Download an evaluation of monetary policy instruments in achieving monetary

AN EVALUATION OF MONETARY POLICY INSTRUMENTS IN
ACHIEVING MONETARY TARGETS IN NIGERIA
BY
NWABUKO KELECHI KELVIN
PG/MBA/12/64221
BEING A PROJECT PRESENTED TO
THE DEPARTMENT OF MANAGEMENT,
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA, ENUGU CAMPUS
IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR
THE AWARD OF THE MASTER OF BUSINESS
ADMINISTRATION DEGREE IN MANAGEMENT
SUPERVISOR: DR AGBAEZE, E.K.
SEPTEMBER, 2014
1
APPROVAL PAGE
This work has been approved for the Department of Management, Faculty of Business
Administration, University of Nigeria Enugu Campus, by:
________________________________
________________________________
-
Dr Abgaeze, E.K.
Date
(SUPERVISOR)
_____________________________
_____________________________
DR. E.O. Ugbam
Date
(Head of Department)
2
CERTIFICATION
Nwabuko Kelechi Kelvin, a postgraduate student in the Department of Management, Faculty of
Business Administration with Registration Number PG/MBA/12/64221 has satisfactorily
completed the requirements for research work for the Degree of Master of Business
Administration in Management. The work incorporated in this dissertation is original and has not
been submitted in part or in full for any other Diploma or Degree of this University or any other
Institution of higher learning.
......................................................................
NWABUKO KELECHI KELVIN
(STUDENT)
3
DEDICATION
This project is dedicated to the Almighty God for his infinite mercy and divine favour
toward me.
4
ACKNOWLEDGEMENT
I give thanks and praises to God Almighty for giving me the ability to complete this
project. Considering the numerous traveling and sleepless nights. I also want to thank
wife and family for their support and understanding during this program.
Special thanks to my supervisors, Dr Agbaeze E.K for his support Dr. Augustine Ujunwa
for his help and mentorship.
Finally, I want to thank my friends who in one way or the other contributed to the success
of this work, I love you all, you guys are wonderful.
Nwabuko Kelechi Kelvin
PG/MBA/12/64221
Management
5
ABSTRACT
The study evaluates the impact of monetary policy instruments in achieving monetary
policy targets in Nigeria. The study used correlation co-efficient to evaluate monetary
policy transmission mechanisms on monetary policy targets such interest rate, inflation
rate and exchange rate. The findings of the study show that monetary policy tools have
not been effective in achieving monetary policy targets. The researcher attributes this to
frequent changes in monetary policy and the level of uncertainty of the Nigerian economy
as shown in the review of monetary policies in Nigeria. Based on the findings, the study,
recommends for ensuring stable macroeconomic environment, promotion of healthy and
competitive financial system, the need to bolster the technical competence of CBN among
others.
6
TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION
1.1
Background of the Study
1
1.2
Statement of Problem
2
1.3
objective of the Study
2
1.4
Research Questions
3
1.5
Research Hypotheses
3
1.6
Scope of the study
3
1.7
Significance of the study
4
1.8
Limitation of the study
4
References
6
CHAPTER TWO: LITERATURE REVIEW
2.1
Monetary policy and Economic schools
7
2.2
Empirical literature
16
2.3
Stylized facts of inflation in Nigeria
19
2.3.1
Components and structure of Consumer Price Index
19
2.3.2
Institutional Framework and the Mandate of price stability
21
2.4
Relationship between Inflation and key Macroeconomic Variable
22
2.5
Trends in inflation and policy response in Nigeria
24
2.5.1
Definitions of variable
28
2.6
The Conceptual basis for Monetary Management
30
2.7
Appropriate Exchange rate
34
2.8
Interest rates
38
2.9
Achieving the trinity
44
References
49
7
CHAPTER THREE: RESEARCH METHODOLOGY
3.1
Research Design
53
3.2
Sources of Data
53
3.3
Method of Data Analysis and Technique for Analysis
53
References
54
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
4.1
Introduction
55
4.2
Data Presentation
55
4.3
Data Analysis
62
4.4
Test of Hypothesis
63
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1
Summary of Findings
66
5.2
Conclusion
66
5.3
Recommendation
67
Bibliography
69
8
LIST OF TABLE
Table 1: Percentage contribution of Items in the CPI Basket of Goods
21
Table 4.2.1: Margin of Deviation between Actual Inflation Rate and
Monetary Policy Target Inflation Rate
55
Table 4.2.2: Margin of Deviation between Actual Interest Rate and
Monetary Policy Target Interest Rate.
