This study examines the effectiveness of monetary policies on inflation in the Nigerian economy using a data-rich framework. The stationarity state of the data series was tested using the Augmented Dickey Fuller (ADF) Unit Root test to avoid spurious results; while the causal relationship between inflation and monetary policy variables was determined using the Granger Causality Test and the relevance of monetary policy indicators in explaining changes in the general price level was investigated using the Ordinary Least Squares (OLS) technique which contains annual data for the period 1986-2013. The Unit Root result revealed that inflation and economic growth data series were stationary at level; while monetary policy rate, broad money supply and exchange rate were stationary at first difference implying the short-run effect of monetary policy variables on inflation in Nigeria. The Granger Causality result indicated that a uni-directional relationship exists between inflation (INF) and
1.1 BACKGROUND OF THE STUDY
policy of a country deals with control of money stock (liquidity) and therefore
interest rate; in order to influence such macro economics variables as inflation,
employment, balance of payment, aggregate output in the desired direction.
There is no standard and ideal structure of monetary policy target and
instrument, the instrument varies from country to country, depending on the
size and stage of development of the financial market.
Over the years,
the objective of monetary policy have remained the attainment of external
balance. However, emphasis on techniques/instrument to achieve this objective
have change over the years. There have been two major phases in the pursuit of
monetary policy namely, before and after 1986. the first phase placed emphasis
on the direct monetary control, while the second relies on market mechanisms.
policy before 1986: the economic environment that guided monetary policy before
1986 was characterize by the dominate of the oil sector, the expanding role of
the public sectors in the economy, and over dependence on the external sector.
In order to maintain price stability and a healthy balance of payment position,
monetary management depend on the use of direct monetary instrument such as
credit ceiling, selective credit controls, administered interest and exchange
rate, as well as the perception of cash reserve requirement and special
deposits. The use of market – based instrument was not feasible at that point
because of the underdeveloped nature of the financial market and the deliberate
restraint of interest rate.
The most popular
instrument of monetary policy was the insurance of credit rationing guideline,
which primary set rate on the change for the component of commercial bank loan
and advances to the private sector. Globally the problem of the inflationary is
not peculiar to Nigeria, but it is a general problem confronting the majority,
if not all countries of the world. The attempt by Nigerian government to attain
a higher level of economic development at this period, generally lead to
inflationary spiral in the country.
inflation in Nigeria is due to monetary mismanagement on the part of the authorizes
concerned or caused by interest structural deficiencies, still remain
uncertain. Many factors have been identified to be responsible for inflationary
pressure in the country. In a symposium of inflation in Nigeria held at
university of Ibadan
in 1983, November, most of the participant stressed on money supply, nature of
government expenditure limitations in real output and the inflation (imported)
as the major causes of inflation in Nigeria. In the case of formulating
monetary policy, it is of paramount importance to specify objectives and also impossible
to evaluate performances.
Analysis of the
institutional growth and structure shows that the financial growth rapidly in
the mid 1980s and 1990s. the number of commercial banks rose from 34 – 64 in
1995 and decline to 51 in 1998 while the number of merchant banks increased
only to 12 in 1986, to 54 in 1991 and subsequently decline to 38 in the
network, the combined commercial and merchant bank branches rose from 12,549 in
1996. There was also substantial growth in the number of non – financial
institutions especially insurance companies.
The objective of
monetary policy since 1986 remained the same as in the earlier period namely;
the stimulation of output and employment and the promotion of domestic and
external stability. In line with the general philosophy of economic management
under structural adjustment programme (SAP). Monetary policy can be developed
for encouraging investment and controlling inflation, while fiscal policy can be
effective to reducing consumption of luxury and ostentation goods. But our
major concern will be to explore the efficiency of monetary policy in an
economy in controlling inflationary pressure in an economy like Nigeria.
It is generally
believed by some economist that inflationary effects are quite harmful to some
business establishment. Thus could be so because venders often lose in the
sense that the valve of the money falls short of it original purchasing power.
The extent of the effect of inflation
in Nigeria could be appreciated from the following examples: in 1985, it stood
at 5.5 percent, indicating an annual percentage increase of 20.1 percent
compared to 40.9 percent in 1989.
It has been
accompanied with high level of unemployment rate at 4.3 percent in 1985 and 18.5
percent in 1989. Thus has force Nigeria to adopt several monetary measures
within and the problem of inflation as could be seen from the associated
increases in the cost of production during the periods under consideration.
It is therefore
under the above that we will like to adopt some of the mix of policy instrument
used and hence their efficiency as regard inflation control.