Impact Of Monetary Policy On Private Domestic Investment In Nigeria (1990-2018)

Project and Seminar Material for Economics

Impact Of Monetary Policy On Private Domestic Investment In Nigeria (1990-2018)


The study explores the relationship between monetary policy and private domestic investment in Nigeria by tracing the effects of monetary policy through the transmission mechanism to explain how investment responded to changes in monetary. Several studies have offered a means to understand the manner in which monetary policy actions affect investment, prominent among them are the Classical school. The study utilises quarterly macroeconomic data from 1990-2018 and the methodology draws upon unit roots and cointegration testing using a vector error correction model to explore the dynamic relationship of short run and long run effects of the variables due to an exogenous shock. The variables are stationary in first differences and using ordinary least squares the estimated long run relationship is: LRPSC = 1.84 – 0.54LRGDD + 0.62LRGDS + 0.75LRMS – 0.04LTBILL

Table of Content

  • Title Page
  • Certification
  • Dedication
  • Acknowledgement
  • Table of Content
  • List of Tables
  • Abstract

Chapter One:


  • 1.1 Background of the Study
  • 1.2 Statement of the Problem
  • 1.3 Objective of the Study
  • 1.4 Research Questions
  • 1.5 Research Hypothesis
  • 1.6 Significance of the Study
  • 1.7 Scope of the Study
  • 1.8 Limitation of the Study
  • 1.9 Definition of Terms
  • 1.10 Organisations of the Study

Chapter Two:

Review of Literature

  • 2.1 Conceptual Framework
  • 2.2 Theoretical Framework
  • 2.3 Empirical Review

Chapter Three:

Research Methodology

  • 3.0 Introduction
  • 3.1 Research Design
  • 3.2 Data analysis Technique
  • 3.3 Model Specification
  • 3.4 Aprior Expectation
  • 3.5 Econometrics Test
  • 3.5.1 Pre-estimation Test
  • 3.5.2 Post estimation Test
  • 3.6 Sources of Data

Chapter Four:

Data Presentation and Analysis

  • 4.1 Data Presentation
  • 4.2 Analysis of Data

Chapter Five:

Summary, Conclusion and Recommendation

  • 5.1 Summary
  • 5.2 Conclusion
  • 5.3 Recommendation
  • References

Chapter One


1.1 Background to the Study

Investment is generally classified into four major components: the private domestic investment, the public domestic investment, the foreign direct investment and the portfolio investment. Private domestic investment refers to gross fixed capital formation plus net changes in the level of inventories whereas public investment includes investments by government and public enterprises on social and economic infrastructures, real estate and tangible assets. The combination of private investment and public investment is normally referred to as gross fixed capital formation in order to distinguish them from their counterpart foreign investment. The foreign investment when it is on tangible asset is referred to as direct foreign investment.

Monetary policy refers to the policy of the monetary authority with regard to monetary (money) matters. It deals with the controls of financial institutions, active purchases and sales of paper assets to affect changes in money supply and maintenance of interest rate (Jhingan, 2005). The objective is to achieve set macroeconomic goals such as full employment, economic growth, price stability and external balance. It is an attempt to achieve the national economic goals of full employment without inflation, rapid economic growth and balance of payment equilibrium through the control of money supply and credit. The classical theory of monetary policy postulate that changes in money supply or other aggregates will work through some intermediate variables through which some effects are transmitted to the ultimate goals of price stability, output, employment and external balance (CBN, 2011). Monetary policy transmission mechanism refers to the various intermediate channels through which changes in the nominal money stock or short term interest rates affects the macroeconomic aggregates. In Nigeria, Central bank of Nigeria Act 1969 empowered CBN the monetary policy function under the supervision of Ministry of Finance.

There are normally changes in monetary policy objectives from time to time, depending on the economic situation of a country. For instance, goals of monetary policy in Nigeria in 1993 were to reduce the inflation rate, minimize pressures on the external sector, stimulate growth in production and output, and reduce pressure on the balance of payments to ensure stable exchange and interest rates. By the end of that year, there was a rapid expansion of monetary and credit aggregates as broad money rose by 52.8 percent instead of the targeted 20 percent and narrow money by more than 50 per cent instead of the 18 percent target. The trend was the same for other key aggregates. The rate of growth of real output as measured by GDP at 1984 constant factor cost declined, inflation rose and unemployment increased (CBN, Performance of Monetary Policy, 1993).