56
Table 4.2.3: Margin of Deviation between Actual Exchange Rate and
Monetary Policy Target Exchange Rate.
56
Table 4.2.4: Estimation for Regression Equation for Inflation Rate
57
Table 4.2.5: Estimation for Regression Equation for Interest Rate
59
Table 4.2.6: Estimation for Regression Equation for Exchange Rate
61
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AN EVALUATION OF MONETARY POLICY INSTRUMENTS IN
ACHIEVING MONETARY TARGETS IN NIGERIA
BY
NWABUKO KELECHI KELVIN
PG/MBA/12/64221
DEPARTMENT OF MANAGEMENT
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA
ENUGU CAMPUS
SEPTEMBER, 2014
10
CHAPTER ONE
INTRODUCTION
1.1
Background of the Study
Because money can affect many economic variables that are important to the wellbeing
of any economy, politicians and policy makers throughout the world care about the
conduct of monetary policy- that is -the management of inflation rates, exchange rates
and interest rates (Cukierman, Webb and Neyapti, 1992). The institution responsible for
the conduct of a country’s monetary policy is the Central Bank. Monetary policy involves
changes in the money supply or the choice central banks make regarding the money
supply (Essien, 2005).
According to Essien (2002), it is how the monetary authorities choose to regulate and
control the value, supply and cost of money in the economy in consonance with the
expected level of economic activity. In choosing how best to regulate the money supply,
the Central Bank makes use of monetary policy instruments to influence certain variables
to achieve some intermediate goals, which would eventually lead to the ultimate
objectives. The impacts of these policy instruments are translated to the economy through
a process called transmission mechanism. De-Brouwer and Ericsson (1995) stresses that,
the channel of transmission can be through either quantities or prices. He however, added
that the policy could be transmitted through quantities via the monetary or credit channels
and through prices via the interest rate, exchange rates or asset prices.
Monetary policy generally describes the actions taken by the central bank to influence
monetary conditions in the economy with a view to achieving some defined
macroeconomic goals.The mandate of the Central Bank of Nigeria (CBN) is derived from
the CBN Act of 1958, as amended in 1991, 1993, 1997, 1998, 1999 and 2007.The Act
charges the Bank with the overall control and administration of the monetary and
financial sector policies of the Federal Government of Nigeria. The act statutorily
mandates CBN to: issue legal tender currency in Nigeria; maintain external reserves to
safeguard the international value of the legal tender currency; ensure monetary and price
11
stability; promote a sound financial system in Nigeria; and act as banker and provide
economic and financial advice to the Federal Government of Nigeria. The attainment of
these goals would result into the country achieving both internal and external balance
(Duravell and Ndungu’u, 1999). The essence of this study is to appraise the effectiveness
of these monetary policy instruments in the management of Nigerian economy.
1.2
Statement of Problem
Nigeria economy like many others of the developing countries has in the last two decades
been beset by a number of problems which includes:- rising inflations, persistent
weakness of the national currency (the Naira) in the foreign exchange market, slow
growth, high interest rate, massive unemployment and huge external debt burden.
These problems have remained persistent and challenging to the authorities and managers
of the nation’s economy despite the application of various monetary policy measures.
