Home Project-material THE PERFORMANCE OF MONETARY POLICY IN THE NIGERIAN ECONOMY (1980-2010)

THE PERFORMANCE OF MONETARY POLICY IN THE NIGERIAN ECONOMY (1980-2010)

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Abstract

The purpose of this project work is based on the relative performance of monetary policy in the Nigerian economy. This work discussed the meaning of monetary policy is as combination of measures designed to regulate the value, supply and cost of money in an economy in consonance with the expected value of economies activities. The study shows further, the aims and objectives of monetary policy which includes price stability, maintenance of balance of payment equilibrium, promotion of employment, tackling inflation, output growth and sustainable development. The literature review shed more light on conceptual and evolutionary framework of monetary policy in Nigeria, review of monetary policy before and offer the structural adjustment programme (SAP), and appraisal of the performance of monetary policy in Nigeria were thoroughly discussed. also appropriate measures for managing inflation in the economy were also suggested from the research instruments and techniques, if wa
1.1 BACKGROUND OF THE STUDY

For most economies, the objectives of monetary policy include price stability,

maintenance of balance of payments equilibrium, promotion of employment and

output growth, sustainable development. These objectives are necessary for the

attainment of internal and external balance, and the promotion of long run

economic growth. The importance of price stability derives from the harmful

effect of price volatility which undermines the objectives. This is indeed a general

consensus that domestic price fluctuations undermines the role of monetary

values as a store of value, and frustrate investments and growth.

Ajayi and Ojo (1981) and fisher (1993), empirical states on inflation,

growth and productivity have confirmed the long run inverse relationship

between inflation and growth. When decomposed into its components, that is

growth due to capital accumulation, productivity growth, and the growth rate of

the labour force, the negative association between inflation and growth has been

traced to the strong negative relationship between it and capital accumulation as

well as productivity growth respectively. The importance of these empirical

findings is that stable prices are essential for growth due to capital accumulation,

productivity growth, and the growth rate of the labour force, the negative

association between inflation and growth has been traced to the strong negative

relationship between it and capital accumulation as well as productivity growth

respectively. The importance of these empirical findings is that stable prices are

essential for growth. The success of monetary policy depends on the operating

economic environment, the institutional framework adopted, and the

implementation of monetary policy is the responsibility of the central bank of

Nigeria (CBN). The mandates of the CBN as specified by the CBN Act of 1958

include;

? Issuance of legal tender currency.

? Maintaining external reserves to safeguard the international value of the

currency.

? Promoting monetary stability and a sound financial system.

? Acting as banker and financial adviser to the federal government.

However, the current monetary policy framework focuses on the maintenance of

price stability while the promotion of growth and employment are the secondary

goals of monetary policy. The performance of monetary policy depends on some

legal framework upon which it operates. The legal framework are quantitative

general or indirect and second, qualitative selective or direct. The effect effects

the level of aggregate demand through the supply of money, cost of money and

availability of credit. Out of the two types of instruments, the first category

include bank are variations, open market operation, and required reserve ratio.

They are meant to regulate the overall level of credit in the economy through

commercial banks. The selective credit control aims at controlling specific types of

credit. This includes changing margin requirement and regulation of consumer’s

credit (M.L Jhingan, 2003).

In any economy, the conducts of both policies are normally rooted through

banking institutions that play in the intermediation process. The role of bringing

lenders and borrowers together through this process the central bank plays a very

important role in determining the price of money (Ebhodaghe, 1996). Therefore,

monetary policy is important in its own right from the past view of monetary

economists and policy maker’s interns of its impacts on the economy. Of all tools

available to government for directing the cause of the economy, monetary

policies have proven to be the most visible instrument for achieving medium term

stabilization objectives (CBN guideline 2002). Indeed monetary policy formulation

and implementation emerged as a critical government responsibility so that the

economy does not go astray. Policies are made not only for their own sake rather

for achieving some desired goals over a given period of time.

Generally, the primary objectives of monetary policy is concerned with the

application of expansionary monetary policy measures during economic recession

and contractionary monetary policy controls money supply because it is believed

that its rate of growth has an effect on inflation. The basic aim of monetary

policies is not to aggregate themselves but the aggregate in the real sectors of the

economy such as, level of capital price stabilization and economic development.

