i
MONETARY POLICY APPLICATION AND ITS PERFORMANCE ON
NIGERIAN ECONOMY
(1990 – 2014)
BY
YUSUF ABDULKABIR ABIODUN
U12BA1044
A PROJECT SUBMITTED TO THE DEPARTMENT OF BUSINESS
ADMINISTRATION, FACULTY OF ADMINISTRATION
AHMADU BELLO UNIVERSITY, ZARIA-NIGERIA
IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE
AWARD OF BACHELOR OF SCIENCE (B.Sc.) DEGREE IN BUSINESS
ADMINISTRATION
AUGUST, 2016
ii
DECLARATION
I Yusuf Abdulkabir Abiodun hereby declare that this project work is the product of my own
independent research effort, undertaken under the supervision of Mohammad B. Hussaini in
partial fulfilment of B.Sc. Degree in Business Administration (Banking and Finance option)
and submitted to the Department of Business Administration, Ahmadu Bello University Zaria.
The information derived from the literature has been duly acknowledged in the text and list of
references provided. To the best of my knowledge, this project was not previously presented
for another Degree or Diploma.
YUSUF ABDULKABIR ABIODUN -------------------------------
RESEARCHER SIGNATURE AND DATE
iii
CERTIFICATION
This is to certify that this project work was originally carried out by Yusuf Abdulkabir
Abiodun, a student in the department of Business Administration (Banking and Finance option)
with Registration number U12BA1044, Ahmadu Bello University Zaria, Nigeria.
MUHAMMAD B. HUSSAINI ------------------------------
MY PROJECT SUPERVISOR SIGNATURE & DATE
MAL. YAZEED MOHAMMAD --------------------------------
PROJECT CORDINATOR SIGNATURE & DATE
PROF. BELLO SABO ---------------------------------
HEAD OF DEPARTMENT SIGNATURE & DATE
iv
DEDICATION
This project is dedicated to the best mother in the world ‘‘Amisu Ismat Amope’’ (Iya ni
wura) and to my entire family.
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AKNOWLEDGEMENT
My utmost gratitude to the Almighty, for His Grace and Mercy on me in leading me through
in this part of journey of life.
And to my Sweet Mother, you have really proven to me your worthiness; with your kindness,
love, care, prayers and financial support in my life. No wonder why the Yoruba say “Mother
is Gold’’. You are indeed a blessing to me.
To my supervisor Muhammad B Hussaini, despite other commitment, you still created time for
me in reading through, correcting and guiding me in this project work. I appreciate your effort.
To all my lecturers, I thank you all for you contribution and the knowledge you impacted in
me in various courses.
My blood brother Mr. Yusuf Afeez Oladapo (Big Bro), your contribution to this project work
is not small at all. Thanks for your words of encouragement and academic advice. I also thank
my friends; Mr. Afolabi Abdulmajid (Afodapsy), Mr. Aliyu Yusuf (Ojeje one), Mr. Sodeeq
Abdul Muttalib (MD), Mr. Aliyu Haliyu and others. They have really contributed to my stay
in school.
I’m forever grateful to a brother Mr. Yusuf Oyedeko, for taking his time and effort in advising,
guiding, correcting and his words of encouragement regarding my study and this project work.
Lastly, to my friends, loved ones and all my family members who have in one way or the other
contributed to the success of my program, I express my gratitude to you all.
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TABLE OF CONTENTS
Title page i
Certification ii
Dedication iii
Acknowledgement iv
Table of contents v
Abstract viii
CHAPTER ONE: INTRODUCTION
1.1 Background of the study ---------- ---------------------------------------------------------- 1
1.2 Statement of the problem --------- ---------------------------------------------------------- 3
1.3 Research questions ------- ------------------------------------------------------------------- 4
1.4 Objective of the study ---- ------------------ ------------------------------------------------- 5
1.5 Research hypotheses ----- ------------------------------------------------------------------- 5
1.6 Significance of the study --------- ---------------------------------------------------------- 5
1.7 Scope and limitation of the study ---------------------------------------------------------- 5
1.8 Definition of related terms ---------------- ------------------------------------------------- 6
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction ------ ---------------------------------------------------------------------------- 8
2.2 Conceptualization of Monetary Policy -- ------------------------------------------------- 8
2.2.1 Instruments of Monetary Policy -------- ------------------------------------------------- 9
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2. 3 Theoretical Framework - ------------------------------------------------------------------- 12
2.3.1 Monetary Policy Framework and Implementation in Nigeria - ---------------------- 14
2.4 Review of Empirical Studies ----- ---------------------------------------------------------- 19
2.4.1 An appraisal of the performance of monetary policy in Nigeria ------- ------------- 26
2.4.2 Strategies of Monetary Policy in Nigeria ------ ---------------------------------------- 30
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Introduction ------ ----------------------------------------------------------------------------- 33
3.2 Research Design ---------------------------- -------------------------------------------------- 33
3.3 Method of Data collection ------------------------------------------------------------------- 33
3.4 Method of Data Analysis -------------------------------------------------------------------- 33
3.5 Model specification -------------------------------------------------------------------------- 34
3.6 Measurement of Variables ------- ---------------------------------------------------------- 35
3.7 Method of evaluation ------------------------------------------------------------------------ 35
CHAPTER FOUR: DATA PRESENTATION, ANALYSIS AND INTERPRETATION
4.1 Introduction ------ ---------------------------------------------------------------------------- 39
4.2 Data Presentation ---------------------------------------------------------------------------- 39
4.3 Result Presentation ---------------- ---------------------------------------------------------- 41
4.4 Test of Hypothesis -------- ------------------------------------------------------------------- 50
4.5 Discussion of Findings --- ------------------------------------------------------------------- 50
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CHAPTER FIVE: SUMMARY, CONCLUSION, AND RECOMMENDATIONS
5.1 Summary of Findings ------------------------------------------------------------------------52
5.2 Recommendation ---------------------------------------------------------------------------- 53
5.3 Conclusion ------------------------------------------------------------------------------------ 53
References ---------------------------------------------------------------------------------------- 55
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Abstract
This study examine the performance of monetary policy on the economic growth of Nigeria
from 1990 to 2014. Knowing that CBN used many instruments of monetary policy to regulate
Nigerian economy, this study only focused on three instruments (money supply, monetary
policy rate and exchange rate) in relation with gross domestic product (GDP). Relevant data
were collected from the CBN and these data were subjected to various statistical and
econometric test using Ordinary Least Square method (OLS) and E-view statistical package.
The result showed that money supply (MS) was positively related and statistically significant
to GDP. Monetary policy rate (MPR) was found to be positively related but highly statistically
insignificant. Exchange rate result on the other hand, showed that exchange rate was
negatively related and statistically insignificant to GDP.
The result of the overall significance (F-statistic test) showed that monetary policy had a
positive impact on Nigerian economic growth. In conclusion, the study shows that monetary
policy exerts significant impact on the level of economic growth in Nigeria. It is recommended
that the monetary authorities should exercise influence that would affect the behaviour of
monetary aggregates, inflation, monetary policy rate, bank credit, among others, in the overall
liquidity of the economy.
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CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Achieving pro-poor and long term sustainable economic growth and development has
long been emphasized as a major macroeconomic objective of every nation of the world.
The course of attaining this goal however depends, among other things, on the
establishment and the responsibility of the financial sector regulator of each country. The
Central Bank of Nigeria (CBN) since its establishment in 1959, has continued to play the
traditional role expected of a central bank, which is the regulation of the stock of money
in such a way as to promote the social welfare (Ajayi, 1999). This role is anchored on the
use of monetary policy that is usually targeted towards the achievement of full-
employment equilibrium, rapid economic growth, price stability, and external balance
(Fasanya et al, 2013; Adesoye et al, 2012).
This action of the monetary authority is usually carried out by changing the volume of
money in circulation and the interest rate. It is not an exaggeration that the importance of
money in economic life has made policy makers and other relevant stakeholders to accord
special recognition to the conduct of monetary policy. This policy application could
either be expansionary or contractionary at any given time depending on the monetary
authorities.
Monetary policy as a technique of economic management to bring about sustainable
economic growth and development has been the pursuit of nations and formal articulation
of how money affects economic aggregates dates back to the time of Adams Smith and
later championed by the monetary economists. Since the expositions of the role of
monetary policy in influencing macroeconomic objectives like economic growth, price
stability, equilibrium in balance of payments and host of other objectives, monetary
authorities are saddled with the responsibility of using monetary policy to grow their
economies.
This role has facilitated the emergence of active money market where treasury bills, a
financial instrument used for open market operations and raising debt for government,
has grown in volume and value becoming a prominent earning asset for investors and
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source of balancing liquidity in the economy. There have been various regimes of
monetary policy in Nigeria. Sometimes, monetary policy is tight and at other times it is
loose, mostly used to stabilize prices. Monetary and fiscal policies are the two most
important macroeconomic tools to achieve high employment rates, price stability and
overall economic growth. An important issue that has exercised the minds of
macroeconomists is the understanding of how the dependence, independence and
interdependencies between monetary and fiscal policies could lead the economy closer
or further away from set goals and targets. In a poorly co-coordinated macroeconomic
environment, fiscal policies might affect the chances of success of monetary policies in
various ways, such as: its eroding impact on the general confidence and efficacy of
monetary policy, through its short-run effects on aggregate demand, and by modifying
the long-term conditions for economic growth and low inflation. On the other hand,
monetary policies may be accommodative or counteractive to fiscal policies, depending
on the prevailing political and economic paradigms.
Monetary policy is one of the macroeconomic instruments with which monetary
authority in a country employs in the management of their economy to attain desired
objectives. It entails those actions initiated by the Central Bank which aim at influencing
the cost and availability of credits (Nwankwo, 1991 and Wrightsman 1976). For most
economies, the fundamental objectives of monetary policy include price stability,
maintenance of balance of payments equilibrium, and promotion of employment, output
growth and sustainable development. These objectives are necessary for the attainment
of internal and external balance of value of money and promotion of long run economic
growth. Ajisafe and Folorunso (2002) noted that the objectives of monetary policy
include increase in Gross Domestic Product growth rate, reduction in the rates of inflation
and unemployment, improvement in the balance of payments, accumulation of financial
savings and external reserves as well as stability in Naira exchange rate, the policy as
well as instruments applied to attain these objectives, however, have until recently been
far from adequate. Economic development is one of the major objectives of many
countries in the world and economic growth is fundamental to economic development.
The economy has also witnessed times of expansion and contraction but evidently, the
reported growth has not been a sustainable one as there is evidence of decline in
manufacturing output which is the main engine of growth according to Kaldor’s first law
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and the growing poverty among the populace. Monetary policy is one of the
macroeconomic instruments with which nations (including Nigeria) do manage their
economies (Ajie and Nenbe, 2010). According to Ubi, Lionel and Eyo (2012), monetary
policy is an aspect of macroeconomics which deals with the use of monetary instruments
designed to regulate the value, supply and cost of money in an economy, in line with the
expected level of economic activity. It covers gamut of measures or combination of
packages intended to influence or regulate the volume, prices as well as direction of
money in the economy per unit of time. Specifically, it permeates all the debonair efforts
by the monetary authorites to control the money supply and credits conditions for the
purpose of achieving diverse macroeconomic objectives. Actually, monetary policy
attempts to achieve a set of objectives that are expressed in terms of macroeconomic
variables, such as inflation, real output and unemployment.
