Impact of Monetary Policy on Economic Growth in Nigeria 1980-2021
Chapter One
Objectives of the Study
The General objective of the study is to find out the extent to which monetary policy (captured by MPR) could bring about Economic growth (stability in inflation, interest and exchange rates) in Nigeria.
Consequently, the specific objective of the study:
To investigate how interest rate, exchange rate and inflation respond to shocks in monetary policy rate (MPR).
CHAPTER TWO
LITERATURE REVIEW
Conceptual Literature;
Overview of inflation
Inflation could be defined as an economic situation in which the increase in money supply is “faster” than the new production of goods and services in the economy (Hamilton, 2001). More often than not economists draw a line of difference between inflation and an economic condition of a onetime increase in price or when there are price increases in a narrow group of economic goods and services (Piano, 2001). Consequently, inflation signifies a general and persistent increase in the prices of goods and services in an economy (Ojo, 2000; Melberg, 1992).
Usually, the rate of Inflation is measured by the percentage change in the price index, which may be wholesale price index, producer price index, retail price index, or consumer price index. In Nigeria, inflation is measured as the percentage change in the consumer price index, which aggregates the price of a representative basket of goods and services purchased by the average consumer, and obtained through periodic survey of consumer prices (CBN, 2021; Essien, 2002).
The National Bureau of Statistics has the statutory responsibility for compiling inflation statistics in Nigeria. Different weights are assigned to the goods in the representative consumer basket. As a result of these weights, changes in the prices of some goods in the basket exert varying effects on measured inflation. However, in this research work we used the headlines inflation used by CBN as against the consumer price index.
The year-on-year headline inflation was preferred because of the following disadvantages associated with the consumer price index (CPI) as a measure of the price levels; first it does not reflect goods and services bought by firms or government, such as machinery. Second, it does not reflect the changes in the quality of goods which might have occurred over time. Third, changes in the price of substitutable goods are not captured. Lastly, CPI basket usually does not change often. Inflation could also be measured by GDP deflator, though it is sparingly used because CPI represents the cost of living and is therefore more appropriate for measuring the welfare of the people.
As regards the causes of inflation; three school of thought stand out; the neo- Classical/monetarist, neo-Keynesian and structuralist. The neo-Classical/monetarists opine that inflation is driven mainly by growth in the quantum of money supply. However, practical experiences of the Federal Reserve in the United State (US) have shown that this may not be entirely correct. To buttress this, the US money supply growth rates increase faster than the price itself (Hamilton, 2001; Colander, 1995). This has been traced to the increase demand for the US dollar as a global trade currency (Mordi, C et al, 2007). On the other hand, the neo-Keynesians attribute inflation to diminishing returns of production. This occurs when there is an increase in the velocity of money and an excess current consumption over investment. Finally, the structuralists postulate that inflation is caused by structural factors as well as the underlying characteristics of the economy (Adamson, 2000). Examples of these structural factors may include hoarding and hedging in Nigeria.
There are so many factors that affect inflation but the most popular ones could be narrowed down to institutional, fiscal, monetary and balance of payments. Several studies (Melberg, 1992; Cukierman, Webb and Neyapti, 1992; Grilli, et al, 1991; Alesina and Summers, 1993; Posen, 1993; Pollard, 1993, Debelle and Fischer, 1995 as well as Wikipedia, 2010) have shown that the level of independence (legal, administrative, instrument, etc.) of the monetary authority is an important institutional factor that determines inflation, especially in industrialised countries, while the rate of turnover of Central Bank Governors in developing countries was seen as an important factor influencing inflation. However, caution must be exercised in the interpretation of these findings, given the difficulty in measuring the actual level of independence of a central bank (CBN, 2009).
On the other hand, the fiscal factors have to do with the financing of budget deficits, largely through money creation process. The notion held here is that inflation is the result of large fiscal imbalances, arising from inefficient revenue collection procedures and limited development of the financial markets, which tend to increase the reliance on seigniorage as a source of deficit financing (Agenor and Hoffmaister, 1997 and Essien, 2021). The monetary factors or demand side determinants include increases in the level of money supply in excess of domestic demand, monetization of oil receipts, interest rates, real income and exchange rate (Moser, 1995). Prudent monetary management was also found to aid the reduction in the level and variability in inflation (Alesina and Summers, 1993). The supply side factors, popularly addressed as the balance of payment factors on the other extreme have to do with the effects of exchange rate movement on the price level. For instance, exchange rate devaluation/depreciation induces higher import prices, external shocks and accentuates inflationary expectations (Melberg, 1992; Odusola and Akinlo; and Essien, 2021).
