The Impact Of Monetary Policy On Investment In Nigerian Economy

Project and Seminar Material for Economics

The Impact Of Monetary Policy On Investment In Nigerian Economy


This is to examine the impact of monetary policy on investment in’ Nigerian ECPMP and the objectives are as follows: To ascertain if monetary policy instruments have impact on investment in Nigeria, if it does, to ascertain the relationship, To examine if long run relationship exists between monetary policy instruments and investment in Nigeria, To examine if causality exists between monetary policy instruments and investment in Nigeria.

Finally, monetary Nigerian Economy, only an effective monetary policy can guarantee price /stability, which is necessary condition of sustainable growth and development of Nigerian Economy.

Chapter One


1.0 Background to the Study

Financial instability is the new challenge for monetary policy. Most studies indicate that the typical patterns of financial crisis include prolonged unwinding of investment. These phenomena challenge modern monetary policy.

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (ii)cost of money of rate of interest, in order to attain a set of objectives oriented towards the .growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy. ‘

Monetary policy is referred to as either being an expansionary policy or a contractionary policy. Where an expansionary policy increases the total money supply in the economy, the contractionary policy decreases the total money supply in the, economy. ,Expansionary policy is traditionally used to combat unemployment in a recession by lowering the interest rates while contractionary policy involves raising interest rate in order to’ combat inflation. Monetary policy is, contrasted with fiscal policy, which refers to government borrowing, spending and. taxation.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can’ be borrowed and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth (investment), exchange rate with other currencies and employment. Where currency is under a monopoly, of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the system authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve’ Policy goals). The beginning of monetary policy as such comes from the late 19th,century, where it was used to maintain the gold standard.

A policy is referred to as contractionary if it reduces the size of the money supply, or-raises the interest rate, An expansionary policy increases the size of the money: supply, or decreases’ the interest rate. Furthermore, monetary policies are described, as follows; accommodative, if the interest rate set by the monetary authority is ‘intended to create economic growth: neutral if it is intended neither to create economic growth nor combat inflation: or tight, if intended to reduce inflation.

There are several monetary policy tools available to achieve these ends: increasing interest rate, by flat: reducing the monetary base and increasing reserve requirements. All have the effect of contracting the money supply; and if reserved, expand the money supply. Since the 1970s, the BRETTON WOODS system still ensured that most nations would form the two policies separately,

Within almost all modem nations, special institutions (such as ,the Bank of England, the European Central Bank the Federal Reserve in the United States, The reserve Bank, of India, the Bank of Japan or the Bank of Canada) ,exist which have the task of executing the monetary policy and often independently of the ,executive. In general, these institutions are called central banks and often have oilier responsibilities such as supervising .the full operation of the financial system.

The primary tool of monetary policy is open market operations. This entails managing quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of-these purchases or sales results in more or less base currency entering or leaving market circulation.

Usually the short term goal of open market operation is to achieve a specific short term interest rate target in other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of USA, the Federal Reserve targets the federal fund rate, the rate which member banks lend to one another overnight, However the monetary policy of China is to target the exchange rate between the Chinese Renminbi and a basket of foreign currencies.

The other primary means of conducting monetary policy include:

  1. Discount window lending (lender of last resort)
  2. Fractional deposit lending (changes in the reserve requirement)
  3. Moral suasion (cajoling certain market players to achieve specified. outcomes)
  4. “Open mouth operation” (talking monetary policy with the market),

1.1 Statement of the Problem

The problems facing the Nigeria economy, today include increasing level of unemployment; high level/rate of inflation, over-dependence on the oil sector that is oil exports; slow pace of growth and development in real output. And otherproblems may include inadequate policies, unstable pressures on the balance of payment (BOP), persistent weakness of the naira value in foreign exchange ‘market (Forex); and high/interest rates due partly to inflationary expectations, and partly to imperfections in the financial markets (both money and capital markets). Finally is the uneven income distribution, which has militated deeply against the decline in output and living standard of the people. It, nevertheless; is pellucid that, despite the exercising of monetary policy measures, the situation seems Unabated.