Today, monetary and fiscal policies are both commonly accorded prominent roles in the
pursuit of macroeconomic stabilization in developing countries, but the relative
importance of these policies has been a serious debate between the Keynesians and the
monetarists. The monetarists believe that monetary policy exert greater impact on
economic activity while the Keynesian believe that fiscal policy rather than the monetary
policy exert greater influence on economic activity. Despite their demonstrated efficacy
in other economies as policies that exert influence on economic activities, both policies
have not been sufficiently or adequately used in Nigeria (Ajisafe and Folorunsho, 2002).
The objective of this paper is to review the practice of monetary policy in Nigeria. In
spite of many, and frequently changing, monetary and other macro-economic policies,
Nigeria has not been able to harness her economic potentials for rapid economic
development (Ogbole, 2010). These policies span through two broad periods, which can
be classified as “regulation” and “deregulation”. Our main focus is the differential in
monetary policy effectiveness in promoting economic growth in Nigeria.
1.2 STATEMENT OF THE PROBLEM
Monetary policy is known to be a vital instrument that a country can deploy for the
maintenance of domestic price and exchange rate stability, as a critical condition for the
achievement of a sustainable economic growth and external viability”(Amasomma et al,
2011). On a yearly basis, the monetary authority formulate guidelines geared towards the
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enhancement and development of policy variable designed to ensure optimal
performance of the banking industry and ultimately to achieve the macroeconomic goals
or objectives but in the implementation of such policy variable certain conflicting issues
are to be addressed ranging from the ability to comply with various monetary policy
guidelines as well as satisfying depositors and shareholders (Chimezie, 2012). Central
bank of Nigeria uses various instruments to achieve its stated objective and these include:
open market operation (OMO), required reserve ratio (RRR), bank rate, liquidity ratio,
selective credit control and moral suasion. There have been various regimes of monetary
policy in Nigeria. Sometimes, monetary policy is tight and at other times it is loose,
mostly used to stabilize prices. The economy has also witnessed times of expansion and
contraction but evidently, the reported growth has not been a sustainable one as there is
evidence of growing poverty among the populace. Vast researches have been conducted
on the monetary policy measures and its impact on the Nigerian economy. Vast
researches have been done on the nature of monetary policy and the economic growth
for years, most of the studies considered monetary policy impact on the development of
economy in both the developed and developing countries using various methodology and
variables to capture monetary policy instruments with variation in the duration of periods.
However, recent literatures have justified the need to jointly take into consideration
monetary policy and economic growth in an economic model and economic techniques
for unbiased result. Based on these divergent findings the researcher considers this area
of interest and re-examine the dynamic impact of monetary policy application on the
Nigerian economic growth using multiple regression and time series data from 1990 to
2014.
1.3 RESEARCH QUESTIONS
To examine the relationship between monetary policy instruments and the Nigerian
economic growth, the following research questions would be useful to aid the study:
(i) What impact does money supply has on the Nigerian economic growth?
(ii) What impact does monetary policy rate has on the Nigerian economic growth?
(iii) Is there any relationship between the exchange rate and Nigerian GDP?
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1.4 OBJECTIVES OF THE STUDY
The overall objective of this study is to analyse the impact of monetary policy instruments
on Nigerian economic growth. However the specific objectives of the study are:
(i) To examine the impact of money supply on the Nigerian economic growth.
(ii) To assess the impact of monetary policy rate on the Nigerian economic growth.
(iii) To ascertain the effect of exchange rate on Nigerian GDP.
1.5 RESEARCH HYPOTHESES
H01: Money supply has no significant impact on the Nigerian economic growth
H02: Monetary policy rate has no significant impact on the Nigerian economic growth.
H03: Exchange rate has no significant impact on the growth of Nigeria economy.
1.6 SIGNIFICANCE OF THE STUDY
From the empirical point of view, the importance of this study is to examine the
performance of monetary policy on the Nigeria economy. This study will be of immense
benefits and veritable tool for the government of the country, business man, company’s
holders, students, academic independent researchers and others who are interested in the
policies related issues. The study will serve as a criterion for determining the extent to
which the policy implementation is good for the economic growth of Nigeria. It would
also contribute to the existing literature on the subject matter by investigating empirically
the causation of monetary policy and economic growth in Nigeria. This study will also
enable Nigerians to know the impacts of monetary policy instruments on the Nigeria
economy whether is positives impact or negatives on the economic growth of the country.
1.7 SCOPE AND LIMITATION OF THE STUDY
The scope of this study shall be restricted only to the relationship between monetary policy
instruments proxy (money supply, monetary policy rate and exchange rate) and the
economic growth proxy (GDP). The study is limited to 25 years annual observations
ranging from 1990 to 2014. The monetary policy instruments are limited to these variables
because the accessibility of data on tax revenue generated by federal government is a bit
challenging. Data would be sourced from the CBN statistical bulletin and data used would
be only secondary data.
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1.8 DEFINITION OF KEY TERMS
Monetary Policy: It is a government policy which regulates the supply of money and
the cost and availability of credit in the economy.
Fiscal policy: It is government policy that is designed to achieve the objective of price
stability, growth, balance of payments equilibrium, full employment, mobilization of
resources and investment.
Economic Growth: Economic growth represents the expansion of a country’s potential
GDP or output.
Minimum Rediscount Rate (MRR): This was the former anchor policy interest rate of
the CBN. It reflected long-term interest rate and was indicative of the direction of policy
on interest rates structure.
Monetary Policy Rate (MPR): When interest rates were insensitive to changes in MRR,
the MPR which is a short term anchor rate replaced the MRR in December, 2006. It is
designed to influence short term money market rate and promote policy efficiency.
Policy: Guidelines or set of decisions for achieving some objectives or solving problems.
Economic Growth: Increase in a country’s productive capacity, as measured by
comparing gross national product (GNP) in a year with GNP of the previous year.
Gross National Product: GDP of a country to which income from abroad remittance of
nationals living outside and income from foreign subsidiaries of local firms has been
added.
Gross Domestic Product (GDP): This is the total output of goods and services in a
country measured through market prices. It is therefore the summation of the production
of goods and services of all residents in a country within a year.
Money Supply: Population’s spending power represented by the quantity of liquid assets
(usually cash) in an economy that can be exchanged for goods and services.
Liquidity Ratio: The ratio of liquid assets (usually cash) that banks are to remain in their
vault to be able to meet the needs and demands of cash by the depositors.
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Exchange Rate: The rate or the price for which the currency of a country can be
exchanged for another currency.
Interest Rate: the rate at which the central bank is ready to give loan to the commercial
banks when they are in need of liquid cash.
Inflation: A sustained, rapid increase in price of goods and services in an economy as a
result of too much of money circulating in the economy chasing few goods.
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CHAPTER TWO
LITERATURE REVIEW
2.1 INTRODUCTION
This chapter of the study focus of the conceptualization of monetary policy, the
theoretical framework, the review of some empirical studies and the appraisal of the
performance of monetary policy in Nigeria.
2.2 CONCEPTUALISATION OF MONETARY POLICY
Monetary policy is concerned with discretionary control of money supply by the
monetary authorities (Central Bank with Central Government) in order to achieve stated
or desired economic goals. Governments try to control the money supply because most
governments believe that its rate of growth has an effect on the rate of inflation. Hence
monetary policy comprises those government actions designed to influence the behaviour
of the monetary sector. Nigeria’s monetary policy is anchored on the monetary targeting
framework and price stability which represents the overriding objectives of monetary
policies.
Monetary policy is therefore defined as a policy employed by the central bank in
controlling the money supply as an instrument for achieving the objectives of
macroeconomic policy. It is therefore a combination of the measure designed to regulate
the value, supply and cost of money in the economy in consonance with the expected level
of economic activities (Central Bank of Nigeria, 1995).
Monetary Policy is the deliberate use of monetary instruments (direct and indirect) at the
disposal of monetary authorities such as central bank in order to achieve macroeconomic
stability. Monetary policy is essentially a programme of action undertaken by the monetary
authorities, generally the central bank, to control and regulate the supply of money with
the public and the flow of credit with a view to achieving predetermined macroeconomic
goals (Dwivedi, 2005).
Monetary policy consists of a Government’s formal efforts to manage the money in its
economy in order to realize specific economic goals. Three basic kinds of monetary policy
decisions can be made about:
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a) The amount of money in circulation;
b) The level of interest rate
c) The functions of credit markets and the banking system (Ogunjimi, 1997).
The combination of these measures is designed to regulate the value, supply and cost of
money in an economy, in line with the level of economic activity. Excess supply of money
will result in an excess demand for goods and services, prices will rise and balance of
payments will deteriorate.
The challenges of monetary policy management rest wholly on monetary authorities which
have over the years been committed to its effective control. The performance of monetary
policy has improved greatly in recent times- inflation has remained at moderate levels
accompanied by high growth of domestic output (Bolarinwa, Kehinde and Abata, 2012).
To sustain the efforts, there is need for appropriate collaboration with the fiscal authorities
as well as the development of confidence in inter-bank market and the necessary financial
market infrastructure is still relevant.
Monetary policy requires the establishment of a relationship between monetary
instruments, which the authority controls the key target of the policy objectives. Money
supply is therefore the centerpiece of monetary tools and intermediate target of monetary
policy.
Okwu, et al, (2011) stress as well that monetary policy is undoubtedly a veritable tool to
be employed in macroeconomic management and for achieving stability of the financial
system. It implies therefore that in Nigeria like any economies of the world, the primary
objective of monetary policy should be on how to realize a stable and non-inflationary
growth rate of the economy.
2.2.1 INSTRUMENTS OF MONETARY POLICY
To conduct monetary policy effectively, the central bank adjusts the monetary
aggregates, the policy rate or the exchange rate in order to affect the variables which it
does not control directly. The instruments of monetary policy used by the central bank
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depend on the level of development of the economy, especially the financial sector. These
instruments could be direct or indirect.
A. Direct Instruments of Monetary Policy
Direct Instruments of monetary policy are directives given by the central bank to control
the quantity and prices of financial assets/liabilities of deposit money banks (DMBs) and
discount houses.
The central bank can direct Deposit Money Banks on the maximum percentage or amount
of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid
asset ratio and issue credit guarantee to preferred loans. In this way the available savings is
allocated and investment directed in particular directions as desired by the authorities.
