ABSTRACT
The major objective of this study is to analyze the effect of monetary policy on inflation and money supply in Nigeria within the period of 1986-2016. Specifically, we examined the effect of exchange rate, interest rate and net domestic credit on statutory liquidity ratio in Nigeria, as well as determined the effect of exchange rate, interest rate and net domestic credit on cash reserve ratio in Nigeria. Data were collected through secondary sources mainly from central bank statistical bulletin and were analyzed using multiple regression analyses with EVIEW statistical package. The result of analysis shows that there is significant effect of exchange rate, interest rate and net domestic credit on statutory liquidity ratio. However, exchange rate, interest rate and net domestic credit shows no significant effect on cash reserve ratio. The study recommends that monetary authority should re-evaluate these policies to suite the present macroeconomic challenges in Nigeria. Nigeria should develop and strengthen every sector that contributes to economic growth of Nigeria. The monetary authority should not only aim at reducing inflation, but also ensure that the real economy is stabilized. Nigeria should diversify their resource base and not solely depending on oil as its major export earner. On the basis of the findings the researcher concludes that monetary policy in Nigeria has not done well in fighting inflation and stabilizing the economy of Nigeria and as such the policies should be reviewed to solve prevailing macro economic problems of Nigeria.
CHAPTER ONE
INTRODUCTION
- Background to the Study
The economic and financial situation of a country is largely based on the monetary policy being implemented by the Central Bank of the country. It is widely agreed that monetary policy can contribute to sustainable growth by maintaining price stability. According to Christiano and Fitzgerald (2010), when the rate of inflation is sufficiently low households and businesses do not have to take into account when making everyday decisions on income, expenditure and investment.
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting the rate of interest for the purpose of promoting economic growth and stability. Its official goal is to ensure relatively stable prices and low unemployment. In practice, all types of monetary policy, involve modifying the amount of base currency in circulation. This process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called open market operations. The constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate.
Monetary policy is the summation of the economic actions taken by regulatory authorities in-charge of regulating or managing the dynamic economic variables that affect changes in the prices of goods and service, hence the value of money, Demchuk ,(2012). Usually, these dynamic economic variables are grouped as short-term macroeconomic factors and include instruments like demand and supply of money, interest/discount rates, volume of credits, and size of deposit money institutions’ reserves. These instruments are so volatile that their regulation/management has direct implications on the price stability goals of macroeconomic authorities. Of course, it is worth noting that price generally covers the values that goods and services as well as foreign exchanges are traded. Kovanen, (2011). Although little emphasis is paid to deflation, most concerns of regulatory authorities have been on inflation, over time. Again as the controversy on the role of money supply in the control of inflation rages on among classical, Keynesian, monetary and neoclassical economists, managers and policy-makers of emerging economies are tilting towards a combination of the various postulations in managing inflation, with the main focus on inflation targeting as the guiding framework of monetary policy actions (Mukherjee and Bhatta, 2011). Inflation is an economic condition in which more money is demanded in periods of falling value of money as a result of consistent, persistent and sustained increases in the prices of goods and services. It is the economic phenomenon that describes the reduction in the purchasing power per unit of money, meaning a loss of real value in the medium of exchange and unit of account within the economy, Mishkin (2011). Inflation targeting, which is an outshoot of quantity theory of money, considers the after-effect of periods of inflation, given the various stages of monetary transmission process undergone (Lyziaka, 2012). Under inflation targeting, movements in the monetary policy rate and short-term interest rate (ultimately in retail interest rates) form the key transmission media among monetary policy instruments, money supply and inflation, and any mismatch between the monetary and fiscal policy objectives makes price stability macroeconomic objective useless (Ezirim, 2005).
For a developing economy like Nigeria, it is vital to analyze monetary policy transmission effect on inflation and money supply for several reasons, such as the determination of the appropriate channel and the effectiveness of monetary policy in managing inflation and exchange rate among other reasons (Bussimis and Magginas, 2006).
According to the Keynesians, increased private and government spending, natural disasters, or increased prices of inputs, and price/wage spiral are the causes of inflation. However, Ezirim (2005) has shown with the aid of econometrics that monetary factors cause inflation in emerging markets like Nigeria. This is in agreement with the monetary theory school of thought, whether the inflation is money inflation or price inflation, the underpinning assertion is that monetary policies influence price inflation (hereafter referred to as inflation) by influencing the financial conditions existing in the economy. According to Laurence (2001), These financial conditions (savings, deposits, investments, lending / borrowing, conservation/spending of incomes, and proportion of funds meant for effecting demand for goods and services) adjust to the various rates charged or permitted by regulatory authorities for the movement/usage of funds (money supply).
The central bank through the deposit money banks implements policies that guarantee the orderly development of the economy through appropriate changes in the level of its various instruments of monetary policy which include the cash reserve ratio, liquidity ratio, open market operations and primary operation to influence the movement of reserve (Ajie,Nenbere,2010 and Masna et al 2014) .The sectional allocation of bank credit in CBN guideline was to stimulate the production sector and thereby stem inflationary pressure. The fixing of interest rate at relatively low level was done mainly to promote investment and growth. Occasionally special deposits were imposed to reduce the amount of free reserve and credit creating capacity of the bank. Minimum cash ratio were usually lower than those voluntary maintained by the banks, they proved less effective as a restraint on their credit operations.
