The Effectiveness Of Monetary Policy In Achieving Price Stability In Nigerian Economy
This study is to examine the role of monetary policy in achieving price stability in Nigerian economy and the objectives are as follows; to examine the effectiveness of interest rate in achieving price stability in Nigerian economy and also to examine the effectiveness of money supply in achieving price stability.
The method applied in analyzing data for this work are based on statistical at descriptive methods of analysis. (regression analysis was used to analyses the respondents opinion. The finding is that there is significant relationship interest rate and inflation.
Finally, a review of the Nigerian experience in monetary management shows that the interventionist policy stance dominated monetary management in the first two and half decades after which an era of liberalization and deregulation of financial sector followed. Only a sustained stable macroeconomic environment and a sound vibrant financial system can propel the economy to achieve her millennium development goals.
1.0 Background to the Study
Research on effectiveness of monetary policy on economic variables in Nigerian economy has for long been of interest to economist and policy makers however, studies have been carried out on certain aspects of economic variables. These studied are meager and in any case, not covering the effectiveness of monetary policy of price stability in Nigeria, which now necessitated this research work.
An issue which has occupied the minds of government for decades is the effectiveness of monetary policy in influencing price stability despite the lack of consensus among economist on how it actually works and on magnitude of its effect on the economy, there is a remarkable strong agreement that monetary policy has some measure of effect on the economy (Udegbunam 2003).
Monetary policy refers to the combination of measures designed to regulate the value, supply and cost of money in an economy, in consonance with the level of economic activity. It can be described as the art of controlling the direction and movement of monetary and credit; facilities in pursuance of stable price and economic growth In an economy (CBN, 1992).
In modern economics, the central bank is the authority with the mandate to manipulating monetary policy instruments to achieving desired macroeconomic objectives.
However, the primary objective of monetary policy cuts across the mandates of most central banks is the maintenance of price stability which is imperative to the attainment of sustainable growth is the focus of these objectives which is specified in the CBN ACT of 1958.
- Issue of legal currency notes and coins Maintain Nigeria external reserve
- To safeguard the international value of the legal tender currency.
- Promoting monetary stability and a sound financial system.
- Act as banker and financial adviser to the federal government.
- Act as a lender of last resort.
The pursuit of price stability invariably implies the indirect pursuit of other objectives such as economic growth which can only take place under conditions of price stability and allocative efficiency of the financial markets, since inflation is generally considered as purely a monetary phenomenon with significant cost to the economy. The primary goal of monetary policy is to ensure that money supply is at a level that is consistent with the growth target of real income such that non- inflationary growth will be ensured. The pursuit of price stability through monetary policy therefore encompasses all main areas in which the Central Bank can contribute towards stabilizing the macroeconomic environment of the country.
1.1 Statement of the Problem
Central bank of Nigeria (CBN) has been the sole player in using monetary policy in achieving price stability. Central bank of Nigeria has failed to achieve price stability due to the following:
- Lack of consensus on what constitute price stability. For example, Shiratsuka (1997) provides three definition of price stability as follows:
- A tolerable target for inflation rate (if achieved assumes the attainment of the price stability objective)
- Sustainable growth underprice ‘stability, implying price stability is achieved at the inflation crate consistent with sustainable economic growth.
- Stability of inflation expectation
- Moreso, political instability has also been attributed to one of the problem confronting central bank of Nigeria (CBN) in achieving price stability through the use of monetary policy.
1.2 Aim and Objectives of the Study
The aim of this study is to carry out an indepth assessment of the effectiveness of monetary policy in achieving price stability in Nigeria economy. To this end, this study will investigate whether monetary policy will help in achieving price stability.
The objectives of the study are as follows:
- To examine the effectiveness of interest rate In achieving price stability in Nigeria economy
- To examine the effectiveness of money supply In achieving price stability in Nigeria economy.
1.3 Research Questions
- What will be the effectiveness of interest rate ill achieving price stability in Nigeria economy?
- Will money supply affect price stability ill Nigeria economy?
- What will be the effectiveness of interest rate and money supply in achieving price stability in Nigeria economy?
- What will be the effectiveness of interest rate and money supply in achieving price stability in Nigeria economy?
- Will inflationary rate affect the economic growth of Nigeria economy?
- What will be the effectiveness of interest rate and money supply in achieving economic growth in Nigeria economy?
1.4 Significance of the Study
To assess the effectiveness of monetary policy on price stability in Nigeria economy. This study will reflect the effectiveness of monetary policy towards economic growth.
The benefits to be derived from this study will assist the policy makers to fine-tune strategies regarding monetary policy, how the money should be circulated in economy. Other people that also benefits from this research work include instructors, friends and colleagues in the field of studies etc.
1.5 Research Hypothesis
The research hypothesis are as follows:
- Ho: There is no significant difference between interest rate and inflation rate.
- HA: There is significance difference between interest rate and inflation rate.
- Ho: There is no significance difference between money supply and inflation mate.
- HA: There is significance difference between money supply and inflation rate.
- Ho: There is no significance difference between interest rate, money supply and inflation rate.
- HA: There is significance difference between interest rate, money supply and inflation rate.
1.6 Research Methodology
The research methodology is specifically designed to carry out effectiveness of monetary policy on price stability in Nigeria economy for the past seventeen years (17 yrs): 1993-2009.
In this regard, the sources of data are basically based on secondary sources of data collections. ‘These are in the form of dailies, statistical research findings such as: Central Bank of Nigeria (CBN) review etc while regression (OLS) will be used to solve the collection data. The methodology shall be descriptive and qualitative.