B. Indirect Instruments of Monetary Policy
Indirect Instruments of monetary policy involve controlling the price or quantity of base
money. These instruments are discussed below;
i. Reserve Requirements
This instrument is used by the central bank to influence the level of bank reserves and
hence, their ability to grant loans. Reserve requirements are lowered in order to free
reserves for banks to grant loans and thereby increase money supply in the economy. On
the other hand, they are raised in order to reduce the capacity of banks to provide loans
thereby reducing money supply in the economy.
ii. Open Market Operations (OMO)
The most important and flexible tool of monetary policy is open market operations. It is the
buying and selling of government securities in the open market (primary or secondary) in
order to expand or contract the amount of money in the banking system. By purchasing
securities, the central bank injects money into the banking system and stimulates growth
whereas by selling securities it absorbs excess money. Thus, if there is excess liquidity in
the system, the central bank will in a bid to reduce the money supply sell the government
securities such as Treasury Bills. On the other hand, in periods of liquidity shortages, the
central bank buys government securities so as to increase money supply. Instruments
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commonly used for this purpose include treasury bills, central bank bills, or prime
commercial paper.
OMO enables the central bank to influence the cost and availability of reserves and bring
about desired changes in bank credit and money supply. This important instrument of
monetary policy has a number of advantages because it is flexible and precise, it is
implemented quickly and easily reversed and the central bank has complete control. The
effectiveness of OMO, however, depends on the existence of well-developed financial
markets that are sensitive to interest rate movements.
iii. Discount Window Operations
This instrument is a facility provided by the central bank which enables the DMBs to
borrow reserves against collaterals in form of government or other acceptable securities.
The central bank operates this facility in accordance with its role as lender of last resort and
transactions are conducted in form of short term (usually overnight) loans. The central bank
lends to financially sound DMBs at the policy rate. This rate sets the floor for the interest
rate regime in the money market (the nominal anchor rate) and thereby affects the supply
of credit, the supply of savings (which affects the supply of reserves and monetary
aggregate) and the supply of investment (which affects employment and GDP).
C. Other Instruments
iv. Exchange Rate
The balance of payments can be in deficit or in surplus and this can affect the monetary
base, hence the money supply, in one direction or the other. By selling or buying foreign
exchange, the central bank ensures that the exchange rate is at an optimal level. The real
exchange rate when misaligned affects the current account balance because of its impact
on external competitiveness.
v. Prudential Guidelines
The central bank may require DMBs to exercise particular care in their credit operations in
order to achieve specified outcomes. Key elements of prudential guidelines remove some
discretion from bank management and replace them with rules.
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vi. Moral Suasion
The central bank issues licenses to DMBs and regulates the operation of the banking
system. Thus, it can persuade banks to follow certain policies such as credit restraint or
expansion, increase savings mobilization and promote exports through financial support,
which otherwise they may not do, on the basis of their risk/return assessment.
2.3. THEORETICAL LITERATURE
Monetary theory has undergone a vast and complex evolution since the study of the
economic phenomenon first came into limelight. It has drawn the attention of many
researchers with different views on the role and dimensions of money in attaining macro-
economic objectives.
Consequently, there are quite a number of studies aimed at establishing relationship
between monetary policy and other economic aggregates such as inflation and output.
In this chapter we will take a look at the different schools of thought, their views of
money in attaining policy objectives alongside are view the necessary literature relating
to this study.
I. THE CLASSICAL MONETARY THEORY
The classical school evolved through concerted efforts and contribution of economists
like Jean Baptist Say, Adam Smith, David Ricardo, Pigou and others who shared the
same beliefs. The classical model attempts to explain the determination, savings and
investment with respect to money. The classical model on say’s law markets which states
that “supply creates its own demand”. Thus classical economists believe that the
economy automatically tends towards full employment level by laying emphasis on price
level and on how best to eliminate inflation .The classical economists decided upon the
quantity theory of money as the determinant of the general price level. Theory shows
how money affects the economy. It may be considered in terms of the equation of
Exchange.
MV= PY
Two very similar quantity theory formulations were used to explain the level of price viz;
the transactions formulation or the Cambridge equation.
In the transaction version – associated with Fisher and Newcomb, some assumptions
were made: that the quantity of money (m) is determined independently of other variable,
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velocity of circulation (V) is taken as constant, the volume of transactions (T) is also
considered constant.
Thus of price (p) and the assumption of full employment of the economy, the equation
of exchange is given as;
MV = PT, which can readily establish the production that – the level of price is a function
of the supply of money. That is, p= F (m) which implies that, any change in price changes
money supply. In cash balances version – associated with Walras, Marshell, Wicksell
and pigou, the neoclassical school (Cambridge school), changed the focus of the quantity
theory of without changing its underlying assumptions. This version focuses on the
fraction (K) of income, held as money balances. The Cambridge version can be expressed
as:
M= kpy
Where K= Fraction of income, M =Quantity of money, P= price level, Y=value of goods
and services. The K in the Cambridge equation is merely inversion of V, the income
Velocity of money balances, in the original formulation of quantity theory. This version
directs attention to the determinants of demand for money, rather than the effects of
changes in the supply money (Anyanwu, 1993).
II. KEYNESIAN THEORY
The Keynesian model assumes a close economy and a perfect competitive market with
fairly price- interest aggregate supply function. The economy is also assumed not to exist
at employment equilibrium and also that it works only in the short run because as Keynes
aptly puts it ‘’ In the long run, we also will be dead’’. The Keynesian theory is rooted on
one notion of price rigidity and possibility of an economy setting at a less than full
employment level of output, income and employment. The Keynesian macro economy
brought into focus the issue of output rather than prices as being responsible for changing
economic conditions. In other records, they were not interested in the quantity theory per
say.
From the Keynesian in the mechanism, monetary policy works by influencing interest
rate which influences investment decisions and consequently, output and income via the
multiplies process. Thus, the Keynesian theory is a rejection of Say's Law and the notion
that the economy is self-regulating.
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III. THE MONETARIST THEORY
The monetarist essentially adopted Fisher’s equation of exchange to illustrate their theory
as a theory of demand for money and not a theory of output price and money income by
making a functional relationship between the quantities of real balances demanded and a
limited number of variables.
Monetarists like Friedman emphasized money supply as the key factor affecting the
wellbeing of the economy. Thus, in order to promote steady growth rate, the money
supply should grow at a fixed rate, instead of being regulated and altered by the monetary
authorities.
Friedman equally argued that since money supply is substitutive not just for bonds but
also for many goods and services, changes in money supply will therefore have both
direct and indirect effects on spending and investment respectively such that demand for
money will depend upon the relative rates of return available or different competing
assets in which wealth can be.
2.3.1 MONETARY POLICY FRAMEWORK AND IMPLEMENTATION IN NIGERIA
Prior to the banking sector consolidation exercise that was concluded in December 2005,
the framework for monetary policy in Nigeria had witnessed some transformation. This
included the shift from the use of direct monetary policy control to indirect (market-based)
monetary management, and the switch from short-term framework to a two-year medium-
term framework in the conduct of monetary policy. Although the objectives of monetary
policy remained basically the same and monetary aggregates remained the intermediate
target for achieving the ultimate objective of inflation during this period, there were some
fundamental changes in the strategies and instruments employed in the conduct of monetary
policy in order to cope with the evolving financial environment. These changes are phased
as shown below (CBN 2011).
i. Era of Direct Control (Pre-SAP Period)
Prior to the introduction of the Structural Adjustment Programme (SAP) in the mid-1980s,
the monetary policy framework placed emphasis on direct monetary controls. This was
essentially due to the relatively underdeveloped nature of money and capital markets in the
24
country then. The framework relied heavily on sectoral credit allocation; credit ceilings and
cash reserve requirements; administrative fixing of interest and exchange rates; as well as
imposition of special deposits. During this period the set monetary targets were hardly
realized. Instead, the strategy created a lot of distortions and bottlenecks in resource
allocation, resulting in wide spread inefficiencies in resource allocation and utilization.
ii. Period of Indirect or Market Approach (Post-SAP Era)
In line economic deregulation embodied by SAP, there was a paradigm shift from the
hitherto repressive direct monetary control method to an indirect approach anchored on the
use of market instruments in monetary management. This was borne out of the desire to
eliminate the distortions and inefficiencies in the financial system caused by the prolonged
use of administrative controls and the need to engender competition among banks and other
operators in the financial system. Two major policy regimes of short- and medium-term
frameworks can be identified.
iii. Regime of Short-Term Monetary Policy Framework (1986 – 2001)
Consistent with the broad objectives of monetary policy, a number of monetary targets and
instruments were adopted during the short-term (one-year) monetary policy framework
(1986 – 2001). OMO, conducted wholly using the Nigerian Treasury Bills (NTBs),
continued to be the primary instrument of monetary policy. This was complemented by the
cash reserve requirement (CRR) and the liquidity ratio (LR). Other policy instruments
employed included the discount window operations, mandatory sales of special NTBs to
banks and a requirement of 200 per cent treasury instrument to cover for banks’ foreign
exchange demand at the Autonomous Foreign Exchange Market (AFEM). Interest rate
policy was deregulated through the proactive adjustment of minimum rediscount rate
(MRR) to signal policy direction consistent with liquidity conditions. Surveillance
activities of the CBN focused mainly on ensuring sound management and maintenance of
a healthy balance sheet position on the part of deposit money banks (DMBs). On the
external front, the official and inter-bank exchange rates were unified in 1999.
In spite of the reforms in the articulation and execution of monetary policy during this
period, most of the monetary and financial targets were substantially missed. As can be
observed from Table 1, the actual growth rates in broad measure of money supply (M2) and
aggregate bank credit for the years, 1999 – 2001, were higher than the targets by wide
25
margins. Although, inflation performed better in two of the three years, aggregate output
was sluggish during the period. The major problem could be attributed to the expansionary
fiscal policies of the three tiers of government and the resultant liquidity overhang, as well
as lack of coordination of monetary and fiscal policy implementation.
iv. Regime of Medium-Term Monetary Policy Framework (2002 – 2005)
In 2002, the CBN commenced a two-year medium-term monetary policy framework, aimed
at freeing monetary policy from the problem of time inconsistency and minimizing over-
reaction due to temporary shocks. The new monetary policy framework, still in operation,
is based on the evidence that monetary policy actions affect the ultimate objectives with a
substantial lag. Under the new framework, monetary policy guidelines are open to half-
yearly review in the light of developments in monetary and financial market conditions in
order to achieve medium- to long-term goals.
The major objectives of monetary policy since the 2002/2003 period have been to subdue
inflation to a single-digit level and maintain a stable exchange rate of the naira. Attention
has also been focused on the need for a more competitive financial sector geared towards
improving the payments system. The OMO has continued to be the primary tool of
monetary policy, and is complemented by reserve requirements, discount window
operations, foreign exchange market intervention and movement of public sector deposits
in and out of the DMBs. The CBN has also continued to ensure banking soundness and
financial sector stability, not only to ensure the effective transmission of monetary policy
to the real sector but also to enhance the efficiency of the payments system.
