate against the growth of the economy. Thus
adopting monetary policy in manipulating the
fluctuations experienced so far in the economy, CBN
undertakes both concretionary and expansionary measures
in tackling the problems observed above. Therefore, the
need is felt to research on the impact of monetary
policy on the economic growth of Nigeria. Thus, the
following research questions sharpen the focus of the
problem.
Does monetary policy have any significant impact on
Nigeria’s economic growth?
Is there any long-run relationship between monetary
policy and economic growth in Nigeria?
The general objective of this study is to examine the impact of monetary
policy on Nigeria ‘s economic growth.
The specific objectives include:
To determine the effect of monetary policy on the
Nigerian economic growth
To ascertain the long- run relationship between
monetary policy and economic growth in Nigeria.
WORKING HYPOTHESIS
1. Ho: Monetary Policy does not have significant impact
on Nigeria’s economy.
2. Ho: There is no long-run relationship between
monetary policy and economic in Nigeria.
SIGNIFICANCE OF THE STUDY
As the Central Bank of Nigeria is undertaking policies
that will promote the economic growth of Nigeria , this
study will act as a source of information on various
ways of adopting monetary policy and its instruments
for stabilizing the economy. It will guide the policy
makers towards policy initiation.
It will help students and researcher to do further work
related to this research project.
SCOPE OF THE STUDY
The study covers the impact of monetary policy on
Nigeria ‘s economic growth in the period 1970 to 2009.
In the course of the analysis, effects shall the period
under review.
PERATIONANL DEFINITION OF THE RESARCH CONCEPTS
Social sciences concepts have received avalanche of
definitions, and as such, on one definition has all it
takes for universal acceptability. However, the
following concepts, as defined below, are relevant to
the study.
i . Effects are the result or an out come of something.
Ii. Money in an policy is a measure designed to
regulate money in an economy ( Erb 1995).
Iii money supply refers to the stock of liquid assets
held within an economy at a point in time ( Tirwall
1974).
iv. Inflation means a sustained rise in the average
price of a standard basket of goods and services,
without a corresponding increase in the quantity of
those goods and services (Oyejidi 1972).
v. Gross domestic product ( GDP) is the market value of
final domestic production of goods service during a
given period, usually Year.
REVIEW OF RELATED LITERATURE
THEORTICAL LITERATURE
Monetary theory has undergone a vast and complex
evolution since the study of the economic phenomenon
first came into limelight, It has drawn the attention
of many researches with different views on the role
and dimensions of money in attaining macro- economic
objectives. Consequently, there are quite a number of
studies aimed at establishing relationship between the
stock of money and other economic aggregates such as
inflation and output.
In this chapter we will take a look at the different
schools of thought, their views of the role of money
in attaining policy objectives alongside are view the
necessary literature relating to this study.
THE CLASSICAL MONETARY THEORY
The classical school evolved through concerted efforts
and contribution of economists like Jean Baptist Say,
Adam Smith, david Richardo, Pigu and others who shared
the same beliefs . The classical model attempts to
explain the determination, savings and investment with
respect to money.
The classical model on say’s law markets which states
that ‘’ supply creates its own demand. ‘ Thus classical
economists believe that the economy automatically tends
towards full employment level by laying emphasis on
price level and on how best to eliminate inflation
(Amacher and UIbrich, 1986)
The classical economists decided upon the quantity.
Theory of money as the determinant of the general price
level. Theory shows how money affects the economy. It
may be considered in terms of the ‘’ quation of
Exchang’’. This equation 2.1
Implying that changes in the price level can be changes
in the stcok of money. . The equation of exchange can
be startsd thus:
Mv= py 2.1
Mv = py
Where py = Gnp
Mv= Total Expenditure= GNP
M= stock of money
P= General price level
V= Income Velocity of money
Y =The Flow of Real goods and services
MV= measures the total value of transactions t within
a given period of time (total expenditure PY measures
the value of goods currently produced and sold ( total
product in value GNP). The relationship is derived from
the fact that ina closed economy, anything a single
purchased by one person is simultaneously sold by
another ( two parts of with money equals the average
stock of money in existence (m) goods and services
( velocity v).
THE QUANTITY OF MONEY
The classical economists did not introduce the role of
money in their model in terms of its demand and supply.
Insteady introduced money by using the quantity theory.
In short, related the level of economic commodity
price to the quantity of money in the economy and the
level of its commodity production. Two very similar
‘’quantity theory’’ formulations were used to explain
the level of price VIz ; the transactions formulation
or the Cambridge equation.