Over the years the central monetary authority (The Central Bank of Nigeria) has been on the active path of trying to combat the above mentioned problems by adopting one monetary policy after another taking note of the effect(s) which these, may have on various ‘sectors of the economy. The latest of these is the recent bank recapitalization of N25 billion and regulation of bank lending through the interest rate of about 17%. These have had their tolls in the economy by affecting the level of investment considerably and .as we must have noticed, certain of the aforementioned problems persist. . This research project, comparatively,· is to look. at the Monetary Policy Impact on investment in Nigeria as-investment is a key factor in determining the level of performance of the economy. Hence we ask the following:

  1. How far has the various monetary policy Instruments impacted in the investment atmosphere of the Nigerian economy?
  2. Does these exist any relationship between the level of investment and the monetary policy instruments in Nigeria?

1.2 Objectives of the Study

The general objective of this study is to examine monetary policy in Nigeria in relation to its impact on investment. To achieve that, this topic will pursue the specific under listed objectives.

  1. To ascertain if monetary policy instruments have impact on investment in Nigeria, if it does to ascertain the relationship.
  2. To examine if long run relationship exists between monetary policy instruments and investment in Nigeria .
  3. To examine if causality exists between monetary policy instruments and Investment in Nigeria.

1.3 Hypotheses of the Study

The following hypothesis will guide this study:

  1. Ho: Monetary policy instruments do not have any significant impact on investment in Nigeria,
    Hi: Monetary policy instruments have significant impact on investment in Nigeria.
  2. Ho: long run relationship does not exist between monetary policy instruments and Investment in Nigeria
    Hi: long run relationship exists between monetary, policy instruments and investment in Nigeria
  3. Ho: There is no causality between monetary Instruments and investment in Nigeria.
    Hi: There is no causality between monetary instruments and investment in Nigeria

1.4 Significance of the Study


Both the foreign and local investors will benefit from this work since the research exposes the impact of several monetary policy regimes on investment. This will enable the investors to know when to and when not to invest.

Policy Makers:

This research will also be beneficial to the policy makers seeing that the work .will reveal the impact of monetary policy instruments on· investment in. Nigeria. This will help the policy makers know the efficient monetary policy to make regarding certain investments: foreign or local.

1.5 Research Methodology

The method to be used in approaching this subject matter shall be descriptive. It will involve the employment of tabular analysis of data and graph or both. The source of data for the purpose of this essay shall be through primary and secondary sources. This will however be through regression analysis. The secondary data shall include information from journals of commercial banks, specialized banks and the Central Bank of Nigeria (CBN). Also, collections of information from the financial statement of some specialized credit bodies.

1.6 Scope of the Study

This study covers the Nigerian economy from 1970 to 2096. That is, a period of thirty seven (37) years. The choice of this period is based on the availability of data and the fact that it is a time series analysis.

1.7 Plan of the Study

The project work is divided into five chapter which are as follows;

  1. Chapter one consists of the introduction, statements of the problem, aims and objectives of the study, research questions, research hypotheses, research methodology, scope of the study, significance of the study.
  2. Chapter two consists of the literature review of the study.
  3. Chapter three consists of the research methodology.
  4. Chapter four consists of the data analysis, presentation and interpretation of the result finding while
  5. Chapter five consists of the summary of finding, conclusion and recommendation, then the bibliography.

Chapter Five

Summary, Conclusion and Recommendations

5.0 Summary

The study theoretically and empirically investigated how inflation, interest and rate of investment respond to shocks in monetary policy (captured by MPR). The research work used monthly data, beginning from December, 2006 (when the MPR was introduced) through February, 2020. The Structural VAR was employed to estimate the model, where the impulse response revealed how the inflation, interest and rate of investments responded to shocks in MPR and the variance decomposition brought to the limelight the impact of MPR on these Macroeconomic variables. The Granger Causality was equally used to disclose the causal direction among the variables, while Augmented Dickey Fuller (ADF) was conducted on all the variables before the estimations to establish the absence of stochastic process.