For most economies the objective of the monetary policy include price stability, maintenance of balance of payment equilibrium, promotion of employment and output growth, 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 (Imougbele 2014)
The monetary authorities, especially the Central Bank of any country, use their regulatory tools to influence the availability of money in the economy through the various banks and financial institutions.
It is against this background that this study is conducted to ascertain the veracity of the link or relationship between monetary policy and the commonly dreaded economic phenomenon called inflation, and the rate of money supply in Nigeria.
- Statement of the Problem
The dent for effectiveness of monetary policy is deepened in an underdeveloped financial market like Nigeria (Andreas, 2010). Despite the application of the monetary policy tools, inflation and money supply has continued to pose challenges to the monetary authorities. Some of the reasons include the inability of the monetary authorities to enforce compliance through the monetary channel in the banking and non-banking institutions, and fiscal imbalance characterized with expansionary fiscal policy with deficit budget (Gogor, 2011).
Indeed, it is increasingly being recognized that a process of rapid economic growth is likely to provoke inflationary pressures and money supply in a country. However, whether the problem of inflation in this country is due to mismanagement of monetary policy tools or structural deficiencies still remain a controversial matter.
According to Umeredu (2010), the problem is not peculiar to Nigeria but has assumed a global phenomenon. It is generally agreed worldwide that inflation is socially unjust. It also affects general economic behavior and the pattern of resource allocation. By distorting price relations and undermining general confidence, prolonged inflation tends to affect money supply and thus slackens growth. Furthermore, inflation discourages private saving and encourages speculation among the various economic units. Another consequence is that it results to balance of payment difficulties and reduces the external reserves.
The economy of Nigeria is faced with macroeconomic problems of high inflation rate and unemployment. But one of the objectives of monetary policy in Nigeria is price stability, despite the monetary regimes that have been adopted by the central bank of Nigeria over the years. We are still faced with the threat of inflation, unemployment, unsatisfactory expansion of domestic output these problems have continued to make our economy less striving. There is a nagging question of whether monetary policy is not an effective instrument of economic stability because the monetary policy instruments have been in operation in Nigeria since the establishment of the Central Bank of Nigeria as the apex Bank. Monetary policy has not has not solves the major macroeconomic problems of economy. The Nigeria economy is also characterized by policy summersaults. Monetary policies initiated by an administration are not sometimes continues or implemented by succeeding administrations, sometimes Monetary policy measures not implemented at the appropriate time (Folawewo and Osinubi 2006)..
Economic aggregate as: national income, savings, investment and consumption expenditure have been experimented upon to varying degrees with respect to taxes, public expenditure, savings campaign, credit controls, wages adjustments and all the conceivable anti- inflation measures affecting the propensities to consume, save and invest which all combined should determine the general level of living standard.
All the measures so far adopted have remained inadequate for solving the problem of inflation and money supply in the country. The untold sufferings of masses are unending as daily market prices of goods and services surge higher without corresponding increase in money supply. Indeed a more far reaching solution to the problem is needed hence, this study seeks to investigate the effect of monetary policy on inflation and money supply in Nigeria.
- Research Questions
The following research questions are pertinent to the study.
- What is the relationship between exchange rate, interest rate, net domestic credit and statutory liquidity ratio in Nigeria?
- How do interest rate, exchange rate and net domestic credit affect cash reserve ratio in Nigeria?
- Objectives of the Study
The main objective of this study is to investigate the effect of monetary policy on inflation and money supply in Nigeria. However, in achieving this objective, the following specific objectives are necessary.
- To examine the effect of exchange rate, interest rate and net domestic credit on statutory liquidity ratio in Nigeria.
- To determine the effect of exchange rate, interest rate and net domestic credit on cash reserve ratio in Nigeria.
- Research Hypotheses
The following hypotheses were posited from the objectives and are stated in null form:
- Ho: There is no significant relationship between exchange rate, interest rate, net domestic credit and statutory liquidity ratio in Nigeria.
H1: There is significant relationship between exchange rate, interest rate, net domestic credit and statutory liquidity ratio in Nigeria.
- Ho: Exchange rate, interest rate and net domestic credit have no significant effect on cash reserve ratio in Nigeria.
H1: Exchange rate, interest rate and net domestic credit have significant effect on cash reserve ratio in Nigeria.
- Significance of the Study
This work will be of immense benefits to the government (policy makers), investors, academics and the general public. The importance of this study to policy makers cannot be over- emphasized in the economy considering the alarming rate of inflation over the years especially in this time of recession.
At the end of this work, government agent and policy makers will see an avenue to cushion the effect of inflation currently playing the country and revisit the economic policy of the country in order to alleviate the untold hardship the masses are subjected to, as well as ways of boasting money supply in the country.
This study will also be of immense help to investors – both foreign and indigenous as the findings of the study help to highlight the inflationary trend of the country and as such enable the investors to analyze the country critically and invest wisely.
Furthermore, to future researchers, this study will add to the existing literature on the application of monetary policy to cushion the effect of inflation and money supply in the country. as it forms a reference for future related studies.
- Scope of the Study
The study is to investigate the effect of monetary policy on inflation and money supply in Nigeria. It covers the period, 1986 to 2016 taking inflation and money supply as independent variables and monetary policy as the dependent variable.
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