The measures taken to strengthen the banking sector and consolidate the gains of monetary
policy included the introduction of a 13-point reform agenda in the banking sector in July
2004 (the key point of which was the N25 billion minimum capital base for DMBs). The
2004/2005 monetary policy and credit guidelines were fine-tuned in 2005 in the light of
changing environment. New policy measures introduced included maintenance of a tight
exchange rate band of plus/minus 3 per cent, two-week maintenance period of cash reserve
requirement and the injection/withdrawal of public sector deposits from the DMBs. The
various measures put in place, complemented by improved fiscal discipline at the federal
government level, impacted positively on the monetary aggregates in 2004 and 2005,
resulting in achievement of set targets during the period. The CBN was able to achieve the
26
targets by being pro-active in the implementation of sound monetary policies, including
zero tolerance on government borrowing from the CBN.
v. Monetary Policy, Post-Banking Consolidation (2006-2007)
Two key features have defined the monetary policy landscape in the post consolidation
period, 2006/07: persistence of excess liquidity despite reversal of historic conditions, for
example, ways and means and emergence of a new but very important source of excess
liquidity -increased private inflows. The objectives of monetary policy during this period
have however remained unchanged. Current monetary policy strategy involves (amongst
others):
a) Zero tolerance on ways and means advances
b) Gradual run-down of CBN holding of TBs
c) Aggressive liquidity mop-up operations-frequent OMO sales supported by discount
window operations
d) Unremunerated reserve requirements
e) Increased coordination between the Bank and the fiscal authorities
f) Restructuring of debt instruments into longer tenor debts
g) Increased deregulation of forex market, and
h) Occasional forex swap
The strategy is complimented by on-going reforms of monetary policy in particular and the
financial system in general.
The reform of the financial system, a key component of which was bank consolidation, was
intended to minimize macroeconomic instability arising from banking systemic distress;
motivate intermediation through the deepening of the capital market; finance productive
sector growth in the private sector, particularly non-oil growth; minimize the counterfactual
shocks of creating distortions in the money markets and the financial system; encourage
investment inflows through effective participation of the industry in the global financial
system, among others. As a direct consequence of the exercise the capital base of Nigerian
banks (combined) increased from about US$2.5 billion in June 2004 to about US$5.8
billion at end-December 2005. This has been accompanied by rising inflow of foreign
investment in the sector till date. Virtually all the banks have been listed in the Nigerian
Stock Exchange (NSE) with the capital market becoming more liquid and more capitalized.
27
The banks now have the potential to finance big investment transactions as their single
obligor limits have increased, while regulation and supervision have become more effective
given that ownership has been diluted with more regulators having the legal authority to
oversee them. The CBN now focuses on a fewer number of banks. This has raised
efficiency of supervision resulting in zero tolerance towards infractions and improved
corporate governance. Greater transparency is being enforced and the deployment of IT
infrastructure (eFASS and RTGS) has significantly helped the process.
28
2.4.0 REVIEW OF EMPIRICAL STUDIES
Studies have been carried out by many researchers, financial analysts and practitioners
on the topic related to monetary policy application and its performance on Nigeria
economy. This aspect of the study has discussed some such previous research works and
their empirical conclusions that are related to the study.
I. Monetary Rather than Fiscal Policy Exerts a Greater Impact an Economic Activity
in Nigeria
Ajisafe and Folorunso (2002), examined the relative effectiveness of monetary and fiscal
policy on economic activity in Nigeria using co-integration and error correction
modelling techniques and annual series for the period 1970 to 1998. The study revealed
that monetary rather than fiscal policy exerts a greater impact on economic activity in
Nigeria and concluded that emphasis on fiscal action by the government has led to greater
distortion in the Nigerian economy.
II. Effects of Monetary Policy Shocks on Output and Prices in Nigeria
Chuku A (2009), In his paper, he carried out a controlled experiment using a structural
vector autoregression (SVAR) model to trace the effects of monetary policy shocks on
output and prices in Nigeria. We make the assumption that the Central Bank cannot
observe unexpected changes in output and prices within the same period. This places a
recursive restriction on the disturbances of the SVAR. We conduct the experiment using
three alternative policy instruments i.e. broad money (M2), Minimum Rediscount Rate
(MRR) and the real effective exchange rate (REER). Overall, we find evidence that
monetary policy innovations carried out on the quantity-based nominal anchor (M2) has
modest effects on output and prices with a very fast speed of adjustment. While,
innovations on the price-based nominal anchors (MRR and REER) have neutral and
fleeting effects on output. We conclude that the manipulation of the quantity of money
(M2) in the economy is the most influential instrument for monetary policy
implementation. Hence, we recommend that central bankers should place more emphasis
on the use of the quantity-based nominal anchor rather than the price-based nominal
anchors.
29
III. The Impact of Monetary and Fiscal Policies on Non-Oil Exports in Nigeria
Chukuigwe (2008), analyzed the impact of monetary and fiscal policies on non-oil
exports in Nigeria from 1974 to 2003. Using Ordinary Least Squares estimation, the
study revealed that both interest rate and exchange rate, being proxies for monetary
policy, negatively affect non-oil exports. Budget deficits – proxy for fiscal policy also
had a negative effect on non-oil exports. Based on the findings, the study recommended
that there is need to formulate a new strategy to address the identified challenges. This
would be anchored on macroeconomic stability, export promotion, rationalization of the
role of government, fortification of infrastructural facilities and stimulation of demand
for goods and services since it would create an enabling investment climate.
IV. The Relationship between Monetary Policy and Stock Prices in the Nigerian Stock
Exchange Market (NSE)
Ajie and Nenbee (2010), investigated empirically the relationship between monetary
policy and stock prices in the Nigerian stock exchange market (NSE). We employed time
series data on money supply (MSU), interest (RA) and stock prices (SPR) spanning
(1986-2008). This period was considered due to the liberalization of the financial sector.
Using the method of co-integration and Error correction modeling (ECM), the study
revealed that both MSU and IRA were rightly signed with SPR. Again, the error
correction coefficient was relatively high, rightly signed and significant at 5% level. It is
suggested that the SEC should be given enabling environment to monitor the activities
of the market operators to bread efficiency. Above all, the monetary authorizes should
formulate policies that will reduce the rising pace of inflation to encourage availability
of investible funds for investors.
V. Impact of Monetary and Fiscal Policies on Economic Growth
Karimi and Khosravi (2010), investigated the impact of monetary and fiscal policies on
economic growth in Iran using autoregressive distributed approach to co-integration
between 1960 and 2006. The empirical results indicated existence of long-run
relationship between economic growth, monetary policy and fiscal policy. The results
further showed exchange rate and inflation as proxies for monetary policy have inverse
impact on economic growth.
30
VI. Impact of Monetary Policy Instruments on the Economic Development of Nigeria
Akujuobi (2010), investigated the impact of monetary policy instruments on the
economic development of Nigeria, using multiple regression technique. It was found that
cash reserve ratio was significant in impacting on the economic development of Nigeria
at both 1% and 5% levels of significance, Treasury bill at 5.6%, minimum rediscount rate
at 7.4% and liquidity rate at 7.7%, while interest rate was not significant at all. It is
recommended that the country pursues vigorously the development of the money and
capital markets so that the monetary policy instruments would be allowed to play more
positive impact in addition to combining them with fiscal policies.
VII. Effect of Monetary Policy on Macroeconomic Variables in Nigeria
Ditimi, Nwosa and Olaiya (2011), appraised monetary policy development in Nigeria
and also examined the effect of monetary policy on macroeconomic variables in Nigeria
for the period 1986 to 2009. The study adopted a simplified Ordinary Least Squared
technique and also conducted the unit root and co-integration tests. The study showed
that monetary policy have witnessed the implementation of various policy initiatives and
has therefore experienced sustained expansion over the years. The results also shows that
monetary policy had a significant effect on exchange rate and money supply while
monetary policy was observed to have an insignificant influence on price instability.
They noted that the implication of this finding is that monetary policy has had a
significant influence in maintaining price stability within the Nigeria economy. The study
concluded that for monetary policy to achieve its other macroeconomic objective such as
output performance; there is the need to reduce the excessive expenditure of the
government and align fiscal policy along with monetary policy measure.
VIII. Impact of Monetary Policy on the Nigerian Economy
In a study conducted by Charles (2012), he examined the impact of monetary policy on
the Nigerian economy. The study uses Ordinary Least Squares Method (OLS) to analyse
data between 1981 and 2008. The result of the analysis shows that monetary policy
presented by money supply exerts a positive impact on GDP growth and Balance of
Payment but negative impact on rate of inflation. The recommendations are that
monetary policy should facilitate a favourable investment climate through appropriate
31
interest rates, exchange rate and liquidity management mechanism and the money market
should provide more financial instruments that satisfy the requirement of the ever-
growing sophistication of operators. However, the study did not run the diagnostic test
to check the fitness of the model.
IX. How Fiscal and Monetary Policies Influence Economic Growth and Development
in Nigeria
Adeolu et al (2012), assessed how fiscal and monetary policies influence economic
growth and development in Nigeria. The paper argues that curbing the fiscal indiscipline
of Government will take much more than enshrining fiscal policy rules in our statute
books. This is because the statute books are replete with dormant rules and regulation. It
notes that there exist a mild longrun equilibrium relationship between economic growth
and fiscal policy variables in Nigeria. The paper suggest that for any meaningful progress
towards fiscal prudence on the part of Government to occur, some powerful pro-stability
stakeholders strong enough to challenge government fiscal policy.
X. Transmission Channels of Monetary Policy Impulses on Sectoral Output Growth
Nwosa and Saibu (2012) investigated the transmission channels of monetary policy
impulses on sectoral output growth for the period 1986 to 2009 using secondary quarterly
data. Granger causality and Vector Auto-regressive methods of analysis were employed.
They showed that interest rate channel was most effective in transmitting monetary
policy to Agriculture and Manufacturing sectors while exchange rate channel was most
effective for transmitting monetary policy to Building/Construction, Mining, Service and
Wholesale/Retail sectors, indicating that interest rate and exchange rate policies were the
most effective monetary policy measures in stimulating sectoral output growth in
Nigeria.
XI. How The Decisions of Monetary Authorities Influence the Macro Variables like
GDP, Money Supply, Interest Rates, Exchange Rates and Inflation
Hameed, Khaid, and Sabit (2012), the paper presented a review on how the decisions of
monetary authorities influence the macro variables like GDP, money supply, interest
rates, exchange rates and inflation. The foremost objective of monetary policy is to
enhance the level of welfare of the masses. It is instrumental to price stability, economic
32
growth, checking BOP deficits and lowering unemployment? Since monetary policy
blends political and economic realities, study of monetary policy is catching more
attention of the policy makers. The method of least square OLS explains the relationship
between the variables under study. Tight monetary policy with balanced adjustments in
independent variables shows a positive relationship with dependent variable. . The study
recommended that central bank can best contribute to a nation’s Economic health by
eliminating the price uncertainties associated with inflation.