Policies are designed in order to change the trend of some monetary variables in

particular direction so as to induce the desired behavioral change in the monetary

policy. The central bank’s role is to conduct appropriate monetary policy that is

consistent with the main economic objectives that will help the growth of gross

domestic product (GDP), sustainable inflation are and stable balance of payment

position. This is done by putting in place the direct or indirect monetary approach

so as to control monetary trends. In this regards the CBN determines the amount

of money to be supplied that is consistent with the nation’s macro-economic

objectives and manipulate the monetary instrument at its disposal in order to

achieve the stated objectives. Monetary policy influences the macrocosmic

objectives because it is believed that there occurs a relationship between the real

variables. Monetary policy affects all aspects of our economic and financial

decisions whether to buy a car, build a house, start up a business or to expand the

existing ones, whether to send one’s child to school or to make the child learn

trade. Money supply or monetary policy tries to influence the performance of the

economy as reflected in key macro-economic indicators like inflation, GDP and

employment. It works by affecting aggregate demand across the economy, that is,

individuals’ and firms’ willingness and stability to spend on goods and services. In

doing this, monetary policy has two fundamental goals to promote maximum

sustainable output and employment and to maintain sustainable price level in the

economy. The job of stabilizing output in the short run and promoting price

stability in the long run involves several steps first, the central bank tries to

estimate how the economy is doing now and how it is likely to do in the medium

term, then, it compares this estimates to its goals for the output and the price

level, if there is a gap between the estimates and the goals, the CBN have to

decide on how forcefully and swiftly to act to close the gap. Estimate of the

current economic conditions are not as even as the most up-to-date data on key

variables like employment, growth, productivity etc, largely reflect condition in

the past. So to get a reasonable estimate of the current and medium term

economic conditions, the central bank tries to find out what the most relevant

economic developments are such as government spending, economic conditions

abroad, financial conditions at home and abroad and the use of new technologies

that boos productivity. These developments are the incorporated in an economic

model to see how the economy is likely to evolve over time. In doing this, the

central bank is confronted with some unexpected development such as the NigerDelta crisis that disturbed the oil production and slowed down the revenue

generation by the government they therefore, have to build uncertainties into

their model. Uncertainty seems to be problem at every part of the monetary

policy process there is yet no set of policy and procedures that policy makers can

use to deal with all situations that may arise. Instead, policy makers must decide

how to precede by analysis the issue is far from being settled. Indeed, the central

bank spends a great deal of time and effort in researching into the various ways

to deal with different kinds of situation. Since these issues are not likely to be

resolved very soon, the central bank is likely to continue to look at everything.

Nigeria did not have any stable macroeconomic policy enforcement before and

during the inflammation of structural adjustment programme (SAP). The terms of

trade deteriorated for most of the period between 1980 to 1985 and some

previous years before the 1980. The consumer price index (CPI) growth rate was

on the average of 17.1% between 1980 and 1985 and though this fell to about

5.0% in 1986 and 1987, if again started to rise from 1988, peaking at 47.5% in

1989. It has remained consistently high in the 1990s reading an all time high of

54.7% in 1994. The current account reported as surpluses between 1989 and

1993 after a fairly long period of deficit between 1981 and 1988 (there was a

moderate surplus in 1984 and 1985 due to the austerity measures embarked

upon by the federal government under the then military administration of general

Babangida). Domestic savings as a ratio of GDP, which stood at an average of

27.7% between 1970 and1980, started to fall in 1981. Between 1981 and 1986, it

stood at 13.8% the instrument ratio has followed the same pattern although,

reporting slightly lower figures. Fiscal deficit has been chronic and is financed by

borrowing from the banking system. The share of commercial banks in total

financial assets has shown a structural shift from about 57.7% in 1986 to 36.4% in