In the transaction version – associated with Fisher and
Newcomb, some assumptions were made, Viz : that the
quantity of money (m) is determined independently of
other variable, velocity of circulation (V) is taken as
constant, the volume of transactions (T) is also
considered constant. Thus of price (p) and the
assumption of full employment of the economy, the
equation of exchange is given as;
MV = PT, which can readily establish the production
that – the level of price is a function of the supply
of money . That is, p= F(m) which implies that, any
change in price. In cash balances version – associated
with Walras, Marshell, Wicksell and pigou, the
neoclassical school)(Cambridge school), changed the
focus of the quantity theory of without changing its
underlying assumptions. This version , focuses on the
fraction (K) of income, held as money balances. The
Cambridge version can be expressed as:
M= kpy
Where
K= Fraction of income
M =Quantity of money
P= price level
Y=value of goods and services
The K in the Cambridge equation is merely inversion of
V, the income Velocity of money balances, in the
original formulation of quantity theory. This version
directs attention to the determinants of demand for
money, rather than the effects of changes in the
supply money .’ Anyanwu (1993).
KEYNESIAN AND MONETARY PLOICY
The Keynesian model assumes a close economy and a
perfect competitive market with fairly price- interest
aggregate supply function. The economy is also assumed
not to exist at employment equilibrium and also that it
works only in the short run because asKey nes aptly
puts it ‘’ In the long run, we also will be dead’’. In
this analysis too, money supply is said to be
exogenously determined if wealth holderonly have one
choice between holding bouds. The Keyesian theory is
rooted on one notion of price rigidity and possibility
of an economy setting at a less than full employment
level of output, income and employment. The Keynesian
macro economy brought into focus the issue of output
rather than prices as being responsible for changing
economic conditions. In other records, they were not
interested in the quantity theory perse.
From the Keynesian in the mechanism, monetary policy
works by influencing interest rate which influences
investment decisions and consequently, output and
income via the multiplies process (Amacher and Ulbrich,
1989).
THE MONETAIST THEORY
The monetarist essential, quantity theorist who adopted
Fisher’s equation of exchange to illustrate their
theory, as a theory of demand for money and not a
theory of output price and money income by making a
functional relationship between the quantity of real
balances demanded a limited number of Variable (Essia,
1997) .
Monetarists like Friedman (1963) emphasized money
supply as the key factor affecting the wellbeing of
the economy. Thus , in order to promote steady of
growth rate, the money supply should grow at a fixed
rate, instead of being regulated and altered by the
monetary authority (ies). Keyness on the other hand,
maintained that monetary policy alone is ineffective in
stimulating economic activity because it works through
indirect interest rate rate mechanism .
Friedman equally argued that since money supply is
substitutive not just for bonds but also for many goods
and services, changes in money supply will therefore
have both direct and indirect effects on spending and
investment respectively. Brunner and Meltzer modeled
spending the demand for money will depend upon the
relative rates of return available or different
competing assets in which wealth can be.
THE MODERN APPROACH
The modern approach is the restatement of the quantity
theory in modern terms. It resulted in a new and more
sophisticated the quantity theory and in manner
amenable to empirical test.
It view s velocity of circulation as a stable function
of a limited number of key variables. That is,
velocity bears a stable and predictable relationship to
a limited number of other variables, and determiners
how much money people will hold rather than motive for
holding more and sees money as the main type of asset
which yields a flow of services to its holders,
according to the functions it performs (Fried man
1956).
In determining the factors influencing money demand ,
Friedman casts it in function is as follows.
Md = F(rb, re,P, 1/P .dp/dt w, w, u )
Where :
R b= Interest return or Yields on bonds
Re = Rate of return on equities
P= the price level
1/p . dp/dt = ratio of price change overtime w
W= ratio of non human wealth
W= wealth of the economic actor or permanent income
U= tastes and preferences.
Therefore , the demand for money according to this
approach, is not a fixed quantum , but varies in a
predictable fashion with the return on bonds and
equalities, the price level expectation, ratio of human
on non human wealth , or permanent income and tastes
and preferences.
EMPIRCAL LITERATURE
Aaogu (1998) sees monetary policy as actions by
monetary authorities to influence the national economic
objectives by controlling or influencing the quantity
and direction of money supply, credit and the cost of
credit. This according to him is aimed at ensuring
adequate supply of money to support financial
accommodation for growth and development programmes
for sustainable growth and development on the one hand
and , stabilizing various sectors of the , economy
for sustainable growth and development on the other.