XII. Impact of Monetary Policy on Nigerian Economic Growth
Okoro (2013), examined the impact of monetary policy on Nigerian economic growth
from 1970 - 2010. Using a time series data the study employed Augmented Dickey-Fuller
(ADF) test, Philips-Perron Unit Test, Co-integration test and error correction model
(ECM) techniques in the analysis of the data collected. The study result shows that there
exists a long-run equilibrium relationship between monetary policy instruments and
economic growth in Nigeria. From our result interest rate and inflation rate were
negatively correlated with gross domestic product (GDP), while Exchange rate, money
supply and Credit to the Economy were positively related to GDP, based on the long-run
test. Theoretically, the study infer that monetary policy instruments have contributed
significantly to the positive economic growth of Nigeria. Therefore, the suggestion was
that there is need for a suitable monetary supply policy through inflation targeting. In
addition, the Central Bank of Nigeria should employ direct regulation of interest rates
since the existence of high interest rate acts as an obstacle to the growth of both private
and public investment in Nigeria.
XIII. The Responsiveness of Real Sector Output to Monetary Policy Shocks in Nigeria
Samuel, Tamarauntari and Michael (2013), examined the responsiveness of real sector
output to monetary policy shocks in Nigeria. Applying a VAR model and covering the
period 1970 to 2011 the study revealed that credit to the private sector and investment
had direct instantaneous impacts on real sector development (GDP). Real GDP
responded more to shocks in MPR, CPS and own innovations in the log-run. Although
monetary policy rate and interest rate had no instantaneous and direct impact on real
sector development they indirectly do so through the credit and investment channels. To
this end monetary policy rate and bank lending rates are the most important monetary
policy tools that can make or mare the Nigerian real sector. It was concluded that a sound
33
monetary policy in Nigeria is one that encourages credit to the private sector and capital
accumulation.
XIV. The Performance of Monetary Policy on Manufacturing Sector in Nigeria
Nneka (2013) examined the performance of monetary policy on manufacturing sector in
Nigeria for time frame 1986 to 2009. She noted that the main focus of monetary policy
in relation to the manufacturing sector has always been the stimulation of output,
employment and the promotion of domestic and external stability, while that of fiscal
policy has been the generation of revenue for the government and the protection of
domestic infant industries against unfair competition from import and dumping. Vector
Error Correction (VEC) and Ordinary Least Square (OLS) estimation were used to study
the models for significance, magnitude, direction and relationship. The study revealed
that money supply positively affect manufacturing output index while company lending
rate, Company income tax rate, Inflation rate, Exchange rate has a negative impact to the
performance of the manufacturing sector over the years. They recommended that
expansionary policies are vital for the growth of the manufacturing sector in Nigeria
which in turn would lead to economic growth.
XV. The impact of monetary policy on selected macroeconomics variables such as gross
domestic product, inflation, and balance of payment in Nigeria
Michael and Ebibai (2014), empirically examined the impact of monetary policy on
selected macroeconomics variables such as gross domestic product, inflation, and balance
of payment in Nigeria from 1980 to 2011. Data were extracted from the Central Bank
Statistical Bulletin. Monetary policies played an indispensable role in Nigeria’s economy
by regulating and stabilizing the volume of money in circulation in order to create an
enabling environment for investment, which will foster economic development. Today,
the impact of monetary policy has wider implication and this arises partly because of
proactive measures put in place by CBN to ensure macroeconomic stability in the country.
The study is designed in such a way that it is an econometric investigation of the impact
of monetary policy on economic growth in Nigeria using such econometric tools like the
ordinary least square (OLS) regression analysis. The error correction method was used to
ascertain if there is a static long run equilibrium relationship among the explanatory
variables and subsequently derive an adequate dynamic model of the short run
34
relationship. The study showed that the provision of investment friendly environment in
the Nigerian economy will increase the growth rate of GDP.
In summary, the overall findings of the works reviewed so far indicate that there is somehow
a general consensus that there is a direct relationship between monetary policy and economic
growth. However, while the robustness of most of the works reviewed could be widely
acclaimed, it will be noteworthy that there are some flaws inherent in some others which
could somehow hinder the robustness of their results and which this work is intended to
correct.
35
2.4.1 AN APPRAISAL OF THE PERFORMANCE OF MONETARY POLICY IN
NIGERIA
Over the years, the objectives of monetary policy have remained the attainment of
internal and external balance of payments. However, emphasis on techniques/instruments
to achieve those objectives have changed over the years. There have been two major
phases in the pursuit of monetary policy, namely, before and after 1986. The first phase
placed emphasis on direct monetary controls, while the second relies on market
mechanisms. (CBN 2015)
i. Monetary Policy Performance in 2008 - 2011
The conduct of monetary policy by the Central Bank of Nigeria since 2008 has been
designed to: influence the growth of money supply consistent with the required aggregate
Gross Domestic Product (GDP) growth rate, ensure financial stability, maintain a stable
and competitive exchange rate of the naira, and achieve positive real interest rates.
The conduct of monetary policy in the review period was largely influenced by the global
financial crisis which started in 2007 in the U.S. and spread to other regions and emerging
markets including Nigeria. The crisis created liquidity crisis in the banking system, large
quantum of non-performing credits, large capital outflows and pressure on the exchange
rate, decline in oil prices and falling external reserves, sharp drop in government revenue,
huge fiscal injections and collapse of the capital market.
Consequently in the wake of the global financial crisis, the Bank largely adopted the
policy of monetary easing to address the problem of liquidity shortages in the banking
system from September 2008 to September 2010. The monetary policy easing measures
taken during the period included:
a) Stoppage of aggressive liquidity mop-up since September 18, 2008.
b) Progressive reduction of monetary policy rate (MPR) from 10.25 to 6.0 per cent.
c) Reduction of cash reserve requirement (CRR) from 4.0 to 2.0 and 1.0 per cent
d) Reduction of liquidity ratio (LR) from 40.0 to 30.0, and 25.0 per cent.
36
e) Introduction of Expanded Discount Window (EDW) to increase DMB's access to
facilities from the CBN, and by July 2009 was replaced with CBN Guarantee of
interbank transactions.
f) Reduction of Net Open Position (NOP) limit of deposit money banks from 20.00 to
10.00, 5.00 and 1.00 per cent
g) Injection of N620 billion as tier 2 capital in 8 troubled banks
Following the restoration of stability and re-emergence of liquidity surfeit in the
banking system, the Bank adopted a tightening stance from September 2010 to
December 2011.
The monetary policy easing measures coupled with huge fiscal expansion put much
pressure on inflation, exchange rate and external reserves. To curtail these threats the
stance of monetary policy changed from monetary easing to tightening, from September
2010 to December 2011 and the following monetary policy actions were taken during
the period:
h) The Resumption of active Open Market Operations for the purpose of targeted liquidity
management.
i) Progressive increase in the monetary policy rate (MPR) from 6.00 to 12.00 per cent
j) Increase in the Cash Reserve Requirement (CRR) from 1.00 to 2.00, 4.00 and 8.00 per
cent
k) Increase in liquidity ratio (LR) from 25.00 to 30 per cent
l) Introduction of reserve averaging method of computing Cash Reserve Requirement
(CRR), which was later stopped
m) Increase of Net Foreign Exchange Open Position (NOP) of banks from 1.00 to 5.00 per
cent; but later reduced to 3.00 per cent
n) Shift in the mid-point of the foreign exchange band from N150/US$1 +/-3 per cent to
N155/US$1 +/-3 per cent
ii. Monetary Policy Performance (2012)
The monetary policy environment in 2012 was characterized by continuing threat of
inflationary pressures against the backdrop of declining trend in output growth. Other
37
key concerns included sustaining a stable exchange rate for the naira, creating a buffer
for the external reserves, sustaining stability in money market rates, narrowing the spread
between the lending and deposit rates and mitigating the impact of the continued
slowdown in global economic activities on the domestic economy. In view of these multi-
dimensional challenges, monetary policy during the period focused on deploying the mix
of appropriate instruments to deliver price stability.
The Monetary Policy Committee (MPC) held six regular meetings in the review period,
during which it maintained the MPR at 12.0 per cent with a symmetric corridor of +/-
200 basis points. To further sustain the tightening stance, CRR was raised from 8.0 to
12.0 per cent and NOP limit reduced from 3.0 to 1.0 per cent at the July 2012 meeting.
The LR was retained at 30.0 per cent with the mid-point of exchange rate maintained at
N155/US$ within a band of +/-3.0 per cent.
iii. Monetary Policy Performance (2013)
Monetary policy in 2013 aimed primarily at sustaining the already moderated rate of
inflation which was achieved in the first half of 2013. The benign headline inflation rate
of 8.0 per cent at end-December 2013, from 8.4 per cent at end-June 2013, is evidence
of the effectiveness of the policy. Besides, monetary policy also aimed at limiting
pressure on the exchange rate, boosting the external reserves position, sustaining stability
in the money market and reducing the spread between lending and deposit rates. These
goals were largely achieved through a mixed-grill of a number of instruments, which
helped to strengthen investor confidence in the economy.
The Monetary Policy Rate (MPR) was the principal instrument used to control the
direction of interest rates and anchor inflation expectations in the economy. The other
intervention instruments included Open Market Operations (OMO), Discount Window
Operations, Cash Reserve Ratio (CRR) and foreign exchange Net Open Position (NOP).
Open Market Operations (OMO) was the other major tool for liquidity management in
2013; achieved through the issuance of CBN bills. The sale of CBN bills declined by
52.8 per cent in the second half compared with the first half. In the second half, the
volume of transactions of the standing lending facility window rose by 30.66 per cent,
38
while that of standing deposit facility window rose by 53.6 per cent, compared with the
first half.
The Monetary Policy Committee (MPC) held six regular meetings during the review
period, and the MPR was successively maintained at 12.0 per cent with a symmetric
corridor of +/- 200 basis points. The MPC introduced a higher Cash Reserve Ratio (CRR)
for public sector deposits with the Deposit Money Banks (DMBs), in order to further
tighten money supply.
Beside the change in the CRR on public sector deposits, other existing policies were
retained, and complemented with administrative measures. The Net Open Position
(NOP) limit was sustained at 1.0 per cent, Liquidity Ratio (LR) at 30.0 per cent and the
mid-point of the exchange rate at N155/US$ +/-3.0 per cent. The decision of the MPC to
retain most of the existing measures was to assure the market of the continuity of the
tight monetary policy regime.
Monetary policy continued to contribute significantly to the robust performance of the
economy after the shock of the global financial crisis in 2008 (on the one hand and the
domestic banking crisis of 2009 on the other). In spite of these developments, output
remained relatively high while inflation decelerated in 2013.
Most measures of inflation moderated throughout the period in response to the policy
measures implemented by the Bank.
Year-on-year headline inflation decreased to 8.0 per cent in December 2013, from 8.4
per cent in June 2013 and 12.0 per cent in December 2012. Food inflation also declined
marginally to 9.3 per cent from 9.6 per cent over the same period. However, core inflation
rose from 5.5 per cent to 7.9 per cent between June and December 2013.
iv. Monetary Policy Performance (2014)
In 2014, monetary policy was focused on achieving the objective of price and rate
stability. Accordingly, the Bank sustained its tight policy stance with a view to ensuring
that electioneering spending did not result in uptick in inflation. Headline Inflation
remained within single digits, and fluctuated between 7.7 and 8.5 per cent, in the review
period due to the combined effect of the declines in the prices of clothing and footwear;
39
and transport components as well as the relative stability in the price of education in
response to the tight liquidity measures taken at the MPC meetings during the year.