Monetary policy in 2013 pointed fundamentally at continuing the already directed rate of inflation which was accomplished in the first half of 2013. In 2014, monetary policy focus was shifted to achieving the objective of price and exchange rate stability (CBN, Performance of Monetary Policy, 2014). It is the duty of the Central Bank of Nigeria (CBN) to formulate proper monetary policies to cater for the economy deployment of the nation. This duty is backed by various statutes of the bank such as the Central Bank of Nigeria Act of 1958, as amended in CBN Decree No. 24 of 1991, CBN Decree 1993 (Amended), CBN Decree No. 3 of 1997, (Amended), CBN Decree No. 4 of 1997 (Amended), CBN Decree No. 37 of 1998 (Amended), CBN Decree No. 38 of 1998 (Amended), CBN Decree 1999 (Amended) and CBN Act of 2007 (Amended) (CBN, Performance of Monetary Policy, 1993).

Various hypotheses have been formulated on the relationship between money and the economy. Morgan (1981) identified two causal relationships between private investment and monetary policy. McKinnon (1973) underpins the gracefully driving contention by proposing an integral connection between accumulations of cash balances (money related resources) and physical capital accumulation in developing nations. Shaw (1973) additionally supporting the gracefully driving contention and putting together his contention with respect to inside money model, suggested that high interest rates are paramount in drawing more saving (Onouorah, Shaib and Ehikioya, 2012 (Onouorah, Shaib and Ehikioya, 2012). The inabilities for the classical economists to restore equilibrium during the great depression of 1930s remain one of the challenges facing the effectiveness of monetary policy in the developing countries like Nigeria. Empirical studies on monetary policy transmission mechanism have well been documented in literature. Significant proportion of the study focused on monetary policy transmission mechanism and economic growth using Gross Domestic Product as dependent variable (Ogbulu and Torrbira, 2012; Obafemi and Ifere, 2015; Ndekwu, 2013; Ishiroro, 2013). Only few studies of citable significance have dealt on the problem of monetary policy transmission mechanism and domestic real investment in Nigeria. From the above, this study intends to examine the impact of monetary policy on private domestic investment in Nigeria from 1990 to 2018.

1.2 Statement of the Problem

It is observed from the monetary policies of the CBN over the years and related literature that the Nigerian economy is characterized by inconsistency in government policies, political instability, ineffective policy statement, deficit philosophical framework and excessive money supply. Monetary policies are designed to ensure that money supply in the economy is adequate to support desirable and sustained economic development without generating inflation pressures.

Considering all the policies and efforts of the government in improving the economy of Nigeria, this study was designed to find out whether its monetary policies have been able to bring about improvement in savings and private domestic investment in the country.

1.3 Research Objectives

The broad objective of this study is to evaluate the impact of monetary policy on private domestic investment in Nigeria (1990-2018).

Furthermore, the specific objectives include:

  1. To understand the monetary policies of the Central Bank through its instruments and targets not have any significant impact on economic growth in Nigeria
  2. To ascertain the causes of the inability of these policies in achieving their stated objectives and the possible solutions
  3. To investigate the impact of money supply on the level of private domestic investment in Nigeria

1.4 Research Questions

In the light of this, therefore, the questions to guide this research study include the following:

  1. Why has the monetary policies of the Central Bank through its instruments and targets not have any significant impact on economic growth in Nigeria?
  2. What are the causes of the inability of these policies in achieving their stated objectives and the possible solutions?
  3. What is the impact of money supply on the level of private domestic investment in Nigeria

1.5 Research Hypothesis

In this study we shall examine the following hypotheses that:

  1. There is no significant relationship between the monetary policies of the Central Bank and economic growth in Nigeria
  2. There is a significant relationship between money supply and the level of private domestic investment in Nigeria

1.6 Significance of the Study

This research examines the length at which monetary policy as a tool of public policy has been successfully applied in Nigeria and showed its relevance and effectiveness in raising aggregate private sector in Nigeria economy. Among other things to be looked into is how the luck will be of use to financial investment investors as it will give a just indication of how they can be affected by monetary policies.

