This study examines the impact of monetary policy on Nigerian economy using annual data from the period 1970-2009. The empirical findings starts by checking the stationary level of variables using the Augmented Dukey-Fuller test. Also the stationary test was followed by the co-integration test to test for long run relationship among the variables, which was followed by testing the short run relationship among variables using the Vector Autoregressive model. From the Augmented Dukey Fuller unit root test, it was observed that INF was stationary at level form, RGDP and RIR stationary at first difference, RER stationary at second difference. Also from the co-integration test, it was observed that no long run relationship exist among variables. More also, the VAR model reflects that, monetary policy has significant impact on economic growth. From the findings, this project work suggests that government should intensify its effort in pursuing policies that are anti-inflationary in nature.
1.1 BACKGROUND OF THE STUDY
Since its establishment in 1959 the central bank of Nigeria (CBN) has continue to play the traditional role expected of a central bank, which is the regulation of the stock of money in such as 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 target and exchange rate policy have dominated CBN’s monetary policy focus based on assumption that these are essential tools of achieving macroeconomic stability. The economic environment that guided the 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 use of direct monetary instruments such as credit ceilings, selective credit control, administered interest and exchange rate, as well as the prescription of cash reserve requirements and special deposits. The use of market-based instruments was not feasible at that point because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rate.
The most popular instrument of monetary policy was the issuance of credit rationing guidelines, which primarily set the rates of change for the components and aggregate commercial bank loans and advances to the private sector. The sector allocation of bank credit in CBN guidelines was to stimulate the productive sectors and thereby stem inflationary pressures. The fixing of interest rates at relatively low levels was done mainly to promote investment and growth. Occasionally, special deposits were imposed to reduce the amount of free reserves and credit-creating capacity of the banks. Minimum cash ratios were stipulated for the banks in the mid 1970’s on the basis of their total deposit liabilities, but since such cash ratios were usually lower than those voluntarily maintained by the banks, they provide less effective as a restraint on their credit operations.
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. For most economies, the objectives of monetary policy include price stability, promotion of employment and output growth, and sustainable development (Folawewo and Osinubi, 2006). These objectives are necessary for the attainment of internal and external balance, and the promotion of long run economic growth.
The importance of price stability derives from the harmful effect of price volatility, which undermines the ability of policy makers to achieve other lendable macroeconomics objectives. There is indeed a general consensus that domestic price function undermines the role of money as a store of value, and frustrates investment and growth. Empirical studies (Ajayi and ojo, 1981; 1981; Fischer, 1994) on inflation, growth and productivity have confirmed the long-term inverse relationship between inflation and growth.
With the achievement of price stability, the condition in the financial market and institutions would create a high degree of confidence, such that the financial infrastructure of the economy is able to meet the requirements of market participants. Indeed, an unstable 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 signal correctly. Typically, in periods of high inflation, the horizon of the investors is very short, and resources are diverted from long-term investments to those with immediate return 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
One of the major objectives of monetary policy in Nigeria is price stability. But despite the various monetary regimes that have been adopted by the central bank of Nigeria over the years, inflation still remains a major threat to Nigeria’s economic growth. Nigeria has experienced high volatility in inflation rates. Since the early 1970’s there have been four major episode of high inflation, in excess of 30 percent. The growth of money supply is correlated with high inflation episodes because money 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 pushed up the cost of agricultural food items, a significant increase in the proportion of the average consumer’s budget. In addition, during this period, there was excessive monetization of oil export revenue, which might have given the inflation a monetary character.
In addition, in the late 1980’s, following the structural adjustment program, the effects of wage increases created a cost-push effect on inflation. In the long-run, it was the structural characteristics of the economy, coupled in with the growth money supply that translated these into permanent price increases. 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 the conditions of which was devaluation of the domestic currency. The expectation that devaluation was imminent fuelled inflation as price adjusted to the parallel rate of exchange. Over the same period, excess money growth was about 43 percent and credit to the government had increased by over 70 percent. In other respects the causes 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 preceded by structural or real factors followed by monetary expansion.
