1.1 Background to the Study            

It is well known that, there are two main macroeconomic policies (fiscal policy and monetary policy) that can be used by economic managers to manage the health of an economy: expanding economic growth (GDP). The reason is that monetary policy and fiscal policy complement each other. The monetarists believe that monetary policy exert greater impact on economic activity while the Keynesians believe that fiscal policy rather than monetary policy exert greater influence on economic activity (Khosravi and Karimi, 2010). We also believe that economic managers pay more particular attention to one of these two policies (fiscal policy or monetary policy) to stimulate economic growth rapidly. Therefore, the questions that come to mind are: Is the Nigerian economy strongly built on fiscal policy or monetary policy? To what extent do they influence economic growth in Nigeria? How relatively important are they to the growth process of Nigeria? To answer these questions, an empirical study needs to be done, hence, this study.

Fiscal policy is a demand side policy used by the government to achieve macroeconomic objectives. The macroeconomic objectives are economic growth, price stability, reduction in unemployment and balance of payments equilibrium (Kibiwot & Chernuyot, 2012). Fiscal policy involves one of two things; either increasing or decreasing taxation or either increasing or decreasing government spending. All these are done to influence aggregate demand (Kibiwot et al., 2012). If we assume that we want to embark on expansionary policy, two things can be done: We can decrease taxation which might be a decrease in income tax or expenditure tax. This will cause consumption to increase since one’s disposable income increases when income tax falls. In addition, if corporate profit taxes fall, this will make the firms have more profit which can be reinvested into the business, hence, resulting in an increase in investment, all other things remaining unaltered. These will influence the aggregate demand. In a more simplified form, if taxes decrease, consumption will increase, investment will increase and finally aggregate demand will increase. Alternatively, we can increase government spending be it current expenditure or capital expenditure. This will also cause the aggregate demand to increase (Lee & Gordon. 2005; Koeda, & Kramarenko, 2008; Miron, 2013).

Fiscal policy is a major economic stabilization weapon that involves measures taken to regulate and control the volume, cost and availability, as well as direction of money in an economy to achieve some specified macroeconomic policy objective and to counteract undesirable trends in the Nigerian economy (Gbosi, 1998). Therefore, economic stabilization cannot be left to the market forces of demand and supply and as well, other instruments of stabilization such as monetary and exchange rate policies among others, are used to counteract the problems identified (Ndiyo and Udah, 2003). This may include either an increase or a decrease in taxes, government expenditures, as well as public debt which constitute the bedrock of fiscal policy but in reality, government policy requires a mixture of both fiscal and monetary policy instruments to stabilize an economy because none of these single instruments can cure all the problems in an economy (Ndiyo and Udah, 2003).

Monetary policy constitutes the major policy thrust of the government in the realization of various macro-economic objectives. Essentially, monetary policy refers to the combination of discretionary measures designed to regulate and control the money supply in an economy by the monetary authorities with a view of achieving stated or desired macro-economic goals. Another point of view posits that monetary policy refers to any conscious action undertaken by the monetary authorities to change or regulate the availability, quantity, cost or direction of credit in any economy, in order to attain stated economic objectives (Nwankwo, 2000).Monetary policy is designed to influence the behaviour of the monetary sector; this is because changes in the behaviour of the monetary sector influence various monetary variables or aggregates. In effect, the monetary policy in force at any point in time, affects the level of money supply either by expanding it or through contraction of same. It also influences the level and structure of interest rates and thus the cost of funds in the market, depending on the prevailing economic conditions. The regulation and control of the volume and price of money is the discretionary control of money-discretionary in the sense that it is made at the instance of the money authorities. Monetary policy affects the non-bank publics’ holding of real and financial assets in the system. It can thus sustain a divergence between the non-bank publics’ desired portfolio holding (Ajayi, 2008). Monetary policy as a tool of economic stabilization was given by Milton Friedman who held that only money matters, and as such, monetary policy is a more potent instruments of stabilization that fiscal policy (Nzotta, 2004).