This study will therefore be useful to stakeholders, policymakers and the government officials on the effect of monetary policy on private domestic investment in Nigeria. Also, it will serve as body of knowledge upon which foundation for further research can be built.

1.7 Scope of the Study

This study covers a period of twenty eight years, using data from 1990-2018. It is long enough for meaningful statement to be made on the results obtained. The quarterly data gave the study sufficient degree of freedom. Essentially, it is a dynamic analysis of the effects of monetary policy on private domestic investment in Nigeria. This study did not include Small Scale Enterprises because of absence of data. Furthermore the economy of Nigeria is made up of formal and a large informal sector, but the study is limited to the formal sector and did not consider the informal sector because of absence of data in that sector.

1.8 Limitation of the Study

The main limitations are factors such as:

  • Time Constraints: This study is limited by time constraints as researcher needed time to study for the final year examinations while also ensuring that this study does not suffer from dateline.
  • Fund: The inabilities to access more material in order to make several consultations was poised by inadequate supply of money.

1.9 Definition of Terms

Monetary Policy:

Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often as an attempt to reduce inflation or the interest rate, to ensure price stability and general trust of the value and stability of the nation’s currency.

Domestic Investment:

Domestic investment is the measure of physical investment used in computing GDP in the measurement of nations’ economic activity. This is an important component of GDP because it provides an indicator of the future productive capacity of the economy.

Economic Growth:

Economic growth can be defined as the increase or improvement in the inflation-adjusted market value of the goods and services produced by an economy over a certain period of time. Statisticians conventionally measure such growth as the percent rate of increase in the real gross domestic product, or real GDP.

1.10 Organization of the Study

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

  • Chapter one is concern 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.
  • Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
  • Chapter three deals on the research design and methodology adopted in the study.
  • Chapter four concentrate on the data collection and analysis and presentation of finding.
  • Chapter five gives summary, conclusion, and recommendations made of the study.

Chapter Five

Summary, Conclusions and Recommendation

5.1 Summary of Findings

The overall objective of the study was the determination of the effect of monetary policy on Private domestic investment in Nigeria. The long-term relationship was estimated as LRPSC = 1.84 – 0.54LRGDD + 0.62LRGDS + 0.75LRMS – 0.04LTBILL.

The goodness of fit R2 is 73 percent, while the adjusted R2 is 53 percent, suggesting that at least 53 percent of the variation in investment is explained by the regression. The estimated equation signifies that a unit shock of monetary policy has a significant and positive effect on private sector investment.The error correction term is expected negative and significant at 5 percent level of significance suggesting that private sector investment adjusts to deviations from its long-term equilibrium. The ECT is estimated as -.5515 percent. This means that 55.15 percent of last quarterโ€™s disequilibrium is corrected by changes in private Domestic investment.

5.1.1 Private domestic investment and Government Domestic Debt

Domestic borrowing creates a financial crisis in the domestic credit market due to demand for loans, which displaces Domestic investment provided that excess liquidity in the economy is absent. The Central Bank of Nigeria reports that most of the period from 1996 to 2009 was characterised by excess liquidity arising from the slowdown in private sector demand for bank credit, which was in turn attributed to the slowdown in economic growth.

According to Maana et al., (2018), domestic debt increased rapidly from 1996 to 2007 as the Nigerian government (GoK) sought to restructure its share of domestic debt in the overall public debt framework. It increased significantly from 25.8 percent to 50.5 percent during the period. Externalities that included low inflow of cheap external funds forced the GoK to borrow from the domestic market. The composition of the debt portfolio, in particular treasury bonds that were tradable on the Nigeria Stock Exchange (NSE) had the further advantage of developing of the bond market enabling the issuance of other tradable instruments by the private sector especially corporate bonds. The objective of the study and corresponding hypothesis were to examine the effect of government domestic debt on Domestic investment and that Gross domestic debt is negatively related to Private domestic investment respectively. Consequently the short run adjustment is presented as DLRGDD (0.96) indicating an almost complete adjustment one time period later. Obviously this is attributable to the interaction with other variables in the framework. The long-term relationship -.54GDD exhibits the expected sign indicative of an inverse relation between PSI and GDD from crowding out of PSI.

