Home Project-material THE IMPACT OF MONETARY POLICIES ON INFLATION IN NIGERIA

THE IMPACT OF MONETARY POLICIES ON INFLATION IN NIGERIA

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Abstract

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

CHAPTER ONE

INTRODUCTION

1.1 

BACKGROUND OF THE STUDY

The monetary 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.

The monetary 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.

But whether 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.



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