Monetary policy measures are monetary management put in place by the government through the central bank. These measures rely on the control of monetary stocks, that is supply of money in order to influence board macro- economic objectives which includes price stability, high level of employment sustainable economic growth and balance of payment equilibrium. These board objectives are achieved through the use of appropriate instrument depending on which objective the policy formulated want to achieved and also on the level of development on the economy (Ikeaka, 2012). In the application of monetary policy measures as instrument of stabilization, instrument of monetary policy are determined by the nature of the problems to be solved and by this environment in which these problems exist. They are broadly two categories of these instruments VIZ- indirect and direct instruments. Indirect instruments are usually used in the market based on economic where the quality of money stock can affected through the relationship between supply and resume money as well as the ability of the monetary authority to influence the creation of reserved.

The reserved and hence money supply can be affected through the following ways.

  1. Deposit ratio/change in reserve.
  2. Change in discount rate.
  3. Interest rate change.
  4. Engaging in an open market operation.

In order to improve macroeconomic stability, efforts were directed at the management of excess liquidity, thus a number of measures were introduced to reduce liquidity in the system. These included the reduction in the maximum ceiling on credit growth allowed for banks, the recall of the special deposits requirements against outstanding external payment arrears to CBN from banks, abolition of the use of foreign guarantees/currency deposits as collaterals for naira loans and the withdrawal of public sector deposits from banks to the CBN.

Also effective August, 1990, the use of stabilization securities for purposes of reducing the bulging size of excess liquidity in banks was re-introduced. Commercial banks’ cash reserve requirements were increased in 1989, 1990, 1992, 1996, 1999, 2003 and 2012. The rising level of fiscal deficits was identified as a major source of macroeconomic instability. Consequently, government agreed not only to reduce the size of its deficits but also to synchronize fiscal and monetary policies. By way of inducing efficiency and encouraging a good measure of flexibility in banks’ credit operations, the regulatory environment was improved.

Consequently, the sector-specific credit allocation targets were compressed into four sectors in 1986, and to only two in 1987. From October, 2006, all mandatory credit allocation mechanisms were abolished. The commercial and merchant treatment since their operations was found to produce similar effects on the monetary process. Areas of perceived disadvantages to Merchant Banks were harmonized in line with the need to create a conclusive environment for their operations. The liquidity effect of large deficits financed mainly by the Bank led to an acceleration of monetary and credit aggregate in 1998, relative to stipulated targets and the performance in the preceding year. Outflow of funds through the CBN weekly foreign exchange transaction at the Autonomous Foreign Exchange Market (AFEM) and, to a lesser extent, at Open Market Operation (OMO) exerted some moderating effect. The reintroduction of the (D.A.S) of foreign exchange management in July, 2002 engendered relative stability, and stemmed further depletion of reserves during the second half of 2002.

Therefore, fiscal and monetary policies can unequivocally lead to the growth and development of an economy (Anyanwu, 2008). Monetary policy since 1986 to 2010, the Structural Adjustment Programme (SAP) was adopted in July, 1986 against the crash in the international oil market and the resultant deteriorating economic conditions in the country. It was designed to achieve fiscal balance and balance of payments viability by altering and restructuring the production and consumption patterns of the economy, eliminating price distortions, reducing the heavy dependence on crude oil exports and consumer goods imports, enhancing the non-oil export base and achieving sustainable growth. Other aims were to rationalize the role of the public sector and accelerate the growth potentials of the private sector. The main strategies of the programme were the deregulation of external trade and payments arrangements, the adoption of a market-determined exchange rate for the Naira, substantial reduction in complex price and administrative controls and more reliance on market forces as a major determinant of economic activity.