The neo-Keynesian economists identified the existence of three major types of inflation; demand pull, cost push and the structural inflation. Demand pull inflation (also known as the Philips curve inflation) occurs when aggregate demand is in excess of available supply (capacity) (Mordi, et al, 2007). The output gap could be as a result of increases in government purchases, increase in foreign price level, or increase in money supply. On the other end the cost push inflation (also addressed as the commodity or supply shock inflation) occurs when there is a sudden decrease in aggregate supply, as a result of an increase in the price/cost of the commodity/production where there are no suitable alternatives (Thomas, 2006). This type of inflation is becoming more common today than before, as evident in the rising prices of housing, energy and food. It is often reflected in price/wage spirals in firms, where workers try to keep up their wages with the changes in the price level and employers pass on the burden of higher costs to consumers through increase in prices. To wrap this up, the structural inflation is the built-in inflation, usually induced by changes in monetary policy (Mordi, et al, 2007).
Moreover, inflationary episodes can be characterized as low, moderate, high, extreme and hyper. Low inflation refers to a single-digit inflation rate (from 1-2 to 5%), while moderate inflation refers to double digit rates of 15 to 30 per cent, high inflation is in the 30-100 percentage range and extreme inflation ranges between 100- 1000 per cent. Hyperinflation refers to three digit inflation, episodes of more than 1000 per cent annual inflation rate. Last but not the least, any inflation below zero, is regarded as deflation (Vegh, 1992 and Piana, 2001).
Apart from extreme and hyperinflations, Nigeria had since independence in 1960 witnessed most of the known episodes of inflation, ranging from single-digit to moderate and high inflations;
CHAPTER THREE
METHODOLOGY
Research Design
The model specification adopted is the Ordinary Least Square technique(OLS) . Descriptive analysis is carried out using the Pearson Product Moment correlation coefficient and the Unit Root Test (Augmented Dickey Fuller) . The causality test is done using the Granger causality tests.
Sources of Data
The study made use of data mainly from secondary sources, particularly unpublished data from the research as well as monetary policy departments of CBN. We equally used data from the published works in CBN official websites, Statistical Bulletins, monthly journals, financial reviews as well as annual Reports and various Communiqués of the monetary policy committee meetings. Another source of data for the study included statistics and published materials by the National Bureau of statistics (NBS), Nigerian Economic Society, newspapers, magazines, journals, seminar papers as well as my previous lecture notes and similar studies conducted in the department. The variables involved in the study are monetary policy rate (i), market rate of interest (l), inflation rate (In), and exchange rate (x).
Model Specification
The specification model for the vector of endogenous variable, Yt includes it, Int, xt is represented in a SVAR model founded by Granger’s (1969) specification of causality and endogeniety. Thus, we consider the standard form of our VAR model with lag order p as:
CHAPTER FOUR
ANALYSIS OF THE RESULTS
UNIT ROOT TEST
The empirical analysis started with the investigation of the time series properties of each variable employed in the study by using both the Augmented Dickey Fuller (ADF) and Phillip Peron (PP) tests to determine the order of integration of the series. Table 2 below has shown that the two tests were consistent, signifying that the MPR, NEER, INF as well as LEND are all stationary at first difference which implied that, they were all integrated of order one.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
SUMMARY
The study theoretically and empirically investigated how inflation, interest and exchange rate respond to shocks in monetary policy (captured by MPR). The research work used monthly data, beginning from December, 2006 (when the MPR was introduced) through February, 2022. The Structural VAR was employed to estimate the model, where the impulse response revealed how the inflation, interest and exchange rates responded to shocks in MPR and the variance decomposition brought to the limelight the impact of MPR on these Macroeconomic variables. The Granger Causality was equally used to disclose the causal direction among the variables, while Augmented Dickey Fuller (ADF) was conducted on all the variables before the estimations to establish the absence of stochastic process.
OUTLINES OF MAJOR FINDINGS
- Inflation responds to shocks in MPR only in a volatile manner (a pattern that is almost unpredictable); in the first four periods, positive shocks in MPR could not bring down inflation but thereafter, any further increase in MPR produced gradually declining but positive interest
- Exchange rate responds to shocks in MPR in a relatively downward fashion and quickly assumes upward trend from the second period lasting throughoutthe
- Interest rate responds quickly and positively to shocks in MPR from the first thorough the last period. Therefore, MPR has its greatest influence on interest rate (prime lendingrate).