Monetary policy can seen as employing the central
Bank’s control of the money supply as an instrument
for achieving the objectives of economy policy
(Johnson 1962 ). Similarly, from a synthesis of most of
the literature and in the context of the Nigerian
situation , Ubogu (1985) defines monetary policy as an
attempt by the monetary authorities to the level
aggregate economic activities by controlling the
quantity and direction of money and credit
availability . Vaish 9 1979) is the view that the
theoretical roots monetary policy go the way of the
quantity theory money, which according to him ,
remains a central theme in the theory The quantity
theory
State that a change in money supply , ceteris paribus ,
results in a proportional change in he price level .
The controversies in monetary theory and policy have
centered on what has come to be called the transmission
mechanism , the channel by which money supply
influences economic activity .In interest rate, move
to bring the demand for money into equally supply , the
new level of interest rates in turn influences both
consumption and interest spending hence the of out put
(Johnson , 1962 ). Changes in money supply are to be
compatible with the rate of inflation, This change
affect s the wealth of the public and therefore
influences their spending plans even without changes
rates. The interest rate channel, in any fails to apply
in countries where interest rates are not freely
variable but are fixed .Inrush cases, credit is
allocated by some non-price criteria, hence
availability and costs become the channel of
influence (Ubogu, 1985) . Economists, and mainly of the
classical, school, argue that expectations of
individuals and firms play an important role in
transmitted the effect of monetary policy actions
while this debate goes no, many hold the view that;
the relative strength of the various channels of
transmission of monetary policy is likely to very from
country to over time, depending on institutional
arrangements and economic circumstances. It may also be
the case that the time lags inherent in the various
channels of transmission differ. Another area of
debate in monetary theory policy where differences
remain relatively wide is the question of the efficacy
of monetary policy in nominal changes. Here, the
difference in views range from that of the Keynesians
who argue that monetary policy could influence real
output , in both the short and long runs, to the neo-
classical who argue that no such change in real
output is possible even in the short run. The
monetarist is captured by an aggregate supply curve
which is upward sloping to a point represented by full
employment , which is the natural rate and vertical
thereafter. This shape of the aggregated supply curve
allows for inflation/output trade-off, `
In the short but not in the long run. The neo-classical
aggregate supply curves, in contrast to both of these,
are vertical at the full employment level, thereby
precluding any inflation/output trade off even in the
short run. An important point worth stressing from the
policy point of view, is the empirical fact that a
close relationship is found to exist between money
supply and nominal income in all countries. It follows
perhaps logically from this, that if production cannot
adjust in the short run, due to whatever bottlenecks,
monetary action is likely to cause changes in prices
(Dornbusch and Fischer 2004).
As noted earlier, monetary policy refers to the
combination of measures designed to regulate the value,
supply a cost of money in an economy in consonance with
the expected level of economic activity. One of the
principal functions of the Central Bank of Nigeria
(CBN) is to formulate and execute monetary policy to
promote monetary stability and a sound financial
system. The CBN carried out this responsibility on
behalf of the federal government through a process
outlined in the Central Bank of Nigeria decree 24, 1991
and the banks and other financial institution decree
25, 1991 as amended. In formulating and executing
monetary policy, the governor of the CBN is required to
make proposal to the president of the Federal Republic
of Nigeria who has the power to accept or amend such
proposals. Thereafter the CBN is obliged to implement
the monetary policy approved by the president (CBN)
1996).
The CBN is also empowered by the two enabling laws, to
direct the banks and other financial institutions to
carry out certain duties in pursuit of the approved
monetary policy. Usually, the monetary policy to be
pursued is detailed out in the form of guidelines are
generally operated within a fiscal year but the
elements could be amended in the course of those
particular years. Penalties are normally prescribed for
non- compliance with specific provisions in the
guidelines.
The aims of monetary policy are basically to control
inflation maintain a health balance of payments
position in order to safeguard the external value of
the national currency and promote adequate and
sustainable level of economic growth and development.
OBJECTIVES OF MONETARY POLICY
Asogu, (1998) defined monetary policy as a measure
designed to influence the availability, cost and
direction of money and credit in pursuit of specified
economic goals. Monetary policy is art of the overall
economic policy that regulates the level of money
supply and credit in the economy in order to achieve
some desired policy objective. By monetary policy
objectives, we mean the ultimate objectives of
macroeconomic policy. The objectives include:
The maintenance of price stability; maintenance of
balance of payment equilibrium; attainment of high rate
of employment; accelerating the pace of economic growth
and development; exchange rate stability and the
maintenance of Price Stability.