1993, the major gainer has been the central bank whose share has increased from

33.1% to 46.4% during the same period. It is doubtful if the structural adjustment

programme has improved competitiveness in the system as the three largest

banks still amount put a third of total deposits. One major feature of banking in

the period of deregulation is the occurrence of large distress in the banking

system. Close to 42 banks were severely distressed in the system in the system

with 45 percent of loans classified as non-performing loans (CBN 1994). The

performance of major monetary and commercial banks ratios did not show any

appreciable improvement during reforms. For example, total loan and advances

measured as a ratio of GDP declined from 25.6 percent in 1986 to 14.3 percent in

1990. The aggregate domestic credit, GDP ratio which peaked at 50.3 percent in

1986, reduced by half in 1993 (24.5%) with credit to government commanding a

larger proportion. The ratio of both narrow money MI save trend. From a high

trend of 19.2 percent in 1981, MI/GDP ratio phi-meted to 11.5 percent in 1993

and M2/GDP ratio from 30.6 to 20.1 percent following the same pattern severely

negative before the liberalization exercise the deregulation exercise in 1987 yield

interest rate that were mildly negative to positive in the period 1987-1990. But

with pressure on prices thereafter real interest rates have turned severely

negative, again for the period of 1991 to 1994. It can be observed that most

macro-economic aggregates have become severely unstable in recent times it is

in this environment that indirect monetary control was initiated in 1993. Much of

difficulty in achieving the objectives of SAP resulted largely from failure to achieve

fiscal balance and the consequent reliance on borrowing from the central bank to

finance the fiscal deficits. This has adversely affected both the market for foreign

exchange, money and goods and the expected role of market in allocating

resources efficiently. The extent to which open market operations in government

bills can help to successful manage the excess liquidity in the system which is

created by government borrowing from the central bank is one of that while

should be of interest given the enormity of this problem in the attainment of

stabilization goals in the economy.

1.2 STATEMENT OF THE PROBLEM

one a yearly basis, the monetary authority formulate guidelines geared towards

the enhancement and development of policy variable designed to ensure optimal

performance of the banking industry and ultimately to advise the macroeconomic

goals or objectives but in the implementation of such policy variable certain

conflicting issues are to be addressed ranging from the ability to comply with

various monetary policy goodliness as well as satisfying depositors and

shareholders. In fact, commercial banks are reluctant in their responsibility to

comply with the rules and regulations set by the central bank such as the open

market operation (OMO), required reserve ratio (RRr), bank rate, liquidity ratio,

selective credit control and moral suasion. These are the instruments of central

bank in controlling the activities and operations of commercial banks in other to

achieve the macroeconomic objective such as growth, price stability balance of

payment equilibrium, full employment. The central bank of Nigeria (CBN)

guidelines helped in setting of the interest rates charged by the commercial

banks, sales or purchases of securities to control the money supply, and changes

in the required reserve ratios of banks and other financial institutions. The

guidelines affected other interest are both through open market operations to

affect the probability that the banks are going to need to borrow at its own

lending rate, and by the announcement effects of changes in the central bank’s

minimum lending rate, which are regarded by the markets as statement about the

authorities forecasts and objectives. The CBN guideline on monetary policy works

through the effect of the cost and availability of loans to real activity, and through

this on inflation, and on international capital movement and thus on exchange

rate.

Central Bank of Nigeria and the federal government’s formulation and

implementation of the monetary policy more or less finds its ultimate translation

to the economy in real terms. The controversy bothering whether or not

monetary policy measures actually impact on the Nigerian economy is a problem

this study sets to solve.

1.3 OBJECTIVE OF THE STUDY

The broad objective of the study is to examine the effectiveness of monetary

policy in the Nigerian economy. The specific objectives are as follows.

? To assess the impact of money supply on economic growth in Nigeria

? To determine the impact of liquidity ratio on economic growth in

Nigeria.

? To ascertain the effect of interest rate on Nigeria’s GDP

1.4 STATEMENT OF HYPOTHESES

The hypotheses tested in this study are stated in their will forms as follows

H0: Money supply has no significant impact on GDP in Nigeria

H02: Interest rate in Nigeria has no significant impact on GDP

H03: There is no significant relationship between liquidity ration and GDP in

Nigeria

1.5 SCOPE OF THE STUDY

This work is aimed at examining the performance of monetary policy is on the

Nigerian economy, the effects, the appraisal, and possibly the solution to the

problems facing the implementation and working of monetary policies in Nigeria.

1.6 SIGNIFICANCE OF THE STUDY

This study will be of great benefit to bankers, investment analysts, government

agencies, academics, private and public sectors more so, it will be useful to

policymakers in the attempt to fashion out dynamic and reliable monetary policy

measure for controlling commercial banks ability to create money and thereby

influence the effective development of the economy.


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