This study examined the effectiveness of monetary policy in curbing inflation in Nigeria for the period of 34 years (1981-2015) with a time series data. The study econometric model was estimated using Ordinary Least Square (OLS). In the model, inflation was regressed against Exchange Rate, Money Supply, Real Gross Domestic Product and one period lag of inflation. The study found out that there exist a negative significant relationship between Real Gross Domestic Product and inflation rate in Nigeria under the period of study. Furthermore, there exist a positive significant relationship Between Money Supply and inflation rate in Nigeria under the period of study. Exchange rate exerted a positive significant relationship with inflation rate in Nigeria under the period of study. The study recommended that if policy makers want to achieve sustainable economic growth in Nigeria they should focus on the growth of money supply since from our study it was found to have significantly contributed to economic growth.
1.1 Background to the Study
Nigeria monetary policy is enhanced to target the reduction in the rate of inflation with the framework of maintaining price stability as a single most important objective of monetary policy. Monetary policy is directed towards the reducing inflation presupposes the existence of a stable and predictable relationship between monetary aggregates and other economic variable in the economy (CBN, 2015).
For most economies, the 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, and the promotion of long run economic growth. The importance of price stability derives from the harmful effect of price volatility which undermines the objectives. This is indeed a general agreement that domestic price fluctuations undermines the role of monetary values as a store of value, and frustrate investments and growth. (Ajayi, 2014)
According to CBN (2012) Monetary Policy refers to the specific actions taken by the Central Bank (Monetary Authority) to regulate the value, supply and cost of money in the economy with a view to achieving predetermine macroeconomic goals.
Generally, monetary policy refers to combination of measures designed to regulate the supply of money in an economy in relation to the level of economic activity. Monetary policy refers to the credit control measure adopted by the central bank of a country (Friedman, 2000).
Monetary policy according to Olumechere (2013) is a deliberate effort by the monetary authorities to control supply and credit conditions for the purpose of achieving certain broad economic goals Johnson (2014) define monetary policy as policy employing central bank control of the supply of money as an instrument for achieving the objectives of general economic policy.
Akatu (2013) noted, monetary policy in the Nigeria context encompasses actions of the central bank of Nigeria that affect the availability and cost of commercial and merchant bank reserve balances and thereby the overall monetary and credit condition in the economy. The main objective of such action is to ensure that over time, the long-run needs of the growing economy at stable prices.
In Nigeria, the major objectives of monetary policy include the attainment of price stability and sustainable economic growth. In pursuing these objectives, the CBN recognizes the existence of conflicts among objectives necessitating some sort of trade-offs. The targets of monetary policy are the operational target, the intermediate target and the ultimate targets. The Bank manipulates the operating target (reserve money) over which it has substantial direct control to influence the intermediate target (broad money supply, M2) which has impact on the ultimate objective of monetary policy, i.e., inflation and output (CBN, 2012).
The evaluation of monetary policy intends to show how this macroeconomic policy is formulated and executed in practice particularly in an environment of federal government fiscal dominance and highly liquid banks (Anyanwa, 2011).
Monetary policy guides the central bank’s supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income. This is necessary because money is a medium of exchange and changes in its demand relative to supply, necessitate spending adjustments.
Inflation occurs when there is a general and continuous rise in the prices of goods and services in the economy. A major cost is related to the inefficient utilization of resources because economic agents mistake changes in nominal variables for changes in real variables and act accordingly. During inflationary periods opportunity cost of holding money is increased causing inefficient use of real resources in transactions. Therefore, inflation weakens the purchasing power of money and sinks the standard of living of the citizenry. Policy makers have tried to adopt appropriate policies that can combat inflation and ensure price stability. Generally, the level of money supply and the stock of goods and services are two crucial factors that determine the level of inflation in an economy. When inflation becomes persistent, the duo becomes the primary targets of policies. An excess or shortage in the supply of money could either induce excess aggregate demand resulting in higher inflation rate or induce stagnation thus retarding economic growth and development. While fiscal policy proves helpful in combating inflationary pressure, monetary policy has been the principal tool often employed by the central banks to ensure price stability. While it is not arguable that monetary authority have formulated various policy measures as an attempt to curbing inflationary menace, the effectiveness of policy pursuit to curb inflationary environments is questionable as most economies, particularly developing ones still experience inflationary challenges
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 industrial growth.
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 of money supply is correlated with the high inflation episodes because money growth was often in excess of real industrial 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.