In the modern economy, the price level tends to be
sticky if not rigid in the downward direction, so that
the problem of price level stability has essentially
been that of avoiding inflation. Inflation erodes the
purchasing power of economic agents and introduces
uncertainty and other vices. Price stability is
therefore, necessary not only to remove these vices but
also to restore confidence and maintain international
competitiveness.
The Maintenance of Balance of Payments Equilibrium:
In the case of maintenance of balance of payments
equilibrium, policy will be directed at influencing the
components of the balance of payments- the current and
the capital account in such a way that the balance of
payments is always in equilibrium. For instance,
monetary policy affects the interest rate and high
interest rates attract capital inflows and hence
influence the balance of payments. Which this level of
development and growth are attained depends upon the
resource available to the country.
Exchange Rate Stability
Fluctuations that may cause further deterioration or
undue appreciation that may lead to overvaluation in a
country’s currency are checked. The Central Bank in its
monetary measures, aims at maintaining adequate level
of foreign exchange rate consistent with the allocative
efficiency
TECHNIQUES OF MONETARY POLICY CONTROL
The techniques by which the stated objectives are
pursued by the monetary authorities can be classified
into two categories:- the Market Control Approach and
the portfolio Control Approach. Market Control
Approach:
This is an indirect or traditional approach of monetary
control.
They include the manipulation of:-
The Open Market Operation and
The Central Bank’s Discount Rate.
Attainment of High Rate of Employment
In the real world situations, the level of employment
that implies full employment is not obvious.
Economists define a situation of full employment as
one where all people who wish to work at the going wage
rate in the labour market will be employed. But it is
not possible that all those seeking employment will be
employment at one time. Even in the period of boom in a
dynamic economy, some people will always be between
jobs or seeking new employment. Thus, the monetary
policy measures aim at attaining a high rate of
employment that should proxy full employment. In other
words, it aims at maintaining a low and stable level of
unemployment, Anyanwu (2003).
Accelerating the pace of Economic Growth and
Development
Monetary policy aims at promoting economic growth and
development. Development may be measured by the level
of income per heard, capital per head, savings per
head, the percentage of unexploited resources amount of
public goods, the extent to which the working class
obtained education. While economic growth may be said
to concern itself with the effect of investment on
raising potential income and hence causes changes in
the living standard of the people. The extent to which
this level of development and growth are attained
depends upon the resource available to the country.
Exchange Rate Stability
Fluctuations that may cause further deterioration or
undue appreciation that may lead to overvaluation in a
country’s currency are checked. The Central Bank in its
monetary measures, aims at maintaining adequate level
of foreign exchange rate consistent with the allocative
efficiency.
TECHNIQUES OF MONETARY POLICY CONTROL
The techniques by which the stated objective are
pursued by the monetary authorities can be classified
into two categories:- the Market Control Approach and
the Portfolio Control Approach.
Market Control Approach:
This is an indirect or traditional approach of monetary
control.
They include the manipulation of:-
The Open Market Operation and
The Central Bank’s Discount Rate.
Open Market Operations
Open market operation refer to the buying and selling
of government and other approved securities by the
Central Bank in the open market. The Central Bank goes
to the public or ‘Open’ market for either long or short
term government securities and buys or sells them
depending on whether the aim is to create or destroy
bank deposits. Increase in the bank deposit implies an
increase in the money supply. Thus, if the Central Bank
wants to reduce the volume of money in circulation
because the economy is irking by inflation, it sells
securities to be public for which the public pays by
writing cheque favoring their deposit accounts. This
will reduce the commercial bank’s balance with the
Central Bank and hence their ability to create money.
Conversely, in times of depression, the Central Bank
buys securities thereby increasing the reserve base of
the commercial banks and hence their loanable funds.