1.6.1 Model Specifications
Inf Rat = βo + 1 INTt + Et
INFt = Inflation Rate
Where βo – Constant
β1 = Parameter of the Equation
INTt = Interest Rate
Et = Error of Stochastic Term in Time T
1.8 Scope of the Study
The scope of the study shall cover the effectiveness of monetary policy in achieving price stability in Nigerian economy development during the period 1993-2009.
1.9 Limitation of the Study
The perceived limitations are as follows:
- The possibility of getting the relevant data and the information for the purpose of the research work.
- The availability of fund for the research work is another constraint.
- Time constraint is another limitation as the research work is combined with the academic work in school as a final year student.
1.9 Definition of Terms
It is anything that is general acceptable as a medium of exchange, store of value.
Is an instrument that Central Bank of Nigeria uses to control the circulation and money supply in an economy.
It is persistence Increase In price of goods and services.
When there is a fixed price for particular goods and services.
1.10 Organization of the Study
This study will be structured into five (5) chapters.
- Chapter one will examine the introductory aspect of the study containing the background of the study, statement of problem, aim and objectives, research questions, research hypothesis, research methodology, significance of the study, limitations of the study and organization of the study.
- Chapter two will contain the review of relevant literatures.
- Chapter three will focus on the structural analysis.
- Chapter four will examine the data analysis, presentation and interpretation of the results findings.
- Chapter five will focus on the summary, findings, recommendations and conclusion then the references.
Summary, Conclusion and Recommendations
5.1 Summary of Findings
The study analyzed the effectiveness of monetary policy variables on inflation in Nigeria between 1981 and 2019. The study introduced four predictor variables: monetary policy rate, money supply, exchange rate and treasury bills rate, in order to achieve robustness in the analysis of data and hypotheses testing. The study furthermore analyzed the relationship between monetary policy rate, money supply, exchange rate, treasury bills rate and inflation rate in Nigeria. The research made use of secondary data sourced from Central Bank of Nigeria (CBN) Statistical bulletin 2019 and the National Bureau of Statistics (NBS) on monetary policy rate, exchange rate, treasury bills rate, money supply and inflation. The Ordinary Least Square (OLS) and Granger Causality test techniques were employed in the data analysis.
The study commenced with the analysis of testing the variables of interest using Augmented Dickey Fuller (ADF) unit root test and the result indicates that the variables were non-stationary at level but was stationary at first differences. The Johansen co-integration test revealed the existence of long-run relationship between the variables. While the empirical result of the OLS test showed that monetary policy rate, money supply and treasury bill rates exert positive influence on inflation in Nigeria. Exchange rate depreciation leads to inflationary growth. This result is consistent with the prediction of economic theory. Specifically, the study found that;
- The Augmented Dickey Fuller (ADF), unit root test indicated that all the variables were stationary at first differences having found to be non-stationary at their levels. Hence, the need for long run analysis since they are all stationary at 1st differences.
- The Johansen co-integration trace test result indicated 5 co-integrating equations at the 0.05 percent significance level between the variables. This denotes the rejection of the null hypothesis at 0.05% level. While the Maximum Eigenvalue test indicated 1 co- integrating equation at 0.05% level. Both tests result suggests that there exists a long-run relationship between the variables.
- The OLS results indicated that the estimated coefficient of exchange rate (-1.168367) is rightly signed. It is negative and statistically significant. This by implication means that a 1 percent depreciation in Naira exchange rate will increase inflation by 1.17 percent; The estimated coefficient of monetary policy rate (3.675857) is rightly signed (positive) and statistically significant. A 1 percent increase in monetary policy rate will increase inflation by 3.68 percent. The coefficient of money supply (3.677) is positive as expected and statistically significant. A 1 percent increase in money supply will increase inflation by 3.68 percent. The estimated coefficient of treasury bill rate (8.946385) is rightly signed (positive) and statistically significant. A 1 percent increase in treasury bill rate will increase inflation by 8.95 percent. Therefore, relationship existed between inflation and monetary policy rate in Nigeria during the period.
- The Granger causality analysis result shows that we reject the null hypothesis of LINF does not Granger Cause LM2, LTBR does not Granger Cause LMPR, LMPR does not Granger Cause LEXG and LTBR does not Granger Cause LEXG at 5% level of significance while the opposite cannot be rejected. This result indicates that there is a unidirectional causal relationship between LINF and LM2, LTBR and LMPR, LMPR and LEXG and LTBR and LEXG. The results show that changes in inflation will lead to a significant change in money supply but not vice versa. There was no case of bidirectional causality at 5% significance level.
The focus of this study was on the effectiveness of monetary policy on inflation in Nigerian economy. Monetary policy rate, money supply, treasury bills rate and exchange rate were used as the determinant of inflation. The empirical result showed that money supply, treasury bills rate, monetary policy rate and exchange rate had influence on inflation within the period under consideration.
Based on the results and conclusion, the study made the following recommendations:
- This study has identified that the major driver of inflation is expected inflation. It is thereby recommended that government should handle and manage information on crucial macroeconomic variables relating to control of inflationary pressures.
- Secondly, the Central Bank should identify practical means of contracting money supply in the system and make better use of exchange rate to lessen inflation. The study discovered that annual Treasury bill rate through open market operation as proxy has not been effective in influencing inflation. Hence, schemes to make it more effective should be implemented perhaps through competitive rates.
- The monetary authority should re-evaluate the effectiveness and potency of monetary policy rate as a tool to curb inflation in Nigeria during and after the study period especially now that the occurrence of COVID-19 pandemic has shown the world the need to exercise a lot of caution in formulating policies in Nigeria and globally.
- The Central Bank should assess policies before implementation particularly regarding treasury bills rate.
- Finally, the Central Bank should clearly elucidate the objectives its policies and ensure appropriate control and management of monetary policy variables.
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