However, the financial system was typically marked by rapid expansion in monetary aggregate, particularly during the second half of 2000, influenced by the monetization of enhanced oil receipts. Consequently, monetary growth accelerated significantly, exceeding policy targets by substantial margins, savings rate and the inter-bank call rates fell generally due to the liquidity surfeit in the banking system through the spread between deposit and lending rates remained wide.Specifically, 2013 policy measure were designed to promote a stable macroeconomic environment to achieve a non-inflationary output growth rate of 5 percent. In pursuit of its development effort, the Bank, in collaboration with the Banker’s Committee, established the Small and Medium Industries Equity Investment Scheme (SMIEIS).

In 2013, credit delivery to real sector was encouraged through the SMIEIS and an incentive of lower Cash Reserve Requirement (CRR) regime was prescribed for those banks that increased their credit allocation to the real sector by 20 percent or more. Moreover, the Bank provided guarantees for agricultural loans under the Agricultural Credit Guarantee Scheme (A.C.G.S). In recognition of the fact that well-capitalized banks would strengthen the banking system for effective monetary authority increased the minimum paid-up capital of Commercial and Merchant banks in February 1990 to N50 and N40 million from N20 and N12 million, respectively.Distressed banks whose capital fell below existing requirement were expected to comply by 31st March, 1997 or face liquidation. Twenty-six of such banks comprising 13 each of Commercial and Merchant Banks were liquidated in January, 1998.  Minimum paid up capital of Merchant and Commercial Banks was raised to a uniform level of N500 million with effect from 1st February, 1997, and by December 1998, all existing banks were to recapitalize. The C.B.N brought into force the risk-weighted measure of capital adequacy recommended by the Basic Committee of the Bank for International Settlements in 1990. Before then, capital adequacy was measured by the ratio of adjusted capital to total loans and advances outstanding.


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.

The Nigeria economy has encountered the problem of disequilibrium, inability to mobilize domestic savings and unsatisfactory expansion of domestic output. These problems have consistently and presently done severe damage to Nigeria economy; but most strikingly these problems have continued to play the economy unabated that is, the economy is becoming less strong. It is against the background that the problem of this study has been identified and they are as follows. Are monetary and fiscal policy measures effective as instrument of economic stabilization?

The main thrust of this study shall be on the effect of fiscal and monetary policy instruments on the economic growth of Nigeria. This would go a long way in assessing the extent to which the fiscal and monetary policies have impacted on the growth process of Nigeria using the major objectives of fiscal and monetary policies as yardstick.


1.3 Objectives of the study

The general objective of the study is to empirically analyze the relative effect of monetary and fiscal policies on economic growth in Nigeria; the specific objectives are;

1) To examine the relationship between money supply and economic growth.

2) To examine the relationship between balance of payments and economic growth.

3) To examine the relationship between government expenditure and economicgrowth.


1.4 Research questions

In order to investigate effect of fiscal and monetary policy instruments on the economic growth, theformulated research questions are:

  • What is the relationship between money supply and economic growth?
  • What is the relationship between balance of payment and economic growth?
  • What is the relationship between government expenditure and economic growth?


1.5 Research Hypotheses

H01: There is no significant relationship between money supply and economic growth in Nigeria.

H02:There is no significant relationship between balance of payment and economic growth in Nigeria.

H03:There is no significant relationship between government expenditure and economic growth in Nigeria.


1.6 Significance of the Study

This research will provide an insight into monetary and fiscal policy measures as instruments of economic stabilization and will therefore be of valuable use to the following set of people.

  1. To students:It will provide a compliment to the fair existing text on monetary and fiscal policy and economic growth in Nigeria.
  2. To bankers:It will also find a valuable tool toward analysing the effect of government action on their activities whether it is valuable or not.

iii. To investors:It will serve as a guideline on the effect of monetary and fiscal policies on various sectors of the economy in which their fund can be invested.

  1. To the ordinary reader:This work will serve as an open eye and a valuable store of knowledge.


1.7 Scope of the Study

In any research study of this nature, there is normally the enthusiasm to touch as many areas as possible which are connected to the various needs of such study.

However, this study will examine mainly the effect of money supply, exchange rate and government expenditure on economic growth of Nigeria covering the period 1970 to 2016.