The Central Bank’s Discount Rate
Central Bank’s discount rate measures the price changed
by the Central Bank for financial assistance made
available to the banking sector in the events of
perceived shortages of liquidity, (Chowdhry, 1986). In
other words, it is the rate of interest the Central
Bank charges the commercial banks on founds lent to
them against collateral. The term also applies to the
Central Bank’s activity of discounting bills when
commercial banks by discounting bills, such as,
treasury bills, treasury certificates, commercial bills
and promissory notes of short term duration at the
Central Bank. The lending rates of the commercial
banks’ are closely linked; discount rate induces a fall
in commercial banks’ lending rate and vice versa. The
manipulation of the discount rate helps to control the
volume of money in circulation. For instance, if the
economy experiences inflationary pressure, the Central
Bank raise the discount rate thereby making it very
costly for the commercial banks to obtain founds from
her. Consequently, commercial banks, in turn increase
their lending rate. The effect of the increase in
commercial bank’s lending rate is to reduce the demand
for borrowing, as long as the demand is interest
elastic. This will, in effect, cause investment to
shrink, and employment, income and the general price
level will all fall.
Portfolio Control Approach
Portfolio Control Approach is a direct or non-
traditional approach of monetary control. It works
through the instruments of portfolio constants, namely:
Reserve requirements
Special deposits with the Central Bank
Selective credit controls
Moral suasion
Direct Measures.
Reserve Requirements: Commercial banks are required to
keep some reserves with the Central Bank. By increasing
or decreasing the banks’ reserve requirement, the
Central Bank affects the banks’ ability to lend. When
banks are required to hold more liquid assets in
reserve, fewer assets will be left for them to lend to
the general public. On the other hand, a reduction in
reserve requirement release assets held for this
purpose for lending as loans and advances by the banks.
Special Deposits with the Central Bank: Special
deposits with the Central Bank are additional deposits
over and above the minimum legal reserve requirement
that the commercial banks are made to deposit with the
Central Bank. The mandatory special deposits are a
major measure in reducing the deposits available for
banks to lend to their customers. Though they appear on
the asset side of the bank’s balance sheets, they
cannot be used as part of any reserve base.
Selective Credit Control: This is a measure used by the
Central Bank to control the flow of bank credits to
different sectors of the economy. The Central Bank
directs banks on the cost, volume and direction of
credit to different sectors of the economy. The central
Bank may instruct the bank sector to give more loans to
the preferred sector of the economy- the productive
sector while extending little or no credit to the less
preferred sectors- the service or consumption sector of
the economy. By the use of selective credit control,
monetary policy influences the volume of money in
circulation as well as the allocation of resources.
Moral Suasion: This involves the issuing of persuasive
instructions to commercial banks to control the flow of
their credits to the economy. The Central Bank issues
these instructions in its periodic meetings especially
at the Bankers’ Committee Meetings, Annual Dinner of
the Chartered Institute of Bankers of Nigeria and on
other occasions when it meets formally or informally
with the heads of the banking community. Moral suasion
is supposed to be an appeal soliciting for the banks’
voluntary compliance over some credit guidelines.
Direct Measures: The direct measures involves the use
of interest rate ceilings, lending ceilings and
qualitative lending guidelines. The Central Bank may
decide to place a limit on the rate of interest and in
such a situation the rate of interest cannot fluctuate
beyond that limit. The lending ceilings when placed,
will limit the amount of found period of time that
could be lent to the public by the commercial bank.
MONETARY POLICY IN AN ENVIRONMENT OF REGULATED
FINANCIAL SYSTEM
Anyanwu (2003), emphasized that if an economy with
financial regulation starts to observe a fairly steady
upward trend in the velocity of the monetary base M1 and
M3 without a corresponding growth in the gross domestic
product (GDP) the ultimate economic monetary policy
would be in addition to informing the banks (moral
suasion) of this view by way of consultations to
increase the interest rate, raise the special reserve
deposits ratio and thus force the bank to reduce their
asset base. Because of the existence of controls,
change in the reserve ratio have a direct impact on
banks’ lending.
Under the tap system of selling government securities
whereby the price (and not the quality) of these
securities was fixed there was very little risk of
capital losses. Although most nations apply market
operations to affect their liquidity condition, they
are not the primary instrument of monetary policy.
Indeed, it mounts pressure on the primary market,
therefore, discouraging the development of the
secondary market; impairing true portfolio adjustment
is by holders of government debt as well as the
government ability to conduct open market operations.
MONETARY POLICY IN DEREGULATED FINANCIAL SYSTEM
The system of regulatory measures constructed to
protect investors and to maintain confidence in the
stability of financial market and institutions failed
to achieve the set objective as financial institutions
devised other names of operations than their compliance
to the regulatory body controls. As observed by Anyanwu
(2003), the regulations had allowed the banks to emerge
as highly profitable institution but with a declining
market share and at a high cost to depositors. Several
developments according to her, rendered the impact of
regulations of financial institutions a weak tool. One
of such developments is the upsurge of and increase
variability in inflation. Inflation has the potentials
of increasing the opportunity cost of holding moneys
balances. Investors tend to prefer short dated claims
over longer dated claims. Maturity controls imposed on
the banks restricted their ability to meet this demand.
