1.1 Background to the Study
Monetary policy is one of key economic variables that influences economic growth. The growing importance of monetary policy has made its effectiveness in influencing economic growth a priority to most governments. Despite the lack of consensus among economists on how monetary policy actually works and on the magnitude of its effect on the economy, there is a remarkable strong agreement that it has some measure of effects on the economy (Nkoro, 2005)
Monetary policy as a combination of measures designed to regulate the value, supply and cost of money in an economy, in consonance with the expected level of economic activity (Folawewo and Osinubi, 2006). For most economies, the objectives of monetary policy include price stability, maintenance of balance of payments equilibrium, promotion of employment and output growth, and sustainable development. The pursuit of price stability invariably implies the indirect pursuit of other objectives such as economic growth, which can only take place under conditions of price stability and allocative efficiency of the financial markets. Monetary policy aims at ensuring that money supply is at a level that is consistent with the growth target of real income, such that non-inflationary growth will be ensured. Monetary policy is used as inflation is generally considered as purely a monetary phenomenon (CBN, 2014).
Monetary policy can be described as a deliberate effort by the monetary authority to control money supply and credit conditions for the purpose of achieving certain broad economic objectives which might be mutually exclusive(Ajisafe and Folorunsho, 2002). Monetary policy measures is necessary for the attainment of internal and external balance, and the promotion of long-run economic growth. For example, an expansionary monetary policy designed to stimulate economic growth will lower the rate of interest and may generate higher inflation which the level of growth may not be able to prevent (Gertler and Gilchrist, 2009).
The effectiveness of monetary policy in achieving its target objectives, therefore, depends strongly on the operating economic environment, the institutional framework adopted, and the choice and mix of the instruments used (Ogbole, 2010).
Monetary policy is inextricably linked in macro-economic management; developments in one sector directly affect developments in the other. Undoubtedly, monetary policy is central to the health of any economy, as government’s power to tax and to spend affects the disposable income of citizens and corporations, as well as the general business climate (Adefeso and Mobolaji, 2011).
Monetarist strongly believes that monetary policy exacts greater impact on economic activity as unanticipated change in the stock of money affects output and growth i.e., the stock of money must increase unexpectedly for central bank to promote economic growth. In fact, they are of opinion that an increase in government spending would crowd out private sector and such can outweigh any short-term benefits of an expansionary fiscal policy (Adefeso and Mobolaji, 2011). On the other hand, the concept of liquidity trap which is a situation in which real interest rates cannot be reduced by any action of the monetary authorities was introduced by Keynesian economics. Hence, at liquidity trap an increase in the money supply would not stimulate economic growth because of the downward pressure of investment owing to insensitivity of interest rate to money supply(Ogbole, 2010).
Monetary policy is a major economic stabilization weapon that involves measure 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).
1.2 Statement of the Problem
Over the years, there has been expansion in deficit financing and unstable monetary policy, driven largely by oil prices between 1991 and 1992, and 2000 and 2002; revenue and expenditure have increased sharply. This, as typically seen, followed the reduction of expenditures as oil prices substantially decline, though at times with an interval after the decline in oil prices. The implications of such boom-burst fiscal policies include transmission of oil-price volatility to the stable provision of government services. This has added to the failure over the years of public spending and stagnancy in economic growth.
The Nigerian economy has witnessed substantial growth since the country’s attainment of political independence in 1960. The real value of gross domestic product (GDP) jumped from N2, 489 million in 1960 to N4, 219 million in 1970 and therefore heaved to record about N31, 546 million in 1980. Following the foreign exchange crisis of 1981–1986, accompanied by the downfall of international crude oil prices, the magnitude of growth skewed from the path it would have otherwise taken. Economic growth witnessed a steady fall between 1980 and 1984 for thereafter regained momentum taking an upward trend there from. Thus, the growth rate of the Nigerian economy, which had averaged 2.5 per cent annually in the 1960s, climbed to an annual average of 10 per cent between 1970 and 1989.
Industrial development is attributable to several factors and these includes amongst others, the rate of capital accumulation and saving, volume of trade, research and development, volume of external trade (exports) and so on. The enormous fiscal expansion overtime is a key factor cannot be overemphasized. Monetary expansion, which reflects either demand for credit by the domestic economy or government fiscal expansion is a major determinant of inflation. Although with a lag, aggregate demand and inflation move in tandem. However an increase in real output, particularly food output, has a dampening effect on the general price level. It is pertinent to note that monetary and fiscal policy in Nigeria is conducted in an environment characterized by uncertainty and frequent economic policy somersaults. Also the development of an adequate framework for sustainable growth and development is complicated by inconsistent policies, bureaucracy and variations in environmental conditions either of a climatic nature or crises.
