An Assessment On The Effectiveness Of Monetary Policy On Economic Stabilization

Project and Seminar Material for Economics

Project and Seminar Material for Economics


Abstract


The highly unsuitable economic conditions in Nigeria has been a major source of concern among economic and policy makers in recent time. These economic problems can be attributed to the existence of market failure and the inability of the price mechanism to efficiently allocate scarce among economic agents.

This research sets out to examine the extent to which government intervention through monetary policy has been able to regulate the economy by ensuring general price stability and growth.

From the research work, we discover that monetary policy, through the use of the instrument of money supply but have not able to stabilize economic growth which as not been able to regulate the general price level.

This work also viewed the different schools of thought and their option about the use, effects and setbacks of monetary policy in stabilization of an economy, the Classical and the Cambridge model view money as a store of value and they believe that increase in money will cause same increase in prize, while the Keynesian argued that money is demanded for 3 purposes and concluded with their liquidity theory and lastly the monetarist they believed that demand is a stable function variable and money supply.

This work also focused on the means or mechanism through which this policy is been effected in the economy, the apex bank been the avenue through which the government extend this policy, the apex bank also through some means which include a direct and indirect mechanism extend this policy to the commercial banks and then to the general public.

This research work consist of a dependant variable in its hypothesis and some independent variable to explain the importance of monetary policy and its effect on the prize and Gross Domestic Product (GDP) in the economy, a least square regression method was adopted to derive the significant of the independent variable on the dependent variable. A data covering the duration of 32 years was introduced in the model; the result was established, interpreted and concluded was drawn with recommendation.


Chapter One


Introduction

1.0 Background Study

Economies all over the world experience one form of fluctuations or the other at different times. These fluctuations are usually beyond the ability of the market working through the price to cushion them. Hence, market failure.

A key of all central banks including the Central Bank of Nigeria is to promote and maintain monetary stability and a sound financial system. The assumption is that this will help encourage long term planning, aid infrastructural development, attract foreign investments and engender economic growth. While the central bank is totally responsible for the promulgation of sound monetary policies in order to aid the attainment of the above objectives, the formulation of fiscals’ policies, which also affects the achievement of the above objectives, however falls on the wider government, particularly the Ministry of Finance. Given the both monetary and fiscal policies impact on economic growth and development, it is not surprising that they are entwined. This relationship has been explicitly explained thus:

Monetary policies are inextricably linked in macroeconomic management; developments in one sector directly affect developments in the other. Undoubtedly, monetary policy is usually concerned with the use of hanges in money supply and/or interest rates to influence the level of economic activity. It is anchored on the use of all or some of the following policies: Open Market Operations, Liquidity Rations, Rediscount Policy, Minimum Reserve Requirement and Sectoral Credit Guidelines.

On the other hand, fiscal policies involves the use of taxes and changes in government expenditure to influence the level of economic activity (Ekpo, 2003, p.15) affects the disposable income of citizens and corporations, as well as the general business climate. In this regard, the interrelationship between public spending and private sector performance is of paramount importance. On one hand, Government expenditure can provide an impulse for private sector growth, while on the other, it can be harmful if it results in budget deficits and leads to competition for scarce financial resources from the banking sector as the government seeks to finance the deficit. In such circumstances, the crowding out of the private sector by the Government sector can outweigh any short-term benefits of an expansionary fiscal policy.

The key to all these therefore lies in striking a good balance in fiscal management. Having enough expenditure outlays to meet the needs of Government and support growth, but not so much as to deny the private sector the resources it needs to invest and develop.

This has the potentials of destabilizing the macro-economic environment thereby retarding economic productivity and development. The objective of this paper is to review the practice of monetary in Nigeria since independence. In doing so, we hope to explore the following issues: the link between government and development; how monetary policy have affected past developmental programmes in the country, and; the difficulties of conducting monetary in a deregulated environment and in an era of globalization.

According to the classical economists, it is the “invisible hand” of price mechanism that regulates the economy and determines what, how and whom to produce goods and services. It is a well-known fact that the “invisible hand” of price mechanism as propounded by Adam Smith has not been able: to effectively stabilize the economy in the practical sense. This could be attributed to the emergence of market imperfections: where market fails to efficiently allocate and distribute scarce economic resources.

Given this, the Government in order to attain a second-best situation, usually adopts measures such as fiscal policy and income policy to reduce the effect of these fluctuations. In this study, our interest is in monetary policy measures and their effectiveness in an import-dependent economy.