The limited flexibility of banks in the face of high
and variable inflation rates afforded an opportunity
for non-bank financial intermediaries to expand
consequently, money Market Corporation, building
society and credit Unions, experience rapid growth.
Other development is the progressive increase in the
size of government budget deficits. The effect of this
rapid growth places considered pressure on the existing
methods for the sales of public securities.
Osuber (2006) had maintained that monetary authorities
could switch to financial de-regulation to set in
motion changes in both manner in which monetary policy
is transmitted to the real economy and the stability
and interest rate elasticity of the demand for money.
Thus the introduction of tender system of selling
government securities and the move to a floating
exchange rate regime increasing the monetary
authorities potential control over injections of
liquidity into the domestic monetary system thus,
enhancing their ability to use open market operations
to influence domestic monetary condition.
Osuber (2006), pin-pointed that monetary policy in a
deregulated financial system, strengthens the role of
market force in determining operations, and the real
economy through changes in interest rates. With greater
competitions therefore, financial sector, changes in
interest rate, tend to spread quickly through the
whole range of financial assets and liabilities.
Specifically, in the deregulated financial environment,
the value of deposit is determined by both demand and
supply consequently, any tightening of monetary policy
by the monetary authority will induce a rise in deposit
rate resulting in an increase in the supply of deposits
and offsetting to some extend the authorities effort to
reduce the growth of money. Thus, financial
institutions particularly banks are now better able to
protect their deposit base and to sustain their lending
than they had been in the regulated frame work in which
the volume of deposit was primarily determined.
The demand for credit may also have become less
sensitive to interest rate in the deregulated system.
For example, increased use of floating interest rates
and moral suasion and flexible loan packages may result
in less discouragement to marginal borrowers as rate
rises.
MONETARY POLICY AS A TOOL FOR ECONOMIC GROWTH
Consistent and stabilized monetary policy is usually a
set of demand management measures intended to remove
some macroeconomic imbalances, which if allowed to
persist, could be inimical to long-term growth.
According to Anyanwu (2003), countries seeking for
sustainable economic growth after a period of
macroeconomic imbalances must first get stabilized. In
Nigeria, monetary policy effectively implemented is a
veritable tool for stable economic growth.
Efforts for sustainable growth began in Nigeria in the
early 1980’s in response to the emergence and
persistence of unstable macroeconomic developments.
There was need to address basic elements of economic
instability such as the expended government spending
which resulted in large deficits. The instability
variables that needed to be stabilized were:
Excessive government borrowing; rapid monetary
expansion; inflation; chronic overvaluation of national
currency; reduced export competitiveness; introduction
of N200 and N500 currency notes; growth in real GDP
which stood at 2.8 and 3.8 percent in 1999 and 2000
respectively; CBN adoption of Universal Banking (UB) in
Nigeria end of 2000.
FACTORS INFLUENCING MONETARY POLICY
According to Anyanwu (2003) a number of variables or
aggregates have tended to influence the monetary
policy. These variables are:
Economic Stability: for the main thrust of monetary
policy to be fully implementable, there should be
macroeconomic stability otherwise a lot of distortions
and lapses will make the targets unrealizable.
Financial Market Efficiency: A special ingredient for
the monetary policy effectiveness is the money market
segment.
Inflation: The scope or magnitude of the inflationary
trends in the economy goes a long way to influence the
monetary policy. With high inflation any, rate the
price stability exchange rate stability and balance of
payments position, will not be fully realized.
LIMITATIONS OF PREVIOUS STUDY
A review of existing empirical studies indicated that –
for middle income economies, monetary policy shocks
have some modest effects on economic parameters.
Genev (2002) for example, using a structural vector
Autoregressive (SVAR) approach, studied the effect of
monetary shock in ten central and Eastern European
(CEE) countries, found some indications that changes in
the exchange rate affect out put. In the same spirit,
Starr (2005) using SVAR model with orthogonaized
identification, found little evidence of real effects
of monetary policy in five common wealth of independent
states (CIS) with notable exception that-changes in
interest rate have a significant impact on output.