5.1.2 Private domestic investment and Gross domestic Savings

Gross domestic savings influenced positively investment dictated by the long-term finding of 0.62LRGDS. Savings is the second largest effect in the long-term equation that implies that as savings increase by a unit it increases investment by .62 percent. The short run dynamics point towards an adjustment of 23 percent every quarter towards equilibrium. The findings affirm the objective of establishing the effect of gross domestic savings on the Private domestic investment and confirm the hypothesis that gross domestic savings are positively related with Private domestic investment. Increases in GDP can in part explain savings increases. Rising deposits inspire financial intermediaries to place the funds with business firms at a price higher then the deposit rate or invest in financial assets such as treasury bill/bonds. This view is suggested by IMF (2001) cited in Abbas and Christensen (2007) that domestic debt provides an alternative investment avenue for savers and can lure back savings from the non-monetary sector into the formal financial system. Although Aghion et al., (2009) avers that domestic savings cannot help a country grow faster if it has access to international capital markets; this is disputed by the Vision 2030 that deliberately intends to target domestic savings to stimulate investment growth. Additionally the experiences of the 1997 Asian financial crisis brought out the fickle nature of short term international capital and the flight to quality particularly after the structural adjustment reforms that liberalised the capital accounts allowing for unrestricted movement of short term financing.

5.1.3 Private domestic investment and Money Supply

Money supply has the greatest effect on long-term Private domestic investment of .75 percent. Money supply as an increasing function of Private domestic investment presents an expected relationship from literature. In the short run .45 of disequilibrium is corrected every quarter by changes in investment. The estimated short run parameters are by and large lower then the long-term elasticity, consistent with expectations. Clearly the results confirm the objective of evaluating the effect of money supply on Private domestic investment and the hypothesis that money supply positively affects Private domestic investment that were advanced in chapter one. From the long run estimation a unitary change in money supply effected through either one or a combination of central bank lending, open market operations, quantitative easing, cash reserve ratio and liquidity ratio requirements results in a .75 percent change in Private domestic investment. This positive relation suggests that the outcome of loose money supply is to augment investment while tightening money supply will consequently lead to diminished Private domestic investment. Over the 13 year period (1996 โ€“ 2009), the Nigerian economy experienced several changes. Economic growth was affected, by internal and external factors (drought, donor freeze, post elections violence, global financial crisis) slowed down considerably but showed remarkable resilience to record overall gains. Monetary aggregates rose on the back of GDP growth, as the chart below depicts monetary supply grew faster then Private domestic investment.

5.1.4 Private domestic investment and Interest Rates

Regarding the fourth objective, the study sought to assess the effect of interest rates on Private domestic investment in Nigeria, given the hypothesis that interest rates are inversely related to Private domestic investment. These were established through the regression where the long run estimation was found to be -.04. The coefficient signing affirms the negativity of the relationship consistent with theory while the value of .04 reflects the amount that Private domestic investment changes due to a unitary change in the Treasury bill rate. Interest rate effect on Private domestic investment was found to have the weakest effect overall in the long-term equation, a result that was mirrored in the short run by an indicated finding of -1.15. According to Ngugi and Wambua, (2004), when the market faces an upward trend in lending rate reflecting increased demand for credit, financial intermediaries respond by increasing the deposit rate to mobilise more resources and meet the demands in the credit market. Other factors like the amount of liquidity in the financial sector intervene to moderate interest rates. It also depends on the diversity of financial asset portfolio for the depositors and the returns of other financial assets.

5.2 Conclusion

The results have shown that the hypothesis that changes in the monetary policy do not have a significant on investment is rejected. The hypothesis that changes in the bank rate do not significantly affect credit to the private sector is statistically rejected. The results also showed that the impact of the credit to the private sector on private investment is not statistically significant. Therefore, the null hypothesis that changes in the bank credit do not significantly affect private investment is statistically rejected. However, the variance decomposition results showed that the impact is economically significant. In conclusion, the study has shown that like most developing countries monetary policy has impact on private investment. The results imply that monetary policy through the use of the bank rate is important for private investment growth.

5.4 Recommendation

In light of the above findings, the paper recommends as follows:

  1. Expansionary monetary policy should be formulated that will reduce interest rate, encourage borrowings and savings. This will expand commercial banks and other credit granting financial institutions which will encourage real investment in the economy.
  2. The Central Bank of Nigeria should formulate policies that will enable deposit money banks provide loanable funds to the private sector at a low interest rate.

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