This situation has often created frustrations or even doubt on the relevance or other wise
of the application of monetary policy measures in the management of the economy. For
instance, it was widely reported in the media in 1989 that the former military President of
Nigeria, General Ibrahim BadamosiBabangida once said, “The Nigerian economy has
defiled all known economic theories”.
However, the growing interest on price stability as a major goal of monetary policy is an
acknowledgement of the observed phenomenon that low inflation provides a base for
sustained economic growth and development (Debelle and Fischer, 1995; Dornbusch,
Fisher and Kearnay, 1999). It is in the light of this that it becomes imperative to critically
appraise the relevance of the instruments of monetary management and analyze the
relationship between actual inflation and monetary policy target inflation, actual interest
rate and monetary policy target interest rate as well as actual exchange rate and monetary
policy target exchange rate in Nigeria.
1.3
Objectives of the Study
The objective of this study is to access the effectiveness of monetary policy tools in the
management of Nigerian economy. In order to achieve this, the study pursues the
following specific objectives.
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a. To critically appraise the relevance of the instruments of monetary and credit
policies and examine the challenges of ensuring appropriate inflation rate,
exchange rate and interest rate regimes in Nigeria.
b. To find the relationship between actual inflation rate and monetary policy target
inflation rate, actual interest rate and monetary policy target interest rate and
actual exchange rate and monetary policy target exchange rate.
c. Identify those factors prevalent which has led to the ineffectiveness or otherwise
of monetary policy instruments in Nigeria and suggest ways of overcoming them.
1.4
Research Questions
This study provides answers to the following questions;
a. Are monetary policy instruments truly relevant in the management of the
inflation, interest and exchange rate?
b. What is the nature of relationship between actual inflation rate and monetary
policy target inflation rate, actual interest rate and monetary policy target interest
rate and actual exchange rate and monetary policy target exchange rate?
c. What arethose factors prevalent which has led to the ineffectiveness of monetary
policies in Nigeria
1.5
Research Hypotheses
The following research hypotheses are postulated:1.
The monetary policy instruments are relevant in the management of inflation rate,
exchange rate and interest rate in Nigeria.
2.
There is a linear relationship between actual inflation rate and monetary policy
target inflation rate, actual interest rate and monetary policy target interest rate and
actual exchange rate and monetary policy target exchange rate.
3.
There are causative factors that made monetary policy ineffective in checking
inflation, interest rate and exchange rates.
1.6
Scope of the Study
The study covers the period: 2000-2007. The choice for this is first, to allow for the lag
effects of financial sector deregulation which started in 1986, and not drift into the 2008
13
financial crisis so as not to allow the stimuli packages bias the results. It is also a period,
which was characterized by mounting pressure for granting of full autonomy to the CBN to
enable the apex regulatory body well positioned to play its statutory role in the management
of the economy in line with the global trend.
1.7 Significance of the Study
The results of this study will be significant to the following;
a. Regulatory Authorities
The regulatory authorities and policy makers have often been accused of not doing enough
towards solving the nation’s economic problems. Many a time, actions taken are
misunderstood, thereby making it very difficult for the enjoyment of the co-operation of all in
order to realize the objectives of the policy. This has been so despite the fact that the cooperation and understanding of the citizenry is needed for the policy measure to work. This
research work will therefore, assist the Government and policy makers to appraise the
relevance of the monetary policy instruments that has been in use and help in finding a lasting
solution towards solving the nation’s economic crises both in the short and long term.
b. Firms and Households
The business class and household will benefits as they will be made to come to terms with the
past, present and future efforts of the government and policy makers toward addressing the
crises besetting the nation’s economy.
c. Body of Academics
This study will benefit students offering courses in monetary theory and policies. Essentially,
the study provides a very good understanding of monetary policy transmission channels
mechanisms in Nigeria. This is very important for having a practical understanding of how
monetary policies impacts on the economy. The study will also provide valuable research
materials for scholars wishing to pursue further studies along this area. This study opens-up
further research areas around this topic
1.8.
