Evaluation Of The Impact Of Monetary Policy On Economic Growth And Inflation In Nigeria

Project and Seminar Material for Economics

Evaluation Of The Impact Of Monetary Policy On Economic Growth And Inflation In Nigeria


Abstract


Generally, monetary policies seek to achieve relative macroeconomic stability. Based on countries’ experience especially that of Nigeria on the role of monetary policy in controlling economic stability, this study examines the efficacy of monetary policy in controlling inflation rate and output fluctuation and taking into cognizance the evaluation and framework of monetary policy in Nigeria.

Using annual data spanning over 1985-2008 and applying the Ordinary Least Square (OLS) technique on the data used, the paper shows that the effort of monetary policy in influencing the finance of government fiscal deficit through the determination of inflation-tax rate affects both the rate of inflation and real output, thereby causing volatility in their rates. The result data analysis shows that there is a positive relationship between the real gross domestic product, exchange rate and money supply but a negative relationship exists between real gross domestic product and interest rate. The policy import of the paper is that monetary policy should be set in such a way that the objective is to be achieved well defined.


Chapter One


Introduction

1.1 Background of the Study

Monetary policy as defined by Anyanwu (1993) involves measures designed to control the volume, cost, availability and direction of money and credit in an economy to achieve some specified macroeconomic policy objectives. It also refers to the policy of monetary authority of a country with regard to monetary matters. It may be defined as the policy that deals with;

  1. The control of financial institutions
  2. Active purchases and sales of paper asset by the monetary authority as a deliberate effort/attempts to effect changes in the money conditions and
  3. Maintenance of particular interest rate structure, the stability of security prices or meeting other obligations and commitments.

Monetary policy is one of the macroeconomic policies available for managing the economy. It is however important today because of its effects on such macroeconomic aggregate as price, output, interest rates and exchange rates.

In most countries, the central bank is saddled with the responsibility of conducting monetary policy. In the case of Nigeria, the responsibility entirely lies with the Central Bank of Nigeria (CBN) .The discretionary control of money stock by the monetary authority involves the expansion/contraction of money, influencing interest rate to make money cheaper or more expensive, depending on the prevailing economic situation.

The evaluation of monetary policy intends to show how this macroeconomic policy is formulated and executed in practice particularly in an environment of federal government fiscal dominance and highly liquid banks.

However, there is need to point out that the Central Bank of Nigeria (CBN) adopted a medium term framework for the conduct of monetary policy. In the words of CBN, say “in recognition of the fact that monetary policy impacts on the ultimate objectives with substantial lag”. Furthermore, the shift was designed to free monetary policy from the problem of time inconsistency and overreaction owing to temporary shocks.

The annual reports of the Central Bank of Nigeria (CBN) and monetary policy circulars that it issues to the commercial banks form the basis for a quantitative assessment changes in monetary policies. With regard to the monetary circulars, the content changes from one year to another depending on the objective pursued by the central bank.

This study will enable us to understand what the framework of monetary policy in Nigeria looks like. It will further throw more light on its evaluation in the Nigerian economy. Data relating to necessary variables in the research work will be sound from the Nigerian economy.


1.2 Statement of the Problem

The monetary policy implemented in the economy over the past years has been detrimental to and inconsistent with the developmental needs of the economy (Apata. J.T 2007). This concern has exerted pressures on the national monetary authorities in Nigeria to re-examine and re-evaluate their domestic monetary policies with the view of finding possible solutions. As a result of this, the Structural adjustment programme was introduced in Nigeria in 1986 in order to correct structural imbalances in the economy and to liberalize the financial system.

There is an agreement that monetary and fiscal policies jointly and individually affect the level economic activities on which the policies focus. The degree and relative superiority of one instrument over the other in achieving these objectives has been the subject of debate and controversy among economists and policy makers and tentative resolutions are attempted empirically for different countries and different periods and circumstances.

In ensuring optimal expansion in liquidity for meeting desired growth and balance of payment objectives and at the same time achieve economic stability, monetary policy should be complemented with and coordinated fiscal policy but past studies have revealed that the effectiveness of monetary policy was hindered by the pursuit of expansionary fiscal policy. Due to this, the outcome of monetary policy was affected by administrative controls which involved the fixing of basic prices such as interest rate and exchange rate at below market level.

Despite various actions used by the monetary authorities in administering monetary policy in Nigeria, there are still limits to the effectiveness of monetary policy. There has been a wide discrepancy between target and outcome due to the fact that the central bank has not been able to achieve the various objectives it set out for itself. For instance, the target for M1 (money supply) was fixed at 10.2 percent in 1998 but M1 rose by 20 percent that year. In 2001, M1 target growth rate was 4.3percent but rose by 28.1 percent. The same pattern of failure is observed for M2 (broad money) series. There has been a problem also hitting the inflation target. For example, the target for inflation in 2007 was 7 percent but the performance was about 19 percent.

What a developing economy like Nigeria needs an effective, efficient, sound, and consistent monetary policies that have a positive impact on interest rate, inflation rate, employment and real output. Instead, these policies have led to price instability thereby causing inflation, high interest rate and unemployment in the economy.

