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EVALUATION OF THE IMPACT OF MONETARY POLICY ON ECONOMIC GROWTH AND INFLATION IN NIGERIA

Format: MS WORD  |  Chapter: 1-5  |  Pages: 72  |  1717 Users found this project useful  |  Price NGN5,000

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Monetary policy as defined by Anyanwu (1993) involves measures designed to control the volume, cost, availability and direction of money and credit in an economy to achieve some specified macroeconomic policy objectives. It also refers to the policy of monetary authority of a country with regard to monetary matters. It may be defined as the policy that deals with;

(a) The control of financial institutions

(b) Active purchases and sales of paper asset by the monetary authority as a deliberate effort/attempts to effect changes in the money conditions and

(c) Maintenance of particular interest rate structure, the stability of security prices or meeting other obligations and commitments.

Monetary policy is one of the macroeconomic policies available for managing the economy. It is however important today because of its effects on such macroeconomic aggregate as price, output, interest rates and exchange rates.

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 line with the expected level of economic activity (Okwu et al, 2011; Adesoye et al, 2012; Baghebo and Ebibai, 2014). For most countries, the objectives of monetary policy include price stability, maintenance of balance of payments equilibrium, promotion of employment and output growth, as well as sustainable development (Folawewo and Osinubi, 2006). These objectives are necessary for a nation to attain internal and external balance, and the promotion of long-run economic growth (Imoughele, 2014).

The importance of price stability derives from the harmful effects of price volatility, which undermines the ability of policy makers to achieve other laudable macroeconomic objectives. There is indeed a general consensus that domestic price fluctuation undermines the role of money as a store of value, and frustrates investment and growth. Empirical studies (Ajayi and Ojo, 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 conditions 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 or crisis-ridden 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 signals correctly. Typically, in periods of high inflation, the horizon of the investor is very short, and resources are diverted from long-term investment to those with immediate returns 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.

In most countries, the central bank is saddled with the responsibility of conducting monetary policy. In the case of Nigeria, the responsibility entirely lies with the Central Bank of Nigeria (CBN) .The discretionary control of money stock by the monetary authority involves the expansion/contraction of money, influencing interest rate to make money cheaper or more expensive, depending on the prevailing economic situation.

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.

However, there is need to point out that the Central Bank of Nigeria (CBN) adopted a medium term framework for the conduct of monetary policy. In the words of CBN, say “in recognition of the fact that monetary policy impacts on the ultimate objectives with substantial lag”. Furthermore, the shift was designed to free monetary policy from the problem of time inconsistency and overreaction owing to temporary shocks.

Central Bank of Nigeria was established in 1959 with the primary function of regulating stock of money in a way to promote social welfare (Ajayi, 1999). This function is tied to the use of monetary policies which aim to achieve core macroeconomic objective of full-employment equilibrium, rapid economic growth, price stability, and external balance (Fasanya et al, 2013; Adesoye et al, 2012). Thus, inflation targeting and exchange rate policy have dominated CBN’s monetary policy focus based on supposition that these are vital tools of achieving macroeconomic stability (Aliyu and Englama, 2009).

The economic conditions that influenced monetary policy before 1986 were mainly dominated by the oil sector, the increasing role of the public sector in the economy and over-reliance on the oil sector. In order to maintain price stability and a healthy balance of payments position, monetary authority relied on the use of direct monetary instruments such as credit ceilings, selective credit controls, administered interest and exchange rate, as well as the recommendation of cash reserve requirements and special deposits. The use of market-based instruments was not viable due to the underdeveloped nature of the financial markets and the deliberate restraint on interest rates (Ajayi, 1999).

After 1986, with the CBN’s amended Act, the apex bank assumed full autonomy and discretion in the conduct of monetary policy and consequently, the focus of monetary policy during this period shifted considerably from growth and developmental objectives to price stability (Adeoye, et al. 2014). However, Ebiringa, et al. (2014) conceded that monetary policies implemented lately in Nigeria have been designed in fast tracking economic reform programmes with the aim of providing favorable financial system infrastructure and environment to support sustainable economic growth. The most widely use instrument of monetary policy was the issuance of credit rationing guidelines, which basically set the rates of change for the components and aggregate commercial bank loans and advances to the private sector. The sectoral allocation of bank credit in CBN guidelines was to induce the productive sectors and thereby arrest inflationary pressures. The setting of interest rates at reasonable levels was done mainly to promote investment and growth. Periodically, special deposits were enforced 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-1970s on the basis of their total deposit liabilities, but since such cash ratios were usually lower than those maintained by the bank, they proved less efficient as a restraint on their credit operations.

The annual reports of the Central Bank of Nigeria (CBN) and monetary policy circulars that it issues to the commercial banks form the basis for a quantitative assessment changes in monetary policies. With regard to the monetary circulars, the content changes from one year to another depending on the objective pursued by the central bank.

This study will enable us to understand what the framework of monetary policy in Nigeria looks like. It will further throw more light on its evaluation in the Nigerian economy. Data relating to necessary variables in the research work will be sound from the Nigerian economy.

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EVALUATION OF THE IMPACT OF MONETARY POLICY ON ECONOMIC GROWTH AND INFLATION IN NIGERIA

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