Limitations of the Study
The time requirements, the financial involvement and the difficulty of obtaining the necessary
materials for an extensive research involving a national as well as International dimension like
14
the relevance of the monetary policy instruments in Nigeria will be tremendously beyond the
purview of this academic exercise. Perhaps the most serious limitation to this research is with
regards to data. Apart from the above limitations, it is said that there is a dearth of published
works on this national issue in Nigeria. Most of those available are outdated and have not been
reviewed. The research, therefore, rely mostly on foreign literature, CBN publications,
Newspapers and Magazine.
15
REFERENCES
Cukierman, A., Webb, S.B. and Neyapti, B (1992), “Measuring the Independence of
Central Banks and its Effect on Policy Outcomes”. The World Bank
Economic Review, Volume 6, Number 3, pp. 123-153
De Brouwer, G and Ericsson, N.R (1995), Modeling Inflation in Australia”. Reserve
Bank of Australia Research Discussion Paper 9510, Economic Analysis and
Economic Research Departments, November.
Debelle, G.and Fischer, S. (1995). “How Independent should a Central Bank
Be?”.Fuhrer, J.C (Eds). In Goals, Guidelines, and Constraints Facing
Monetary Policymakers, proceedings of a Conference held at North
Falmouth, Massachustts, Conference Series No. 38 (Boston, Massachusetts:
Federal Reserve Bank of Boston), June.
Dornbusch, R., Fisher, S. and Kearney, C. (1996), Macroeconomic, Sydney: The
McGraw-Hill Companies, Inc.
Duravell, D. and Ndung’u N.S. (1999), “A Dynamic Model of Inflation for Kenya,197419960”.IMF Working Paper,WP/99/97,Research Department.
Essien, E.A(2002). “Identifying the Trend OF Core Inflation in Nigeria”.Central bank of
Nigeria Economic and Financial Review, Volume 40 ,Number 2,June.
Essien, E. A.(2005). “Exchange Rate Pass-Through to Inflation in Nigeria”.West African
Journal of Monetary and Economic Integration (First Half), Volume
5,Number 1,Accra; West African Monetary Institute.
16
CHAPTER TWO
LITERATURE REVIEW
2.1Monetary Policy and Economic Schools
For most countries, the maintenance of price stability continues to be the overriding
objective of monetary policy. The emphasis given to price stability in the conduct of
monetary policy is with a view to promoting sustainable growth and development as well
as strengthening the purchasing power of the domestic currency amongst others. In order
to do this, they employ monetary policy frameworks/instrument considered best suited
for achieving this mandate. The Central Bank of Nigeria (CBN) employs the monetary
targeting framework in the conduct of its monetary policy. This is based on the
assumption of a stable and predictable relationship between money supply and inflation.
Consequently, the need to understand the dynamics of inflations is central to the success
of monetary policy to ensure the achievement of price stability.
In the economics literature, the concept of Inflation has been intrinsically linked to
money, as captured by the often heard maxim “inflation is too much money chasing too
few goods”. Inflation has been widely described as an economic situation when the
increase in money supply is “faster” than the new production of goods and services in the
same economy (Hamilton, 2001). Usually, economists try to distinguish inflation from an
economic phenomenon of a onetime increase in prices or when there is price increase in a
narrow group of economic goods or services (Piana, 2001). Thus, the term inflation
describes a general and persistent increase in the prices of goods and services in an
economy (Ojo, 2000; Melberg, 1992).