Therefore, this research work is set to examine the monetary policy framework and also to see how monetary processes. And (if possible) suggest ways (from the wealth of experience of renowned economist in their write ups both in Nigeria and abroad) to solve the problem of ineffectiveness and inconsistencies in the evaluation of monetary policy in Nigeria


1.3 Objective of the Study.

The main objective of the study is to examine the framework and the evaluation of the monetary policy in Nigeria. However, the general overview of the monetary policy in Nigeria will be looked into. Likewise the tool of monetary policy will be extensively evaluated.

The specific objectives of this study are:

  1. To examine the various monetary policy instruments used in Nigeria.
  2. To estimate the effects of various monetary policy instruments on the economic growth in Nigeria.
  3. To estimate the effects of the various monetary policy instruments on inflation rate in Nigeria.

1.4 Research Hypothesis.

Hypotheses one
  • Ho: Monetary policy instruments do not affect economic growth in Nigeria.
  • Hi: Monetary policy instruments do affect economic growth in Nigeria.
Hypotheses two
  • Ho: Monetary policy instruments do not affect inflation rate in Nigeria.
  • Hi: Monetary policy instruments do affect inflation rate in Nigeria.

1.5 Significance of the Study

Establishing a monetary policy framework that follows and builds on recent historical experience around the world would greatly improve economic stability and growth in Nigeria.

Past studies have revealed that there are limits to the effectiveness of the monetary policy in Nigeria. From the mid-1970s, to achieve the aims of monetary policy became increasingly difficult. The major source of problem in monetary management was the nature of the monetary control framework interest rate regime and the non harmonization of fiscal and monetary policies. The monetary control measures which relies heavily on credit ceiling and selective credit controls, increasingly failed to achieve the set monetary targets as their implementation became less effective with time.

Overtime, the Central Bank of Nigeria has recognized that achieving stable prices would require continuous reassessment and evaluation of its monetary policy implementation framework to enable it respond to the ever-changing economic and financial environment.

This study is however important because its findings will reveal extensively how monetary policy in Nigeria has been carried out. This research study will be relevant due to the fact that it is expected to demonstrate how monetary policy can be effectively used in financing other sector in the Nigerian economy.

It will also help the monetary authorities to understand and know how best to direct monetary policy instruments in order to achieve macroeconomic goals of the government. It will likewise aid the public’s understanding of striking a balance in the trade-off in monetary goals such as full employment and growth and price stability among others.


1.6 Scope and Limitation of the Study

This research work will entail a survey of monetary policy in Nigeria. It will take into consideration the various tools of monetary policy and its evaluation and review the relevant literature on monetary policy. The research work in addition will look briefly at the limitations. This study seeks to cover a period of 23 years, 1985-2008.The researcher encountered some constraints, which limited the scope of the study. These constraints include but are not limited to the following.

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.


1.7 Definition of Terms

Monetry Policy:

Monetary policy is how a central bank or other agency governs the supply of money and interest rates in an economy in order to influence output, employment, and prices.

Economic Growth:

Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

Inflation:

Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. The measure of inflation is the inflation rate.


1.8 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

  1. Chapter one is concerned with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
  2. Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
  3. Chapter three deals on the research design and methodology adopted in the study.
  4. Chapter four concentrate on the data collection and analysis and presentation of finding.
  5. Chapter five gives summary, conclusion, and recommendations made of the study

Chapter Five


Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to have a critical analysis of evaluation of the impact of monetary policy on economic growth and inflation in Nigeria.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations are made, which in the opinion of the researcher will be of benefit in addressing the challenges of inflation and economic growth in Nigeria.


5.2 Summary

The research work investigated the impact of monetary policy on economic growth in Nigeria: 1985-2008. It further examined the determinant of efficient monetary policy management and growth in Nigeria. A time series data were employed with variables such as: Financial deepening, interest rate, money supply and GDP a proxy of growth. The study found that monetary policy application in Nigeria within the period in review marginally impacted on growth of the economy. However, with an exception of financial deepening, other variables used in the analysis rather declined growth instead. Finally, it equally showed that this scenario would endureeven in the long run.


5.3 Conclusion

Based on the above findings pertaining to the objectives of the study the following conclusions are drawn.
It has been established in this study that monetary policies implemented in Nigeria depended on major policy instrument such as interest rates, exchange rate, external reserve, and monetary base. This study also evaluates the impact of monetary policy variables within the institutional framework and basic theoretical model on economic growth.

Overall, the study found evidence that monetary policy innovations have both real and nominal effects on economic parameter depending on the policy variable selected. The study notes that monetary policy implementation in a developing country like Nigeria faces additional challenges that are not present in developed economies; such has fiscal dominance and the treat of currency substitution.

This study conclude therefore that the inability of monetary policies to effectively maximize its policy objective most times is as a result of the shortcomings of the policy instruments used in Nigeria as such limits its contribution to growth even though monetary policies had brought impressive contribution over the years.


5.4 Recommendation

  1. To fasten up the rate of growth of the Nigerian economy, government needs to initiate and push forward effective and efficient monetary policy measures via money supply, interest rate e.t.c. in order to adequately stabilize prices, reduce poverty and inequality by encouraging holistic macroeconomic growth.
  2. There is also the need to put in place an enabling policy instruments and strategies in the likes of increasing available domestic credit via potent interest rate in-order to encourage production.
  3. Finally, government should deepen the level of finance in the economy; this would encourage investment through provision adequate credit facilities required for optimal performance of real sector of the economy.

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