- Of all the three macroeconomic variables, inflation is the most difficult to deal with and cannot always be successfully conquered with the manipulation of MPR
- Low and stable interest and exchange rate can only be achieved when inflation is low and Hence, inflation is the greatest enemy of oureconomy.
- Changes in the interest and exchange rate as well as MPC meetings can be used to predict
CONCLUSION
The study concludes that both interest (prime lending rate) and exchange rates respond quickly and almost in a predictable way to shocks in MPR. However, changes in MPR do not automatically and consistently produce changes in inflation and above all inflation responds to shocks in MPR only in a volatile manner (a pattern that is almost unpredictable). Hence of all the three variables, inflation is the most difficult to deal with (stability of which could leads to stability in the remaining two) and could not be totally addressed by mere manipulations of MPR. Hence low and stable inflation is a necessary condition for the achievement of low and stable interest and exchange rate. We also conclude that MPR is also responsive to Monetary Policy Committee (MPC) meetings.
RECOMMENDATIONS
- Other monetary policy instruments particularly Cash Reserve Requirements (CRR) and especially, OMO should be prudently used to compliment MPR in achieving Economic growth.
- The current monetary tightening stance of the CBN is a step in the right direction but should be used with caution. Considering the dual objective of CBN, themonetary policy should be tailored to promote real sector lending while trying to achieve low and stable
- There is the need for policy harmonization between the monetary and fiscal authorities. Budget deficit should be avoided and more fund be appropriated for capital as against the recurrent
- CBN should license more banks to operate non-interest banking so as to boost financial deepening and inclusion. The large informal sector in the country that cripples the transmission mechanism of monetary policy and constraints the ability of CBN to control money supply was to some extent caused by cultural and religious belief that interest is unlawful; this could be avoided by introducing more non-interest banks.
- The “cashless policy” of CBN should be maintained, made more efficient and user friendly. Researches have shown that a system that is cash based is inefficient and distorts transmission mechanism. More efficient point of sale (POS) terminals, multifunctional ATMs as well as mobile payment compatible system should be put in
- There is the need for proper enlightenment of the public about any new CBN policy initiatives (e.g. non-interest banking & cash-lite policy). The communication strategy should be clear and
- The physical and social infrastructures of the economy should be improved to reduce the cost of doing business and by extension the interest charged by the
- The three tiers of Government should exercise fiscal prudence and fiscal responsibility act be fully implemented. More so, Banks and OtherFinancial Institutions should improve their operational efficiency by cutting down overhead and any other unnecessary expenses.
- The CBN should reduce or strike out any unnecessary stringent documentation requirement for the purchase of forex in the official market. This would kill patronage and by extension the life of parallel market/street
- To ensure policy continuity and consistency, the rate of turnover of CBN Governors should be checked and the frequency of MPC meetings be reduced to at most quarterly unless in case of
- The Oil and Gas sector should be fully deregulated, corruption in the sector and other sectors of the economy be fought to the latter and above all the saved subsidy proceeds be used to boost physical infrastructure. This would reduce pressure on forex demand as well as cost of doing business and in addition boost external reserve in the
- Last but not the least, CBN should avoid policy summersault, a situation where CBN would initiate a policy that originally supposed to be applicable to all economic agents (e.g. cash-lite) and latter begin to exonerate some agents (e.g. government parastatals, foreign embassies, Primary Mortgage Banks, Microfinance Banks etc.) from compliance, would not augur well for the If Monetary Policy must strive, the credibility of CBN should be held in high esteem especially under condition ofuncertainty.
REFERENCES
- Adamson, Y. K. (2002), “Structure Disequilibrium and inflation in Nigeria; A Theoretical and Empirical Analysis”. Centre for Economic Research on Africa. New Jessy 07043; Montclair state University, upper Montclair.
- Alesina, A. and Summers, L. H. (1993), “Central Bank Independence and Macroeconomic Performance: Some comparative evidence”, journal of Money, Credit and Banking, volume 25, number 2, may.
- Amato, J. D. and Gerlach, S. (2002), “Inflation Targeting in Emerging Transition Economies; Lesson after a Decade”. European Economic Review, 46; 781-790.
- Anguyo, F. L. (2008), “Exchange Rate Pass-through to Inflation in Uganda:
- Evidence from a Vector Error Correction Model”; Working Paper (BOUWP/09/08), Research Department Bank of Uganda.