The third high inflation episode stated in the last quarter of 1987 and accelerated through 1988 to 1989. The episode is related to the fiscal expansion that accompanied the 1988 budget. Though initially the expansion was financial credit from the CBN, it was later sustained by increasing oil revenue (occasioned by oil price increase following Persian Gulf War) that was not sterilized. In addition, with the debt conversion exercise through which ‘debt for equity’ swaps took place, external 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 points in 1991 i.e. 13%
The fourth inflationary episode occurred in 1993, and persisted through the end of 1995.Though inflation gathered momentum towards the tail end of 1992, it reached 57 percent by the end of 1994, the highest rates since the eighties, and by the end of 1995, it was 72.8 percent. As with the third inflation, it conceded 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. Continuous fall of the inflation rate has been experience since 1996 as a result of stringent monetary policies of the central Bank. It however, increased in 2001 and 2003, 2004, 2005 and 2008 to 18.9%, 14%, 15% 17.9% and 11.6% respectively.
Structural factors have proven to be important in the inflation spiral. Reduction in the oil revenue (a supply shock) led to a reduction in real income, with serious distributional implications. As workers pushed for higher nominal wages, while producer’s mark-ups on costs, an inflationary spiral followed. In addition to these factors the government also transfer problem in order to meet debt obligation.
The failure of the monetary policy including price instability has caused growth instability as Nigeria record of development has been very poor. In marked contrast to most developing countries, its GDP was not significantly higher in the year 2000 that it was 35 years before. As many economic indicator show, Nigeria’s economy has experienced different growth stages. The GDP growth rate recorded negative growth in the early 1980’s (-2.7 in 1982, 7.1 in 1983 and -1.1in 1984). The growth rate increased steadily between 1985 and 1990 but fell sharply in 1986 and 1987 to 2.5% and -0.2%. Except in 1991 when a negative growth rate of -0.8% was recorded, 1990’s witnessed an unstable growth. However, the growth rate has been relatively high since 2001. An examination of the long-term pattern reveals the following secular swings: 1965-1980 Rapid declines (civil war years), 1969-1971 Revival, 1972-1980 Boom, 1981-1984 crash, 1985-1991 Renewed Growth, 1992-2008 mobbing. In view of the monetary policy in Nigeria the research question would be;
· What would be the impact of monetary policy on economic growth in Nigeria?
· What is the trend and structure of monetary policy in Nigeria?
1.3 OBJECTIVE OF THE STUDY
· To identify the impact of monetary policy on economic growth in Nigeria.
· To examine the trend and structure of monetary policy in Nigeria.
1.4 RESEARCH HHYPOTHESIS
· That monetary policy does not have significant impact on economic growth in Nigeria.
· That monetary instrument does not have significant impact on economic growth in Nigeria.
1.5 SIGNIFICANCE OF THE STUDY
Due to the relevant important importance of the work ‘impact of monetary policy on the Nigerian economy’ it would seek to contribute step on the acquisition and understanding on the field of monetary economic and financial system. Also, it could serve as source of reference for project writers, researchers and financial institutions, who might like to know more about the rule of money supply on economic activities.
More also, the study would be significant for the partial fulfillment of the course requirement in awarding a B.Sc. in economics.
Furthermore, it would help policy makers in making appropriate policies in relation to monetary policies and economic growth or development.
1.6 SCOPE/LIMITATIONS OF THE STUDY
The economy is a large component with lot of diverse and sometimes complex parts. This study will have real gross domestic product as the dependent variable and major fact affecting monetary policy e.g. interest rate, inflation rate and real exchange rate as it independent variable. This study will cover all the facts that make up the monetary policy, but shall empirically investigate the effect of the major once. The empirical investigation of the impact of monetary policy on microeconomic variable in Nigeria shall be restricted to the period between 1970 and 2009.
This research work is limited to the use of secondary data gotten from secondary sources, as such if there are any errors made by those who generated these data, this research work incorporates such errors.