In an attempt to define the term monetary policy, the word “Policy” is first defined as a formulated idea or action used to achieve specific goals or objectives. On the whole, monetary policy can be defined as formulated plans or actions by government through the monetary authorities to regulate the volume, supply and cost of money in order to achieve certain goals and objectives.

The oxford dictionary of Economics (2003) defines “Stability” as the condition for a system to revert its original condition after a disturbance, or to speed up the rate at which it does so. Thus, the term “Economics Stability” cannot be described as not economics stability per se nor is it a state of static equilibrium. Rather, economics stability can be defined as a situation where by if there is disturbance or distortion, the system is not adversely affected.

There is no doubt that the volume and growth of money stock and the structure of interest rates play an important role in the operation of the macro economy.

Hence, this study seeks to assess the effectiveness of monetary policy as a tool of economics stabilization.


1.1 Statement Of Problem

  1. There is no consensus among economist of the different schools of thought with regards to the effectiveness or even appropriateness of using monetary policy as a weapon of economic stabilization.
  2. Although some progress has been made by Central Bank of Nigeria (CBN) towards resolving the structural imbalance in the economy, there is still a lot of disagreement of monetary policy in Nigeria
  3. There is also the problem of which goal should be assigned to monetary policy since it cannot be used to achieve or pursue all the Macro-Economic goals. This is because of conflicts in goals and the trade-off that exists among some Macro­economics aggregates. It is in view of these problems that this study is being undertaken.

1.2 Significance Of Study

  1. The study will help monetary authority to identify some lapses and short-comings on their own part in the implementation of monetary policy
  2. The study will be important to policy makers especially the Federal Government and the Central Bank of Nigeria (CBN) who will from it, know best the instrument of credit control issued by CBN to other banks and financial institute could be effective in economic stabilization in Nigeria
  3. The study will assist monetary authority in evaluating the true economic realities of the country by formulating monetary policy for specific economic goal.
  4. This study will also aid policy makers decide on appropriate policy instruments needed to achieve the ultimate macro-economic objective of attainment of high rate of economic growth and deflation.

1.3 Objective Of Study

  1. The study will seek to offer useful and meaningful suggestion on how to improve monetary policy performance in order to achieve certain desired objectives
  2. The study will also look at the extend to which monetary policy has succeeded in the maintaining relative stability in these macro-economic aggregates.
  3. In view of the persistent economic instability being experienced in the Nigerian economy, the study will therefore attempt to establish the extent to which money supply affects economic growth and the general price level.

1.4 Research Hypothesis

The research hypothesis to be tested will help bring the research work to a firm conclusion through empirical analysis.

The central or general hypothesis of this study is that monetary policy is an effective tool for regulating an import-dependent economy like Nigeria.

The specific hypotheses are stated below:

Hypothesis I:
  • Ho: There is no significant relationship between changes in money supply and changes in general price level in Nigeria.
  • H1: There is significant relationship between changes in money supply and changes in general price level In Nigeria.
Hypothesis II:
  • Ho: Variation in Gross Domestic Product (GOP) cannot be explained by variation in the stock of money supply
  • H1: Variation in Gross Domestic Product (GOP) can be explained by variation in the stock of money supply

1.5 Scope Of The Study

This study will focus on monetary policy, its formulation and implementation. The work will cover the effectiveness policy in Nigeria economy in Nigeria for the period between 1970 – 2003. This time series data is quite appropriate because it covers when the Nigerian economy fluctuated between boom and recession.


1.6 Organization Of Study

This research work will be divided into five (5) chapters and each chapter is presented as follows:

  1. Chapter One is the introductory chapter which gives insight into the background of the study. It also states the problem of the study, highlights the objectives of the study, states the hypothesis of the study and the significance of the study.
  2. Chapter Two focuses on the theoretical underpinning and literature review. The contributions of economist of the different school of thought will be reviewed in this chapter
  3. Chapter Three centers on the statement of hypothesis, data collection and econometric/statistical tests of data
  4. Chapter Four is based on empirical analysis of data tested in his chapter three are interpreted
  5. Chapter Five will round up the research work, as it would summarize previous chapters and findings in the course of the research work would be made based on the result gotten via the hypothesis test and other empirical analysis employed

1.7 Limitation Of Study

The data used in this research work is limited due to the errors that may have occurred during the military era, where data are vague in nature; due to this the reflection of the result may not be conclusive.


An Assessment On The Effectiveness Of Monetary Policy On Economic Stabilization


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