However, for developing country like Nigeria, the
evidence is weak and full of puzzles”. For example,
Balogun (2007) used simultaneous equation model to test
the hypothesis of monetary effectiveness in Nigeria,
and found that-rather than promoting growth, domestic
monetary policy was a source of stagnation and
persistent inflation. Again, Chuku (2009) using a
structural Vector Autoregressive (SVAR) approach in
measuring the effect of monetary innovations in Nigeria
found that price based nominal anchors do not have a
significant influence on real economic activity
modestly.
The idiosyncratic evidence (inconsistent with
theoretical expectations), returned from different
investigations in different countries, is what
economists usually referred to as “puzzle”. The three
most common puzzles identified in the literature are:
the liquidity puzzle, the price puzzle and the exchange
rate puzzle. The liquidity puzzle is a finding that-
increase in monetary aggregates is accompanied by an
increase (rather than a decrease) in interest rate.
While the price puzzle is the finding that contraction
monetary policy through positive innovations in the
interest rate seems to lead to an increase (rather than
a decrease) in prices. Yet, the most common in open
economics is the exchange rate puzzle , which is a
finding that an increase in interest rate is associated
with depreciation (rather than appreciation) of the
local currency.
Intuitively, it is discovered that the causes of the
above identified puzzles, are due to inability of the
pervious researchers to specify their model correctly.
For example, Chukwu (2009) in measuring the effect of
monetary policy innovations in Nigeria, did not include
interest rate in his model, which is an important
instrument for monetary policy.
Again, inability of the researchers to use the correct
econometric method in their regression analysis. For
example, Balogum (2007) in determining effectiveness of
monetary policy in Nigeria, applied only simultaneous
equation model, which did not give room to test for
stationarity of data in order to avoid spurious result.
Therefore. It is with the view of annihilating these
puzzles, that the researcher would apply unit root test
and co-integration econometric model, in order to
stationarize the data, and ascertain the long run
relationship between monetary policy and economic
growth in Nigeria.
RESEARCH METHODOLOGY
This chapter focuses on the research method that will
be adopted. Regression analysis based on the classical
linear regression model, otherwise known as Ordinary
Least Square (OLS) technique is chosen by the
researcher. The researcher’s choice of technique is
based not only on its computational simplicity but also
as a result of its optimal properties such as
linearity, unbiasedness, minimum variance, zero mean
value of the random terms, etc (Gujarati 2004).
MODEL SPECIFICATION
In this study, hypothesis has been stated with the view
of examining the impact of monetary policy on
Nigeria’s economic growth. In capturing the study,
these variables were used as proxy. Thus, the model is
represented in a functional form. It is shown as below:
GDP = F (MS, INT, EXCH) ………….. 1.1
Where
GDP = Real Gross Domestic Product
MS = Money Supply
INT = Interest rate
EXCH = Exchange rate
In a linear function, it is represented as follows,
GDP = b0 + b1 MS + b2 INT + b3 EXCH+ Ut …………….. 1.2
Where
b0 = Constant term
b1 = Regression coefficient of MS
b2 = Regression coefficient of INT
b3 = Regression coefficient of EXCH
Ut = Error Term
DATA PRESENTATION
Year RGDP
(N=Million)
MS
(=N=Million)
INT
Rate
EXCH
Rate
1970 11.76819 6. 501738 7 0.7143
1971 3.759941 16.61547 7 0.6955
1972 8.526815 25. 31896 7 0.6579
1973 199.806 54. 50246 7 0.6579
1974 70.6816180. 30013 7 0.6299
1975
7.266672
39. 23182 6 0.6159
1976
8.144374
33. 76234 6 0.6265
1977 – 7
32195
1.096369 6 0.6466
1978 2. 28.04118 7 0.606
518109
1979 5.
338587
47.68304 7.5 0.5957
1980 550. 5322 7. 031126 7.5 0.5464
1981 -2.69796 11. 95357 7.75 0.61
1982 -7.0547 15. 39495 10.25 0.6729
1983 -1.09651 11.93011 10 0.7241
1984 9.518966 12.44159 12.5 0.7649
1985 2.45483 4.232502 9.25 0.8938
1986 -0.56556 22.91948 10.5 2.0206
1987 7.357725 34.98785 17.5 4.0179
1988 7.665243 935.3842 16.5 4.5367
1989 13. 01924 -85.408 26.8 7.3916
1990 -0.8114 27.43463 25.5 8.0378
1991 2.2557 47.52662 20.01 9. 9095
1992 1.277907 53.75794 29.8 17. 2984
1993 0.224609 34.49515 18.32 22. 0511
1994 2.162566 19.41172 21 21. 8861
1995 4.384391 16.17814 20.18 21. 8861
1996 2.81778 16.039 19.71 21. 8861
1997 2.936073 22.31778 13.54 21. 8861
1998 0.416031 33.12089 18.29 21. 8861
1999 5.443978 48.06769 21.32 92. 6934
2000 8.45 27.00465 17.98 102.