The financial market was generally stable for 2014, although, significant fluctuations
were noticed towards the end of the year. A number of policy instruments were deployed
to achieve price and financial system stability, with a view to boosting investor
confidence and reduce concerns about declining foreign exchange reserves.
The policy instruments used to achieve price and financial system stability objectives
were the Monetary Policy Rate (MPR), and other intervention instruments such as Open
Market Operations (OMO), Discount Window Operations, Cash Reserve Ratio (CRR)
and Foreign Exchange Net Open Position (NOP) limit. During the period, the MPC raised
MPR by 100 basis points from 12.0 to 13.0 per cent while maintaining the symmetric
corridor of +/- 200 basis points around the MPR.
The CRR on private sector deposits was raised by 500 basis points from 15.0 to 20.0 per
cent, while CRR on public sector deposits was raised from 50.0 per cent to 75.0 per cent.
The MPC also retained the Liquidity Ratio at 30.0 per cent, in order to address liquidity
surfeit in the banking system.
OMO was principally used to mop up or inject liquidity into the system as a strategy for
monetary management by the Bank.
The Bank's monetary policy decisions strengthened financial system stability and
supported the growth of the Nigerian economy.
2.4.2 STRATEGIES OF MONETARY POLICY IN NIGERIA
The strategy of monetary policy involves modifying the amount of base money (M1) in
circulation. This process of changing base money through the sale and purchase of
government securities is called open market operations. Continuous market transactions
by the monetary authorities modify the supply of money which affects other market
variables such as short term interest and exchange rates.
The distinction between the various strategies of monetary policy lies primarily with the
set of instruments, targets and variables that are used by the monetary authorities to
40
achieve the desired goals (Table 2.4). The strategies of monetary policy could be
classified as; monetary targeting, price level targeting, inflation targeting and exchange
rate targeting.
Table 2.4
i. Monetary Targeting
Under this approach, the target variable is the growth in money supply designed to
achieve the long-term objective of price stability. This is currently used by CBN. Under
this framework, the central bank watches very closely growth in the monetary aggregates
in order to predict the future size of money supply. If the monetary aggregates were
growing too quickly, it could trigger inflationary pressures (more money chasing after
the same amount of goods and services leads to rising prices) and cause the central bank
to raise interest rates or otherwise halt growth in money-supply. While other monetary
policy strategies focus on a price signal of one form or another, this approach is focused
on monetary quantities.
ii. Price Level Targeting
Price level targeting is similar to inflation targeting in that both establish targets for a
price index like the CPI. However, where inflation targeting only looks forward (i.e., a
Monetary Policy Strategy Target Variable Long Term Objective
Monetary Targeting Growth in money supply A given rate of change in CPI
Price Level Targeting
Interest rate on overnight
debt
A specific CPI
Inflation Targeting Interest rate on overnight
debt
A given rate/band of
inflation
Fixed Exchange Rate
Spot price of the currency A given rate of change in CPI
41
2% inflation target per year), price level targeting actually takes past years into account
when conducting open market operations. So, if the price level rose by 2% in the previous
year (from a theoretical base of 100 to 102), the price level would have to drop the next
year in order to bring the price level back down to the 100 target level. This could mean
more forceful action needs to be taken than would be required if inflation targeting were
used.
Price level targeting is generally considered a risky policy stance, and one not used by
many central banks. It is believed to bring more variability in inflation and employment
in the short run compared to inflation targeting. Most economies feel that a small amount
of annual inflation is (up to about 2% per year) actually good for the economy.
iii. Inflation Targeting
Inflation targeting is a monetary policy framework, in which a central bank estimates
makes public a projected, or "target", inflation rate and then attempts to steer actual
inflation towards the target through the use of interest rate changes and other monetary
tools. The likely actions of the central bank to raise or reduce the policy rate become
more transparent under inflation targeting. If inflation is above the target, the central
bank is likely to raise the policy rate. This usually (but not always) has the effect over
time of cooling the economy and bringing down inflation. If inflation is below the target,
the central bank is likely to lower the policy rate. This usually (again, not always) has an
effect over time of accelerating the growth rate of the economy and raising inflation.
Under the framework, investors know the target inflation rate and therefore can more
easily anticipate interest rate changes and factor these into their investment decisions.
This is regarded by proponents of inflation targeting as leading to increased economic
stability.
iv. Exchange Rate Targeting
Under exchange rate targeting, the value of a currency is fixed in relation to another
currency or a basket of currencies. This facilitates trade and investment between the two
countries, and is especially useful for small economies where external trade forms a large
part of their GDP. It can also be used as a means to control inflation. However, as the
reference value rises and falls, so does the currency pegged to it.
42
43
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 INTRODUCTION
This chapter presents the general design of this study. It deals with the means by which
data are collected and analysis for the research conducted on the relationship between
monetary policy instruments and the economic growth in Nigeria. It explains the method
and instrument used in the study. This study will employ the techniques of ordinary least
square (OLS) to examine the impact of monetary policy instruments on the Nigeria
economy.
3.2 RESEARCH DESIGN
The research is designed to establish the statistical and econometric relationship between
the monetary policy instruments and economic growth in Nigeria. It is a survey research
design which ensures that the procedure to be employed in the study is carefully planned
so as to obtain correct and reliable information about the research work. Data relating to
monetary policy instruments (money supply, monetary policy rate and exchange rate)
and economic growth (GDP) were obtained from secondary sources.
3.3 METHOD OF DATA COLLECTION
Data for the study are obtained from secondary sources (time series data). These sources
include the statistical bulletin of the Central Bank of Nigeria (CBN) for various editions
and the Central Bank of Nigeria (CBN) annual publication. This study uses annual data
with a sample period from 1990 to 2014.
3.4 METHOD OF DATA ANALYSIS
The study employs the use of the multiple regression technique which offers explanation
on the relationship between a dependent variable and two or more explanatory variables.
The ordinary least square (OLS) method was used based on its BLUE (best, linear,
unbiased, estimator) properties which distinguish it from other techniques of estimation
of models. A system based program known as E-Views (Econometrics views) has been
adopted for the econometric and statistical analysis of the data.
44
3.5 MODEL SPECIFICATION
Model specification is a mathematical expression used to measure the economic
relationship that exists between the dependent and independent variable(s). Model
specification is based on the available literature and the theory as they help in the
specification of the relationship between the independent variable and the dependent
variable. This stage is one of the most difficult stage yet the most important because of
specification errors that occurs in the model. The model of this study is specified below:
GDP=β0 + β1MS + β2 MPR + β3EXR + μ
Where; MS is money supply, MPR represent monetary policy rate, EXR represent
exchange rate, β0 is intercept or constant term of the relationship, β1 ----β3 (Betas) are
the regression coefficients or the slope parameters for the various regressors (explanatory
variables stated above), and μ is random disturbance/error term. The error term takes care
of the measurement errors that would have resulted in the collection and processing of
the data. This specification was in line with the one applied by Adeoye (2006).
3.5.1 A priori Expectation
Here we highlight the theoretical relationship between independent variables and the
dependent variables. It is expected that based on a priori functional relationship between
dependent and independent variables, the model will adopt; β1> 0 because it is positively
related to GDP, β2 < 0 because it is negatively related to the Nigerian GDP and β3< 0
because it is negatively related to the GDP. The functional relationship between
dependent and independent variables are presumed to exist based on the assumptions
mentioned above.
3.6 MEASUREMENT OF VARIABLE
a. Money supply (MS): is the aggregate stock of money in circulation in the economy
for a given period of time, usually a year. It is a strong determinant of the level of
economic growth. Hence the study adopts broad money as a measure of money supply
(M2).
b. Monetary Policy Rate (MPR): is an instrument used by the CBN to control the
direction of interest rates and anchor inflation expectation in the economy. MPR,
45
which is a short term anchor replaced the MRR in December, 2006. It is designed to
influence short term money market rate and promote policy efficiency. Due to the fact
that MPR was introduced in 2006, to replaced MRR, the data of MRR from the period
of 1990 to 2005 will be used in place of MPR.
c. Exchange Rate (EXR): the price of a nation’s currency in terms of another currency.
An exchange rate thus has two components, the domestic currency and the foreign
currency, and can be quoted either directly or indirectly. In a direct quotation, the price
of a unit of foreign currency is expressed in terms of the domestic currency. In an
indirect quotation, the price of a unit of domestic currency is expressed in terms of
foreign currency. The exchange rate to be compared in this study is the rate of Naira
per US dollar.
3.7 METHOD OF EVALUATION
The study adopted regression analysis to examine the impact between the variables in the
model.
Model evaluation is concerned with the reliability of the result of the estimation from
multiple regressions. The evaluation will consist of deciding whether the estimates of the
parameters are theoretically meaningful and statistically satisfactory and significant. The
following criteria will be useful:
3.7.1 Economic criteria
Economic a priori criteria are derived from the economic theory from which the model
is being specified. The criterion is in regards to the sign of the economic relationship
between the monetary policy instruments and the economic growth in Nigeria. This
criteria has to do with the coefficient of the regressors, they are used to measure by how
much a change in the independent variable would affect the dependent variable. Here we
highlight the theoretical relationship between the independent and dependent variables.
3.7.2 Statistical Criteria
This criterion is often referred to as first order test. It is used to measure the extent of
reliability of the parameter of the variables in the model. The statistical criteria appear to
be superior to the graphical, however all these criteria should be used together in making
46
decision about the model. There are different test used in testing the statistical reliability
of the parameters which includes the following;
i. Coefficient of determinant (R2)
The overall fitness is measured using R2. It shows the percentage of the total variation in
the economic growth that can be explained by the independent variable; invariably it
helps to measure the fitness of the model. The value of R2 ranges from 0-1. The closer
the value to 1, the higher the R2 which denotes a strong relationship between explained
and the explanatory variables and the better the model is considered to be.
ii. T –Test
The student T-table will be used to measure the statistical significance of the coefficients
of the explanatory variables in the specified models. This will be at 5% level of
significance.
If T calculated < T tabulated do not reject H0
If T calculated > T tabulated reject H0
iii. Test of Significance
This is used to verify the truthfulness or otherwise of a null hypothesis. It determines the
basis for accepting or rejecting the null hypothesis. The null hypothesis will not be
rejected if the t-calculated is less than the t tabulated, otherwise it will be rejected.
iv. Test of overall significance (F-Test)
F-Test measures the overall significance of the coefficients of the explanatory variables
in the specified model. It is used to test the joint significance and to form the basis of
either not rejecting the null hypothesis (H0) or the alternative hypothesis (H1)
Decision rule:
If F calculated < F tabulated Accept H0
If F calculated > F tabulated do not accept H0
47
3.7.3 Econometric Criteria
i. The Durbin Watson Test (dw)
The Durbin – Watson statistics (dw) is used to test for the presence of auto-correlation in
the disturbance term which implies that the error term of successive periods relates to
one another. It is used to test whether or not one of the ordinary least squares has been
violated i.e. the assumption of serial independence or non-autocorrelation of the
disturbance (error) term. Auto correlation is a special case of correlation. It refers to the
relationship that occurs, not between two (or more) different variables but between the
successive values of the same variable.
ii. Diagnostic Test Statistics
This study further performed various diagnostic tests to ensure that the data series was
consistent with all the OLS assumptions. These includes the White’s test which is used
to test for heteroscedasticity problems, the Breusch-Godfrey Lagrange Multiplier (LM)
test is used to test for autocorrelation and the probability distribution will also be tested.
iii. Unit root test
Based on Ordinary least square (OLS) regression techniques, the data were subjected to
unit root test to figure out whether the data is stationary or not. According to Sajjad, Syed,
Shafi, Haroon, Jan, Sddat, Madina, and Ur (2012) economic time series tend to have a
strong trend, which causes these series to depict rising or falling patterns. The study will
apply unit root tests represented by the Augmented Dickey Fuller (ADF).