Growth in money supply was substantial as broad and narrow money have exhibited upward trend overtime. Money supply, M1 and M2 grew rapidly from 16.3 and 19.4 per cent in 1995 to 48.1 and 62.2 per cent in 2000, respectively. The growth in monetary aggregates was due to factors such as: rapid monetization of oil inflows, minimum wage adjustments, and the financing of government’s fiscal deficits through the banking system. Credit to the private sector, by contrast, declined sharply from 48.0 per cent in 1995 to 23.9 per cent in 1997 and thereafter increased gradually to 30.9 per cent in 2000. However, it stayed within the prescribed limits in only three (3) out of the six-year time frame (1995-2000). Overall, the major source of liquidity was growth in credit to government in most of the years. Generally, inflationary pressure induced by high money supply has been one of the major factors that have consistently undermined the attainment of sustainable growth in Nigeria, even amidst persistent and robust economic reform packages.
It will be recalled that amongst the major macroeconomic objectives of Nigeria and other economies is the pursuit of growth and maintenance of price stability. Using this yardstick, the outcome of inflation and money growth in Nigeria has been generally mixed. By definition, price stability in Nigeria refers to the achievement of a single-digit inflation rate on an annual basis. Indeed, this objective has not been achieved on a sustained basis. For example, in 1995 the rate of inflation was 72.8 per cent while the target of single digit inflation was achieved in only three (3) out of six (6) years, between 1995 and 2000. In fact, the single-digit inflation rate that materialized was attributable to a favourable agricultural harvest3
. The performance of the real sector improved in 2001, with the real gross domestic product growing by 3.9 per cent. The major sources of growth were agriculture, manufacturing, merchandise, transportation, finance and insurance and government services. However, inflationary pressures accelerated as a result of the liquidity surfeit fuelled by expansionary fiscal operations and the lingering structural bottlenecks that increased costs of doing business in the economy while the unemployment level remained high.The Nigerian economy started experiencing recession from early 1980s that led to a depression in the mid-1980s. This depression continued until early 1990s without recovering from it. As such, the government continually initiated policy measures that would tackle and overcome the dwindling economy. Drawing from the experience of the great depression, government policy measure to curb the depression was in the form of increased government spending (Nagayasu, 2003).
According to Okunroumu (1993), the management of the Nigerian economy in order to achieve macroeconomic stability has been unproductive and negative, hence one cannot say the Nigerian economy is performing. This is evident in the adverse inflationary trend, government fiscal policies, rippling foreign exchange rates, the fall and rise of gross domestic product, unfavourable balance of payments as well as increasing unemployment rates which are all symptoms of growing macroeconomic instability. As such, the Nigerian economy is unable to function well in an environment where there is low capacity utilization attributed to shortage in foreign exchange as well as the volatile and unpredictable government policies in Nigeria (Isaksson, 2001). Therefore, there is need to examine the impact of monetary policy on economic growth of Nigeria.
1.3 Research Questions
The following questions will be examined in this study:
1.4 Objective of the Study
The broad objective of this study is to examine the impact of monetary policy on economic growth in Nigeria from 1981 to 2015. While the specific objective objectives of the study include:
1.5 Hypotheses of the Study
HO1
: money supply has no significant effect on the economic growth in Nigeria HO2
: Monetary Policy Rate (MPR) has no significant effect on the economic growth in Nigeria1.6 Significance of the Study
Monetary policy is undoubtedly one of the most important tolls used by government to achieve macroeconomic stability of the economy of most developing countries. Therefore, this study will be an invaluable tool to the following;
The government; this study will be relevant to the government, as it will help them in making and implementing policies that will help to stabilize the Nigerian economy.
Students; it will bring increased visibility, usage and impact for their work by adding to the existing literatures on the impact of monetary on economic growth in Nigeria.
Researchers: this study will serve as a tool for reference purposes for other researchers in similar areas.
1.7 Scope and Limitation of the Study
This study focuses exclusively on the effect of monetary on economic growth of Nigeria. The study will examine the impact of monetary on economic growth of Nigeria from 1981 to 2015. This period of time is chosen due to the availability of data on the subject matter and the change in the economic structure of Nigeria in the year 1986. The study would make use of key variables such as money supply and monetary policy rate.
However, the study would be limited by the data range covering 1981-2015 due to the available latest bulletin of CBN statistical report as the time of the research proposal.