1052
2001 21.34746 21.55423 18.29 111.
9433
2002 10.23295 24.11369 24.85 120.
9702
2003 10.47949 14.02364 20.71 129.
3565
2004 6.511934 24.35329 19.18 133.
5004
2005 6.031021 43.09492 17.95 132. 147
2006 6.449833 44.23953 17.26 128.
6516
2007 6.407226 57.78557 16.94 125.
8606
2008 6.296026 48.38334 15.94 118.8606
2009 -100 -100 16.7 124.4484
ESTIMATION METHOD AND PROCEDURE
Currently modern economic analysis involve the use of
econometric method where appropriate statistical and
econometric test can be conduced to ensure the validity
and reliability of the data and result, for accurate
projection and prediction of the phenomenon in
question. The multiple equation model is presented by
the real Gross Domestic product (GDP) at current factor
cost as the dependent variable, with the total function
of Money supply (MS), Interest rate (INT) and Exchange
rate (EXCH), as the explanatory variable. The model
being a time series regression estimates, the
researcher will therefore test for the empirical
viability of the model using the ordinary least square
(OLS) analytical technical. The use of OLS method
according to koutsoyians (2001), yields parameter
estimates with optimal properties such as unbiased
minimum variance and efficient, thereby making the
parameter estimates best linear and unbiased (BLUE).
Other reasons include that its computational procedure
is fairly simple, as compared with other econometric
methods.
EVALUATION OF THE ESTIMATED PARATMETERS
Specifically, to carry out a thorough statistical
estimation on this study, the summary statistics R2 S.E,
unit root, co integration and Durbin Watson statistics,
would be conducted at 5% level of significance. For the
evaluation of the estimates as stated by koutsoyianis
(2003), after the estimate of the parameters of an
economic model, the next stage is the evaluation.
According to him, evaluations consist of deciding
whether the estimated parameters are theoretically
meaningful and statically satisfactory.
The coefficient of determination (R2) is usually
employed in order to evaluate the explanatory power of
the model. The value of the (R2) gives the proportion
of the variation in the dependent variable explained by
changes in the explanatory variables. The value of (R2)
lies between 0 and 1. the higher R2, the greater the
percentage of variation of Y explained by the
regression plan. That is, the better the goodness of
fit. The closer R2 to zero, the worse the fit.
Standard Error test (S.E): It is used to test for the
reliability of the coefficient estimates.
Decision Rule
If S.E < 1/2b1, reject the null hypothesis and
conclude that the coefficient estimate of parameter is
statistically significant. Otherwise accept the null
hypothesis.
Durbin Watson (DW) test: it is used to test for the
presence of autocorrelation (serial correlation).
Decision Rule
If the computed Durbin Watson statistics is less than
the tabulated value of the lower limit, there is
evidence of positive first order serial correlation. If
it is greater than the upper limit there is no evidence
of positive first order serial correlation. However, if
it lies between the lower and upper limit, there is
inconclusive evidence regarding the presence or absence
of positive first order serial correlation.
Unit Root Test: It will be used to test for the
stationarity of the time series data. Augmented
Dickeyfuller (ADF) test will be used in the course of
the test.
Decision Rule
Considering the absolute values, 5% level of
significance will be used.
If the critical value of the ADF tests in less than the
ADF test statistics, we concluded that the time series
data is stationary considering the level it is
differenced. Otherwise, the data is not stationary.
If the data is differenced once before stationarity is
induced, we conclude that the data is integrated of
order one. i.e 1(1), if it is differenced of twice, so
that stationerity is obtained, we say that it is
integrated of order two i.e 1 (2). However, should the
time series become stationary at level, i.e no
differencing, we say that the series is integrated of
order zero i.e 1(0).
Co integrated Test
It is used to test for the long run relationship
between the variables. Johansson co-integration test
will be utilized in the co integration analysis and the
normalized co-integrating coefficient, shall be
ascertained to examiner the nature of the long run
relation between the variables estimated in the model.
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