48
CHAPTER FOUR
DATA PRESENTATION, ANALYSIS AND INTERPRETATION
4.1 INTRODUCTION
This chapter of the study focus on the analysis and the interpretation of the result. Data
are collected from the CBN statistical bulletin and are subjected to various test as
specified in the chapter three, by running the data on the E-view software package. The
result of the data tested are interpreted with appropriate conclusions related to the result.
The hypothesis are also compared with the result to know whether or not to reject the
hypothesis stated. The last chapter of the study emphasise on the discussion of the
findings in the study.
4.2 PRESENTATION OF DATA
Based on this research study, time series data of Gross Domestic Product (GDP),
money supply (MS), monetary policy rate (MPR) and Exchange rate (EXR) of naira
to US dollar from 1990 to 2014 (25 years) were collected from the Central Bank of
Nigeria Statistical bulletin. The data collected from the secondary source are
presented in the table below:
Table 4.1: Data presentation
YEAR
GROSS
DOMESTIC
PRODUCT (GDP)
(N‘000,000,000)
MONEY
SUPPLY (MS)
(N’000,000,000)
MONETARY
POLICY
RATE (MPR)
(%)
EXCHANGE
RATE
(EXR)
(N)
1990 472.65 52.86 18.50 8.0378
1991 545.67 75.4 14.50 9.9095
1992 875.34 111.11 17.50 17.2984
1993 1,089.68 165.34 26.00 22.0511
49
1994 1,399.70 230.29 13.50 21.8861
1995 2,907.36 289.09 13.50 21.8861
1996 4,032.30 345.85 13.50 21.8861
1997 4,189.25 413.28 13.50 21.8861
1998 3,989.45 488.15 14.31 21.8861
1999 4,679.21 628.95 18.00 92.6934
2000 6,713.57 878.46 13.50 102.1052
2001 6,895.20 1,269.32 14.31 111.9433
2002 7,795.76 1,505.96 19.00 120.9702
2003 9,913.52 1,952.92 15.75 129.3565
2004 11,411.07 2,131.82 15.00 133.5004
2005 14,610.88 2,637.91 13.00 132.147
2006 18,564.59 3,797.91 12.25 128.6516
2007 20,657.32 5,127.40 8.75 125.8331
2008 24,296.33 8,008.20 9.81 118.5669
2009 24,794.24 9,411.11 7.44 148.8802
2010 54,612.26 11,034.94 6.13 150.298
2011 62,980.40 12,172.49 9.19 153.8616
2012 71,713.94 13,895.39 12.00 157.4994
2013 80,092.56 15,160.29 12.00 157.3112
2014 89,043.62 17,680.52 12.25 158.5526
Source: Extracted from 2014 Central Bank of Nigeria Statistical Bulletin
50
4.3 RESULT PRESENTATION
In trying to find the performance of monetary policy application on Nigerian economy,
data such as; Gross Domestic Product, Money Supply, Monetary policy rate and
Exchange rate obtained from the CBN statistical bulletin were computed on the E-view
software and the result of the analysis are presented below.
Table 4.2: Modeling GDP by OLS
Variable Coefficient Std. Error t-Statistic Prob.
Constant 2.770137 0.487259 5.685144 0.0000
LOG(MS) 0.926232 0.091563 10.11579 0.0000
MPR 0.004428 0.018478 0.239650 0.8129
LOG(EXR) -0.122638 0.137411 -0.892490 0.3822
R2 = 0.976983
F (3, 21) = 297.1244 [0.0000]
Durbin-Watson stat (DW) = 0.807375
From table 4.2 above, the estimated model is stated as:
GDP = 2.770137+ 0.926232MS + 0.004428MPR – 0.122638EXR + μ
Interpretations:
From the result above, when all the independent variables are equal to zero, the intercept
for GDP becomes 2.770137.
MONEY SUPPLY: A unit increase in the money supply will increase the GDP by
0.926232.
MONETARY POLICY RATE: A unit increase in monetary policy rate will increase
GDP by 0.004428.
51
EXCHANGE RATE: A unit increase in exchange rate will decrease the GDP by
0.122638.
From the result presented above, the coefficient of money supply shows that money
supply possess a positive relationship and highly significant impact on the Nigerian GDP,
monetary policy rate coefficient shows a positive relationship and highly insignificant
impact of the GDP. On the side of exchange rate, the coefficient shows that exchange
rate has a negative relationship and insignificant impact on Nigerian GDP.
4.3.1 EVALUATION BASED ON ECONOMIC CRITERIA
This criteria shows if the a priori expectations conform to the empirical findings. The
result is presented in the table below;
Table 4.2: Economic a priori expectation
Variable Expected sign Estimate Remark
MS + + Conform
MPR - + Does not conform
EXR - - Conform
From the table above, money supply and exchange rate conform to the a priori
expectation of the study. Only monetary policy rate (MPR) does not conform to the
expectation. The sign of the MS and MPR is an indication that an increase in money
supply and monetary policy rate increase the economic growth, the sign of the exchange
rate on the other hand, indicates that an increase in the exchange rate decreases the
economic growth.
4.3.2 EVALUATION BASED ON STATISTICAL CRITERIA
52
These test includes;
i. Coefficient of determinant (R2)
R2 shows the percentage of the total variation in the economic growth that can be
explained by the independent variable. From thee result obtained in the regression, R2 is
0.976983 showing a goodness of fit of 97.6%, the fitness in the model shows that the
explanatory variables (money supply, monetary policy rate and exchange rate) pointedly
accounted for 97.6% of the variations in the explained variable (GDP).
ii. T –Test
The student T-table will be used to measure the statistical significance of the coefficients
of the explanatory variables in the specified models. This will be at 5% level of
significance.
If T calculated < T tabulated do not reject H0
If T calculated > T tabulated reject H0
The summary of the student t-test is presented in the table below:
Table 4.3: T-statistic test
Variables t-Statistic 5% critical value Decision
Constant 5.685144 2.080 Significant
MS 10.11579 2.080 Significant
MPR 0.239650 2.080 Not significant
EXR -0.892490 2.080 Not significant
The result above shows that monetary policy rate and exchange rate are not statistically
significant, only money supply is found to be statistically significant in the model. Thus,
for this model, we cannot reject the null hypothesis for the variable of monetary policy
rate and exchange rate but we can reject the null hypothesis of no significant relationship
in the model and accept the alternate hypothesis in the case of money supply.
53
iii. Test of Significance
Here we test the significant of the independent variables in the model using the
probability value of the t-statistic. By comparing the p-value with the critical value of
5%, we will be able to know if the independent variables has a significant impact in our
model.
The table below shows the summary of the result:
Table 4.4: Test of significance
Variables P-value Significant
level
Decision Conclusion
MS 0.0000 0.05 Significant Reject H0
MPR 0.8129 0.05 Not significant Accept H0
EXR 0.3822 0.05 Not significant Accept H0
From the result presented in the table above, it shows that MS has a high significant
relationship with GDP because it present a probability of 0.0000 which is less than the
critical value of 0.05. MPR and EXR on the other hand, shows that they have no
significant relationship with GDP because they present the probability of 0.8129 and
0.3822 respectively, which is greater than the significant level of 5% (0.05).
iv. Test of overall significance (F-Test)
F-statistic is conducted to see if the regression model is well specified. It is used to test
the joint significance and to form the basis of either not rejecting the null hypothesis (H0)
or the alternative hypothesis (H1)
Decision Rule:
Reject H0 if f-cal > f-tab otherwise accept H0.
54
To check for F-test on the critical value table, the degree of freedom is given as:
V1 = K-1 = 4-1 = 3 (numerator)
V2 = n-k = 25-4 = 21 (denominator)
Table 4.5: F-statistic test
Comparing the F-cal with the F-tab, the result shows that F-cal > F-tab (i.e 297.1244 >
3.07) hence, we reject the null hypothesis (H0) and accept the alternate hypothesis (H1),
concluding that at 5% level of significant, the model is well specified and the overall
regression is statistically significant.
4.3.3 EVALUATION BASED ON ECONOMETRIC CRITERIA
i. The Durbin Watson Test (dw)
The Durbin – Watson statistics (dw) is used to test for the presence of auto-correlation in
the disturbance term which implies that the error term of successive periods relates to
one another. It is used to test whether or not one of the ordinary least squares has been
violated i.e. the assumption of serial independence or non-autocorrelation of the
disturbance (error) term.
The decision rule is given below:
Table 4.5: Durbin Watson test
NULL HYPOTHESIS DECISION If
No positive autocorrelation Reject 0 < d* < du
No positive autocorrelation No decision dL ≤ d* ≤ du
No negative autocorrelation Reject 4 – dL < d* ≤ 4
F-statistic Critical value (0.05) Decision
297.1244 3.07 Reject H0
55
No negative autocorrelation No decision 4 – du ≤ d* ≤ 4-dL
No autocorrelation (positive or
negative)
Do not reject du < d* < 4 ≤ dL
Where: dL = lower unit = 1.04
du = upper unit = 1.77
d* = durbin Watson calculated = 0.807375
At 0.05 significant level
The decision falls under 0 < d* < du (i.e 0 < 0.807375 < 1.77)
Thus we can reject the null hypothesis and conclude that there is no positive
autocorrelation in the residuals.
ii. Diagnostic Test Statistics
This study further performed various diagnostic tests to ensure that the data series was
consistent with all the OLS assumptions. These includes:
a) The White’s test which is used to test for heteroscedasticity problems,
b) The Breusch-Godfrey Lagrange Multiplier (LM) test is used to test for
autocorrelation and
c) The probability distribution (normality test) will also be tested.
a) Heteroscedasticity test
This test is carried out to test if the error term have a constant variance. The test follows
chi-square distribution with degrees of freedom equal to the number of regression in
the auxiliary heteroskedasticity regression, excluding the error term. The table below
shows the result of the heteroskedasticity test:
Table 4.6: Heteroskedasticity Test: White
F-statistic 0.696420 Prob. F(9,15) 0.7032
Obs*R-squared 7.367696 Prob. Chi-Square(9) 0.5989
56
Source: Author’s computation on E-view
Test Hypothesis
H0: Homoscedasticity (The variance is constant)
H1: Heteroscedasticity (the variance is not constant)
Decision rule
Reject H0 if X2 cal > X2 tab otherwise accept Ho.