Figure I: graph of inflation rate in Nigeria (CBN, 2016)
In1984, inflation peaked at 39.6 per cent 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 prices 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 (CBN, 2010). In other respects the cause 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 started in the last quarter of 1987and accelerated through 1988 to 1989. This episode is related to the fiscal expansion that accompanied the1988 budget. Though initially the expansion was financed by credit from the CBN, it was later sustained by increasing oil revenue (occasioned by oil price increase following the 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 obligations. However, with the drastic monetary contraction initiated by the authorities in the middle of 1989, inflation fell, reaching one of its lowest points in1991i.e13 %(CBN, 2010). 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 of1995, it was 72.8 per cent (CBN, 2009). 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.
continuous fall of the inflation rate has been experienced since 1996 as a result of stringent monetary policies of the Central bank. It however, increased in 2001, 2003, 2005, and 2008 to 16.5%, 23.8%, 11.6%, and15.1% respectively (CBN, 2010; CBN, 2011). Structural factors have proven to be important in the inflation spiral. Reduction in oil revenue (a supply shock) led to a reduction in real income, with serious distributional implications. As workers pushed for higher nominal wages, while producers increased mark-ups on costs, an inflationary spiral followed. In addition to these factors the government also had a transfer problem in order to meet debt obligations. The failure of the monetary policy in curbing price instability has caused growth instability as Nigeria’s 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 indicators show, Nigeria’s economy has experienced different growth stages. The GDP growth rate recorded negative growth in the early 1980s (-2.7 in 1982, 7.1 in1983 and -1.1 in 1984). The growth rate increased steadily between 1985 and 1990 but fell sharply in 1986and 1987 to 2.5% and -0.2%. Except in 1991 when a negative growth rate of -0.8% was recorded, 1990s 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: 1965-1968 Rapid Decline (civil war years),1969-1971 Revival, 1972-1980 Boom, 1981-1984 Crash,1985-1991 Renewed Growth, 1992-2011Wobbling. The main thrust of this study is to evaluate the effectiveness of the CBN’s monetary policy in curbing inflation in Nigeria.
1.3 Research Questions
- What is the effect of monetary policy on inflation in Nigeria?
- Is there any long run relationship/short run relationship between monetary supply and inflation in Nigeria?
1.4 Objectives of the Study
The broad objective of the study is to examine the effectiveness of monetary policy in curbing inflation in Nigeria. However, the specific objectives are as follows.
- To examine the effect of monetary policy on inflation in Nigeria
- To investigate if there is a long run relationship/short run relationship between monetary supply and inflation in Nigeria.
1.5 Statement of Hypotheses
The hypotheses tested in this study are stated in their will forms as follows
H01: Monetary policy does not have significant effect on inflation rate in Nigeria
H02: There is no long run relationship between money supply and inflation in Nigeria.
1.6 Significance of the Study
This study is significant in the following ways:
- it would provide an objective view of the effectiveness of the monetary policy in Nigeria
- the study would also provide an econometric basis upon which to examine the effect of monetary policy on inflation;
- lastly, it would provide policy recommendations to policy-makers on ways to combat price fluctuations through the monetary policy.
1.7 Scope and limitation of the Study
The economy is a large component with lot of diverse and sometimes complex parts. This study focuses on only two macroeconomic variables i.e monetary policy and inflation. The study covers all the facets that make up the monetary policy, but shall, empirically investigate the effect of the major ones. The empirical research work deals on the effectiveness of monetary policy as a tool for controlling inflation in Nigeria. This research work covers the period of 1981-2015. The data used is a secondary data, which was obtained from the publication of central bank of Nigeria statistical bulletin and the annual reports of accounts.
1.8 Definition of Terms
1.8.1 Financial Programming: The programme is used to evaluate macroeconomic and structural conditions of an economy and determine a monetary programme for achieving policy objectives.
1.8.2 Fiscal Dominance: This is when the Federal Government’s fiscal operations through excessive deficit financing lead to expansionary money supply which renders monetary policy ineffective.
1.8.3 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.
1.8.4 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.
1.8.5 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.
1.8.6 Policy: Guidelines or set of decisions for achieving some objectives or solving problems.
1.8.7 Policy Design: Setting down the process of problem recognition and identification, nature of the problem and stating the objectives of what the policy intends to achieve. It also identifies the processes for policy analysis and implementation.
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