An Evaluation Of Open Market Operation As An Instrument Of Monetary Policy In Nigeria

Project and Seminar Material for Economics

Abstract

Generally, both fiscal and monetary policies seek at achieving relative macroeconomic stability. Based on countries’ experience on the role of monetary policy in controlling economics instability, this study examines the efficacy of monetary policy in controlling inflation rate and exchange rate instability. The analysis performed is based on a rational expectation framework that incorporates the fiscal role of exchange rate. In this research work, the researcher is focusing on monetary policy and micro economic instability in Nigeria. The researcher will consider in chapter one the introduction of the study which will in turn considers the following topics: The background of the study, the statement of research problem, the objective of the study, significance of the study, the hypothesis and the structure of the work. Chapter two focuses on the literature review; this chapter is where the researcher extracts materials from various books, magazines, newspapers and internet resources. In chapter three, the researcher deals on research methodology while chapter four is data analysis and interpretation. The finding, summary and conclusion are in chapter five.

Chapter One

1.0 Introduction

1.1 Background to the Study

Monetary Policy refers to the mechanism for regulating the value, supper and cost of money at optimum levels that will ensure the attainment of desired national economic objective which include price stability, sustainable output and employment growth and external viability it encompasses actions designed to manage the growth of money supply during a period of his optional target. The monetary policy strategy for the achievement of these goals in any economy is often influenced by the stage of development of the economy and its financial infrastructure. when the monetary policy strategy is successful, the level of money becomes compatible with the rate of growth of output inflation and interest rate. Money at this level plays the role of an efficient lubricant of the wheel of economic activities in such a way that it will not constitute a nuisance to the extent that its supply will be too much or first- rate business intentions to that extent that its supply will not be enough .

There are two main monetary policy strategies, which are direct and indirect approach.

The direct approach to monetary could comprise the use of instruments such as credit ceilings. Selective credit control, administered interest and exchanges rate as well as the prescription of cash reserves requirement and special deposits. In the early stages or economy development, central Bank typically rely on direct instrument of monetary policy, notably administrators controls of bank credit and interest rates.

However, the prolong use of there direct control In the Nigeria economy generated considerable problems and because counter productive. The use of direct administrative controls of interest rate, credit ceiling and sectoralallocation have been found, the world over to inhibit efficiency in resources allocation as will as innovative ideas and development in individual institution.

Due to all these negative effect manifested by the direct approach, there was urgent new to more rewards the institutionalization of market basedinstrument of control alsoknown as the indirect approach. This was accompanied by deregulation of interest rate and de-emphasizing of the use of credit allocation and control policies followed by the introduction of indirect tools of monetary policy enchased on open market operator (OMO),.

The open market operations involves the discretionary power of the CBN to purchase or sell securities in the financial market in order to influence the volume of liquidity and levels of indirect taxes, which alternately will affect the money supply and inflationary pressure in the economy. It was introduced in June, 1993 and has continued to be the main instrument of monetary policy in Nigeria.

Omo allows for Flexibility in policy implementation because it permits small and frequent charges in instrument, which enables the authorities respond rapidly to shock as the need arises. Open market operations are preferred by the CBN for the money supply for several reasons .

First, Omo can be used with some precision. If the CBN wants to change the money supply by just a small amount, it can buy or sell – longer change in the money supply, it can buy or sell a long amount.

Secondly, open market operations are extremely flexible. If CBN decides to reverse course, it can easily switch from buying securities to selling securities. Finally Omo have a family predictable effect on the supply of money. Since banks are obliged tomeet their reserves requirement, an open market sell of N 10m in government securities will deduce reserves by N10m, which will reduce the supply of money by N10m times the money multiplies.

1.2 Statement of the Problem

The open market operation is an important weapon of monetary control in Nigeria. There have been various write ups concerning me performance of the open market operation and its effectiveness on the monetary policy, this is because open market operation is how in vogue in both developed countries e.g Nigeria.

The question that baffles one so much the Nigeria economy is the rising inflation rate why has inflation in Nigeria economy remain on the increase despite the different monetary policy instrument of the government? What are the major causes of the instability of domestic prices and also the excessive reserves usually maintained by Banks?

In this study, efforts will be made to answer these question listed above, This study will also analysed the efficacy of money supply and the overall performance of open market operation as a policy tool of indirect monetary control.

1.3 Objectives Of The Study

The main objective of this study is to appraise this vital instrument of monetary policy with emphasize an highlighting us problems and prospects.

Through this study, the performance of open market operations in regulating money supply in the economy will be cortically analysed.

It will also suggest ways and means through which money supply can be effectively controlled. It will also help-in proffering solutions an how to improve the effectiveness of open market operation in Nigeria.

1.3 Hypothesis Testing

It’s an attempt to empirically answer the research question that the following research hypothesis will be tested in order to verify the relationship between money supply and the open market operation in Nigeria.

Ho = that there is no significant relationship between money supply and open market operations.
Hi = that there is significant relationship between money supply and open market operations.

1.4 Significance of the Study

This study is very significant in that, it is very important and effective tool in combating inflation and excess money supply if properly used.

It will also help in mopping – up excess liquidity In the banking system. It will make the monetary authority have insight on how to respond to frequent monetary shock in the economy.

Chapter Five

Summary of Findings, Conclusion and Recommendations

5.1 Summary of Findings

An empirical investigation of the effectiveness of Open Market Operations as instrument of monetary policy management in Nigeria was conducted and the major findings are summarized as follows:

The regression result shows that OMO has a positive and significant relationship with broad money supply (M2) which is used as a proxy for monetary policy. OMO is statistically significant at 1 percent level.
The study further shows that required reserve has a positive and significant relationships with money supply which could be due to the fiscal dominance of government and the influence of government funds in the banking sector.
Monetary policy rate which is an indicative rate for transactions in the money market and deposit money banks reveals a negative and significant relationship with money supply. This implies that monetary policy rate could serve as a veritable tool for the control of money supply and effective monetary policy management in the economy.

5.2 Conclusion

The empirical result of this study reveals that monetary policy instruments have significantly impacted on money supply (used in this study as a proxy for monetary policy) in Nigeria within the period under review. Also, the effectiveness of Open Market Operations, required reserve and monetary policy rate as instruments of monetary policy management is confirmed by the joint significance of the parameters (F-Statistic) which is significant at 1 percent level. Similarly, the coefficient of determination (R2) which measures the goodness of fit of the model is over 96 percent.

5.3 Recommendations

Monetary policy is undoubtedly one of the tools of economic stabilization and its role in any economy cannot be over-emphasized. Based on the major findings of this study, it is recommend that;

Monetary policy in Nigeria should lay emphasis on controlling money supply in order to stabilize the price level, reduce the effect of fiscal dominance of government and align the objectives of fiscal and monetary policy of government.
The government should endeavour to make the financial sector less volatile and more viable for smooth execution of the Central Bank monetary policies.
The Central Bank of Nigeria (CBN) should ensure that laws relating to the operation of financial institutions in the country are made to be less stringent and more favourable for the operators to have room to operate more freely.
The Central Bank should ensure effective and efficient monitoring of the activities of financial institutions and their performance to ensure credibility in the financial sector. The CBN should review periodically the performance of monetary policy with a view to enhancing the effectiveness of monetary policy instruments and achieving macroeconomic objectives.
In order to strengthen the financial sector, the Central Bank of Nigeria (CBN) should encourage the introduction of more financial instruments that are flexible enough to meet the risk preferences and sophistication of operations in the financial sector.

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