Outlines of Major Findings
  1. Inflation responds to shocks in MPR only in a volatile manner (a pattern that is almost unpredictable); in the first four periods, positive shocks in MPR could not bring down inflation but thereafter, any further increase in MPR produced gradually declining but positive interest rate.
  2. Rate of investment responds to shocks in MPR in a relatively downward fashion and quickly assumes upward trend from the second period lasting throughout the periods.
  3. Interest rate responds quickly and positively to shocks in MPR from the first thorough the last period. Therefore, MPR has its greatest influence on interest rate (prime lending rate).
  4. Of all the three macroeconomic variables, inflation is the most difficult to deal with and cannot always be successfully conquered with the manipulation of MPR alone.
  5. Low and stable interest and rate of investment can only be achieved when inflation is low and stable. Hence, inflation is the greatest enemy of our economy.
  6. Changes in the interest and rate of investment as well as MPC meetings can be used to predict MPR.

5.1 Conclusion

The study concludes that both interest (prime lending rate) and rate of investments respond quickly and almost in a predictable way to shocks in MPR. However, changes in MPR do not automatically and consistently produce changes in inflation and above all inflation responds to shocks in MPR only in a volatile manner (a pattern that is almost unpredictable). Hence of all the three variables, inflation is the most difficult to deal with (stability of which could leads to stability in the remaining two) and could not be totally addressed by mere manipulations of MPR. Hence low and stable inflation is a necessary condition for the achievement of low and stable interest and rate of investment. We also conclude that MPR is also responsive to Monetary Policy Committee (MPC) meetings.

5.2 Recommendations

  1. Other monetary policy instruments particularly Cash Reserve Requirements (CRR) and especially, OMO should be prudently used to compliment MPR in achieving Economic growth.
  2. The current monetary tightening stance of the CBN is a step in the right direction but should be used with caution. Considering the dual objective of CBN, the monetary policy should be tailored to promote real sector lending while trying to achieve low and stable inflation.
  3. There is the need for policy harmonization between the monetary and fiscal authorities. Budget deficit should be avoided and more fund be appropriated for capital as against the recurrent expenditures.
  4. CBN should license more banks to operate non-interest banking so as to boost financial deepening and inclusion. The large informal sector in the country that cripples the transmission mechanism of monetary policy and constraints the ability of CBN to control money supply was to some extent caused by cultural and religious belief that interest is unlawful; this could be avoided by introducing more non-interest banks.
  5. The “cashless policy” of CBN should be maintained, made more efficient and user friendly. Researches have shown that a system that is cash based is inefficient and distorts transmission mechanism. More efficient point of sale (POS) terminals, multifunctional ATMs as well as mobile payment compatible system should be put in place.
  6. There is the need for proper enlightenment of the public about any new CBN policy initiatives (e.g. non-interest banking & cash-lite policy). The communication strategy should be clear and concise.
  7. The physical and social infrastructures of the economy should be improved to reduce the cost of doing business and by extension the interest charged by the banks.
  8. The three tiers of Government should exercise fiscal prudence and fiscal responsibility act be fully implemented. More so, Banks and Other Financial Institutions should improve their operational efficiency by cutting down overhead and any other unnecessary expenses.
  9. The CBN should reduce or strike out any unnecessary stringent documentation requirement for the purchase of forex in the official market. This would kill patronage and by extension the life of parallel market/street trading.
  10. To ensure policy continuity and consistency, the rate of turnover of CBN Governors should be checked and the frequency of MPC meetings be reduced to at most quarterly unless in case of emergencies.
  11. The Oil and Gas sector should be fully deregulated, corruption in the sector and other sectors of the economy be fought to the latter and above all the saved subsidy proceeds be used to boost physical infrastructure. This would reduce pressure on forex demand as well as cost of doing business and in addition boost external reserve in the country.
  12. Last but not the least, CBN should avoid policy summersault, a situation where CBN would initiate a policy that originally supposed to be applicable to all economic agents (e.g. cash-lite) and latter begin to exonerate some agents (e.g. government parastatals, foreign embassies, Primary Mortgage Banks, Microfinance Banks etc.) from compliance, would not augur well for the economy. If Monetary Policy must strive, the credibility of CBN should be held in high esteem especially under condition of uncertainty.

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