X2 –tab = 16.919
X2-cal = 7.367696
Conclusion:
Looking at the Chi-squared critical value table at 5% significant value and 9 degree of
freedom, our X2 –tab (16.919) exceed our X2-cal (Obs*R-squared) value = 7.367696,
even the p-value of the X2-cal = 0.5989 also confirm this, because it is greater than the
significant level of 0.05. From the result and the comparism of the X2-cal and the X2-
tab, we cannot reject the null hypothesis because the X2-cal < X2-tab. We conclude that
the variance of the error term is constant.
b) The Breusch-Godfrey Lagrange Multiplier (LM)
This is used to test if there is a serial correlation occur between the residuals, we will
arrive at our decision by comparing the p-value of the Obs*R-squared(X2) with level of
significant of 5% (0.05). The decision rule is:
H0 = there is no serial correlation
Accept the null hypothesis if Obs*-squared (R2) p-value > 0.05 significant level,
otherwise reject.
Scaled explained SS 4.764214 Prob. Chi-Square(9) 0.8544
57
Source: Author’s computation on E-view
Interpretation:
The result above shows that p-value (0.0036) < 0.05 significant level, we can reject the
null hypothesis of no serial correlation and conclude that there is serial correlation in
the model.
c) The probability distribution (normality test)
This test is carried out to test if the error term follows normal distribution. It is done
using the Jarque-Bera statistic which follows chi-square distribution with 2 degrees of
freedom at 5% level of significance.
The result is presented in the diagram below;
0
1
2
3
4
5
6
7
8
-0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5
Series: ResidualsSample 1990 2014Observations 25
Mean 5.51e-16Median 0.006659Maximum 0.435857Minimum -0.545839Std. Dev. 0.236593Skewness -0.440720Kurtosis 2.832867
Jarque-Bera 0.838408Probability 0.657570
Test Hypothesis
H0: ei = 0 (The error term is normally distributed)
H1: ei ≠ 0 (The error term is not normally distributed).
Table 4.7: Breusch-Godfrey Serial Correlation LM Test:
F-statistic 7.791285 Prob. F(2,19) 0.0034
Obs*R-squared 11.26476 Prob. Chi-Square(2) 0.0036
58
a = 5% (0.05 significant level)
Decision Rule:
Reject Ho if X2-cal > X2-tab otherwise accept Ho
From the result obtained from Jarque-Bera test of normality, (JB) = 0.838408
(0.657570).
That is X2 cal = 0.838408 (0.657570)
X2 tab = 5.991(0.05)
Conclusion:
From the result presented above, it shows that X2-cal < X2-tab i.e (0.838408 < 5.991).
Hence, we cannot reject H0, we conclude that the error term is normally distributed.
This can also be verified with the probability presented, our JB p-value is higher than
the 5% significant level which is the basis on which we cannot reject the null
hypothesis.
iii. Unit root test
The study will apply unit root tests represented by the Augmented Dickey Fuller (ADF)
to test for the stationary of the model variables.
Hypothesis testing
H0: The monetary policy variables have a unit root
H1: The monetary policy variables does not have a unit root
Decision rule:
Reject the null hypothesis of unit root if the ADF calculated value exceeds the critical
value in absolute term at a given level of significant.
The table below shows the result of the ADF test.
Table: 4.7: Unit root test
59
Variable ADF 1%
critical
level
5%
critical
level
10% critical
level
Order of
integration
D(MS) 5.964533 -3.737853 -2.991878 -2.635542 I(0)
D(MPR,2) -5.306357 -3.769597 -3.004861 -2.642242 I(1)
D(EXR,2) -4.654699 -3.752946 -2.998064 -2.638752 I(1)
D(GDP,2) -3.512131 -3.752946 -2.998064 -2.638752 I(1)
Source: Author’s computation on E-view
Conclusion
From the result in the table above, it shows that MS attained stationary status at level,
while MPR, EXR and GDP attained stationary status at 1st difference. The critical value
forming the basis of the decision is 5%. Thus, the null hypothesis of non-stationary of
monetary policy variables is rejected at respective critical level. We conclude that all
the variables except money supply are integrated of one order.
4.4 TEST OF HYPOTHESES
The hypothesis have earlier been stated has;
H01: Money supply has no significant impact on the Nigerian economic growth
H02: Monetary policy rate has no significant impact on the Nigerian economic growth.
H03: Exchange rate has no significant impact on the Nigerian GDP.
Conclusion
60
Money supply: Based on the result presented by the p-value of t-test statistic, we reject
H0 and conclude that money supply has a high significant impact on the Nigerian
economic growth.
Monetary policy rate: the result presented in the statistical test shows that p-value
exceed our level of significant of 0.05, which means we cannot reject the null hypothesis
for monetary policy rate. We thereby conclude that monetary policy rate has no
significant impact on the Nigerian economic growth.
Exchange rate: also comparing the result presented by t-test statistic which shows that
t-cal is less than the critical value, hence, we accept the null hypothesis and conclude that
exchange rate has no significant impact on the growth of Nigeria economy.
4.5 DISCUSSION OF FINDINGS
This study examined how monetary policy application by the CBN has performed on
Nigerian economy from 1990 to 2014. The result of the study shows that money supply
possess a positive relationship and highly significant impact on Nigerian economic
growth, this is because if the supply of money is increased, there will be more
availability of funds in the economy and this lead to more investment which will boost
the economy. The result of the monetary policy rate shows that MPR has a positive
relationship and highly insignificant impact on the GDP, this is so because a rise in the
MPR will lead to an increase in the bank rate, which will in turn reduce the demand of
credit by the customer of the bank because of the high rate and by this there will be
little money available in the economy to sustain the business that will boost the
economy. The exchange rate result on the other hand, proves that there exchange rate
has a negative relationship and insignificant impact on Nigerian GDP, an increase in
the exchange rate will cause the economic growth to shrink, because when the exchange
rate rise, the importers of raw materials and equipment to boost production will incur
more in order to purchase this input and this leads to less demand of these input which
indirectly reduce the Nigerian economic growth.
The overall significant of the study shows that monetary policy has a positive
performance on the Nigerian economy. However, previous studies have confirmed the
status of this research study. Nneka (2013), The study revealed that money supply
61
positively affect manufacturing output index while company lending rate, Company
income tax rate, Inflation rate, Exchange rate has a negative impact to the performance
of the manufacturing sector over the years. Also in the study of Okoro (2013), he
conclude that monetary policy instruments have contributed significantly to the positive
economic growth of Nigeria.
It is suggested that further research should be carried out in order to determine how the
CBN can manipulate the monetary policy rate and the exchange rate, so that the policy
objectives can be achieved effectively.
62
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECCOMMENDATIONS
5.1 SUMMARY
The research study focussed on the monetary policy application and its performance on
Nigerian economy. The overall objective of the study is to analyse the impact of
monetary policy instruments on Nigerian economic growth. However, to achieve this,
various data on monetary policy and economic growth were collected and range from
1990-2014. Variables such as money supply (MS), monetary policy rate (MPR) and
exchange rate have been x-rayed to promote effective analysis for the study. These
variables were then subjected to multiple regression analysis, using Ordinary Least
Square method (OLS), with Gross Domestic Product (GDP) as its dependent variable.
The summary of the findings are given below;
i) Money supply was found to conform to the expectation, by having a positive sign.
Its significant test showed that money supply possess a positive relationship and
highly significant impact on Nigerian economic growth.
ii) Monetary policy rate does not conform to the a priori expectation, because it
showed a positive sign. The significant test also revealed that monetary policy has
a highly insignificant impact on the GDP.
iii) Exchange rate on the other hand, did not conform to the a priori expected sign.
When subjected to individual significance, it was found that exchange rate has an
insignificant impact on Nigerian economic growth.
iv) The goodness of fit test reveal that money supply, monetary policy rate and
exchange rate explain 97.6% of the dependent variable (Gross Domestic Product),
which shows a good sign.
v) Also the overall significance of the model, using F-statistic test showed that the
model is well specified and the overall regression is statistically significant.
63
5.2 CONCLUSION
In this research study, we examined the performance of monetary policy application on
Nigerian economic growth. The overall conclusion from this study is that monetary
policy exerts significant impact on the level of economic growth in Nigeria. This status
is confirmed by the result presented by the F-statistic test in our multiple regression
analysis. The study reveals that money supply and monetary policy rate have positive
influence on economic growth. Where money supply shows a strong influence,
monetary policy rate on its own shows a weak influence on the economic growth. The
study also reveals that exchange rate has negative relationship with the GDP.
In addition, monetary policy rate and exchange rate were found to have insignificant
impact on economic growth in Nigeria. Money supply on the other hand, has highly
significant impact on Nigeria economic growth. This shows that if the CBN increases
the money supply, more money will be available for people to invest and manage their
business which will in turn boost the economy.
5.3 RECOMMENDATIONS
Based on the findings made in the course of this study, particularly the results of the
regression models, it is clear that the growth of the Nigerian economy is highly
dependent on the provision of the right environment for investment. The following
recommendations are hereby made:
1. Monetary policies should be used to create a favourable investment climate by
facilitating the emergence of market based interest rates and exchange rate regimes
that attract both domestic and foreign investments, create jobs, promote non-oil
export and revive industries that are currently operating far below installed
capacity. In order to strengthen the financial sector, the Central Bank has to
encourage the introduction of more financial instruments that are flexible enough
to meet the risk preferences and sophistication of operators in the financial sector.
2. The government should also endeavour to make the financial sector less volatile
and more viable which will allow for smooth execution of the Central Bank
monetary policies. Laws relating to the operation of the financial institutions could
64
be made less stringent and more favourable for the operators to have room to
operate more freely.
3. The Central Bank should find a way of reducing the level of deficit financing,
improve funding of the informal sector and the SMEs and promote their integration
into the formal sector. Also government should improve the tax administration so
as to reduce tax evasion to barest minimum. It should also ensure proper balance
between capital and recurrent expenditures of government.
4. There is the need for the monetary authorities to exercise influence that would
affect the behaviour of monetary aggregates namely; money supply, inflation,
monetary policy rate, bank credit, among others, in the overall liquidity of the
economy.
5. The regulatory bodies should sustain the current economic reforms and maintain
sound fiscal and monetary policies so that inflation trends can be reduced to single
digit on a sustained basis.
6. However, in order to maintain and exploit the current investment climate, the
Central Bank should introduce more monetary instruments that are flexible enough
to meet the ever-growing financial sector. This will allow for the existence of
different measures that will deal with different situations.
7. The Central Bank should make more stringent punishment for non-compliance to
the monetary policies by financial institutions. This will help to curtail the nefarious
activities of some financial institution who undermine the Nigerian economy.
8. The government should also create awareness on the desire of Nigerians to invest
in short-term instruments.
9. Finally, the government of Nigerian should work together with the Central Bank
of Nigeria, in terms of the fiscal policy formulation in other to achieve the macro-
economic objectives. This joint effort will lead to the rapid growth of the Nigerian
economy.
65
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