1.1 Background of the Study
Since its establishment in 1959, the Central Bank of Nigeria 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.
Over the years, the major goals of monetary policy have often been the two later objectives thus, inflation targeting and exchange rate policy have dominated CBN monetary policy focus based on assumption that there are essential tools of achieving macroeconomic stability.
The economic environment that guided monetary policy before 1986 was characterized by the dominance of the oil sector, the expanding role of the public sector in the economy and over dependence on the external sector in order to maintain price stability and a healthy balance of payment position, monetary management depended on the rise of direct monetary instruments such as credit ceilings, selective credit controls, administered interest and exchange rates, as well as the prescription of cash reserve requirements and special deposits. The use of market based instrument was not feasible at the point because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rates.
The most popular instrument of monetary policy was the issuance of credit rationing guidelines, which primarily set the rate of change for the components and aggregate commercial bank loans and advances to he private sector.
In general terms, monetary policy refers to a combination of measures designed to regulate the value, supply and cost of money in an economy in consonance with the expected level of economic activity.
However, an unstable or crisis ridden financial sector will render the transmission mechanism of monetary policy less effective, making the achievement and maintenance of strong macroeconomic fundamentals difficult. This is because it is only in a period of price stability that investors and consumers can interpret market signals correctly: typically in periods of high inflation, the horizon of the investors is very short, and resources of the investors is very short, and resources are diverted from long-term investments those with immediate returns and inflation hedges, including real estate and currency speculation. It is on this background that this study would investigate the effectiveness of the monetary policy in Nigeria with special focus on major growth components.
1.2 Statement of the Problem
Ensuring rapid economic growth is the major macroeconomic goal of every economy. Economic growth is simply defined as a quantitative increase in a country output of goods and services (Onwukwe, 2003).
Monetary policy is of importance to every developing nation. But despite the various monetary regimes that have been adopted by the central Bank of Nigeria has experienced high volatility in inflation rates. Since the early 1970’s there have been four major episodes of high inflation in excess of 30 percent. The growth was often in excess of real economic growth. However, preceding the growth in money supply, some factors reflecting the structural characteristics of the economy are observable some of these are supply shocks; arising from factors such as famine, currency devaluation and changes in terms of trade.
The first period of inflation in the 30 percent range was in 1976. One of the factors often adduced for this inflation is the drought in Northern Nigeria, which destroyed agricultural production and pursed up the cost of agricultural food items, a significant increase in the proportion of the average consumers budget. In addition, during this period, there was excessive monetization of oil export revenue, which might have given the inflation a monetary character.
In the late 1980’s, following the structure adjustment programme, the effects of wage increase created a cost push effect on inflation. In the long run, it was the structural characteristics of the economy coupled with the growth in money supply that translated these into permanent price increase. In 1984 inflation peaked at 39.6 percent at a time of relatively little growth in the economy, at that time, the government was under pressure from debtor groups to reach an agreement with the international monetary fund, one of which was devaluation of the domestic currency. The expectation that devaluation was imminent fuelled inflation as prices adjusted to the parallel rate of exchange. Over the same period, excess money growth was about 45 percent and credit to the government had increased by over 70 percent. In other respects the case of the inflation may also be adduced to the worsening terms of external trade experienced by the country at that time. It is possible therefore, that Nigeria’s inflationary episodes were preceding by structural or real factors followed by monetary expansion.
The third high inflation episode started in the last quarter of 1987 and accelerated through 1988 to 1989. This episode is related to the fiscal expansion that accompanied the 1988 budget. Though initially the expansion was financed by credit from the Central Bank of Nigeria, it was later sustained by increasing oil revenue (occasioned by oil price increase following the Persion Gulf War) that was not Sterilized. In addition, with the debt was repurchased with new local currency Obligation. However, with the drastic monetary contraction initiated by the authorities in the middle of 1989, inflation fell reaching one of its lowest point in 1991, i.e 13 percent.
The forth inflationary episode occurred in 1993, and persisted through the end of 1995. Though inflation gathered momentum towards the fail end of 1992, it reached 57 percent by the end of 1994, the highest rates since the eighties, and the end of 1995, it was 72.8 percent. As with the third inflation, it coincided with a period of expansionary fiscal deficit and money supply growth. The authorities found it too difficult to contain the growth of private sector, domestic credit and bank liquidity, there has been a continuous fall in the inflation rate since 1996 as a result of stringent monetary policies of the central bank. It however, increased in 2001, 2003, 2004, 2005 and 2008 to 18.9 percent, 14 percent, 17 percent and 11 percent respectively.
For this research to be worthwhile, the researcher is interested in these problems such as:
Why has monetary polices introduced in Nigeria in the previous years not been able to achieve any meaningful result?
Could it be that the policies are not effective in achieving economic growth?
Do the policies need further revenue to make it more effective?
Is our financial system reliable in helping in the implementation of the policies?
What is the impact of monetary policy on Nigeria economic growth?
It is on this perspective that the role of monetary policy on Nigeria’s economic growth will be studied.
1.3 Objectives of the Study
The main objective of this study is to assess the effectiveness of the monetary policies in Nigeria. However, the following specific objectives would also be achieved.
To evaluate the performance of monetary policy in Nigeria over the years.
To empirically investigate the impact of the monetary policy on economic growth and other major growth components in Nigeria.
To make recommendations based on the findings.
1.4 Significance of the Study
The result of this research work will be beneficial to both financial and non-financial institutions. It will help to give necessary information on the policy options which the government of Nigeria should adopt to make the economy friendly and attractive to foreign investors. Furthermore, the study will be significant to the private sector, foreign investors and as well as the individuals, as it will inform them on the macroeconomic condition of the country. Thus, this will help in their policy formulation. Finally, the study will be added to the already existing body of knowledge in the field of economics.
1.5 Hypothesis of the Study
The hypothesis to be tested are:-
H0: That monetary policy does not have significant impact on the economic growth of Nigeria.
H1: That monetary policy has significant impact on the economic growth of Nigeria.
1.6 Scope/Limitations of the Study
The economy is a large component with lot of diverse and sometimes complex parts. This study will cover all the facts that make up the monetary policy, but shall empirically investigate the effect of the major ones. This study shall be restricted to the period between (1980-2010).
Nevertheless, many constraints were encountered in the course of this research. The first being, lack of relevant statistical data, some of the data needed for this research were not in existence and moreover, data storage system in Nigeria is very poor and outdated. Closely related to this is the choice of appropriate econometric techniques to estimate the parameters of the relationship under study. These two factors have forced me to limit the number of the macroeconomic indicators in the model to few variables.
Time constraint has shown no mercy to me too. The limited time has to be shared among many alternative uses which are; course work and research pursuance.
Finally, as a student of a developing country, finance poses a lot of problem towards achieving the desired result; research writing is very expensive as it entails many costs which include: mobility cost, of collecting data and other miscellaneous costs.