Inflation rate is measured as the percentage change in the price index (Consumer Price
Index, Wholesale Price Index, Producer Price Index, etc). The consumer price index
(CPI), for instance, measures the price of a representative basket of goods and services
purchased by the average consumer and calculated on the basis of periodic survey of
consumer prices of some goods and services have impact on measured inflation with
varying degrees. There are several disadvantages of the CPI as a measure of the price
level. Firstly, it does not reflect goods and services bought by firms or government, such
as machinery. Secondly, it does not reflect the changes in the quality of goods which
17
might have occurred over time. Thirdly, changes in the price of substitutable goods are
not captured. Lastly, CPI basket usually does not change often. Despite these limitations,
the CPI is still the most widely used measurement of the general price. This is because it
is used for indexation purpose for many wage and salary earners (including government
employees). Another measure of price movement is the GDP deflator. This is available
on an annual basis. However, it is rarely used as a measure of inflation. This is because
the CPI represents the cost of living and is, therefore, more appropriate for measuring the
welfare of the people. Furthermore, because the CPI is available on a more frequent
basis, it is most useful for monetary policy purposes.
In recent times, there have been three dominant schools of thought on the causes of
inflation; the neo-classical/monetarist, neo-Keynesian, and structuralists. The neoclassical/monetarists opine that inflation is driven mainly by growth in the quantum of
money supply. However, practical experiences of the Federal Reserve in the United
States (US) have shown that this may not be entirely correct. For instance, the US money
supply growth rates increase faster than prices itself (Hamilton, 2001,Colander,1995).
This has been traced to the increased demand for the US dollar as a global trade currency.
The neo-Keynesians attribute inflation to diminishing returns of production. This occurs
when there is an increase in the velocity of money and an excess of current consumption
over investment. The structuralists attribute the cause of inflation to structural factors and
underlying characteristics of an economy (Adamson, 2000). For instance, in developing
countries particularly, those with a strong underground economy, prevalent hoarding or
hedging, individuals expect future prices to increase above current prices and, hence,
demand for goods and service are not only transactionary, but also precautionary. This
creates artificial shortages of goods and reinforces inflationary pressures.
The literature is replete with those factors that could affect level of inflation. These
factors can be grouped into institutional, fiscal, monetary and balance of payments.
Several studies (Melberg, 1992; Cukierman, Webb and Neyapti, 1992; Grilli et al, 1991;
Alesina and Summers, 1993; Posen, 1993 Pollard (1993); and Debelle and Fisher, 1995)
18
have shown that the level of independence (legal, administrative, instrument, etc) of the
monetary authority is an important institutional factor that determines inflation,
especially, in industrialized countries, while the rate of turnover of central bank
Governors in developing countries was seen as an important factor influencing inflation.
However, caution should be exercised in the interpretation of these findings, given the
difficulty in measuring the actual level of independence of a central bank.
The fiscal factors relate to the financing of budget deficits, largely through the money
creation process. Under this view, inflation is said to be caused by large fiscal
imbalances, arising from inefficient revenue collection procedures and limited
development of the financial markets, which tends to increase the reliance on seignior age
as a source of deficit financing (Agenor and Hoffmaister, 1997 and Essien, 2005). The
monetary factors or demand side determinants include increases in the level of money
supply in excess of domestic demand, monetization of oil receipts, interest rates, real
income and exchange rate (Moser, 1995). Prudent monetary management was also found
to aid the reduction in the level and variability in inflation (Alesina and Summers, 1993).
The balance of payments or supply side factors, relate to the effects of exchange rate
movements on the price level. For instance, exchange rate devaluation or depreciation
induces higher import prices, external shocks and accentuates inflationary expectations
(Melberg, 1992; Odusola and Akinlo, 2001; and Essien, 2005). There are three major
types of inflation according to the neo-Keynesians. The first is the demand-pull inflation,
which occurs when aggregate demand is in excess of available supply (capacity). This
phenomenon is also known as the Phillips curve inflation. The output gap can result from
an increase in government purchases, increase in the foreign price level, or increase in
money supply.
The second is known as cost-push inflation, “commodity inflation” or supply shock”
inflation and occurs in the event of a sudden decrease in aggregate supply, owing to an
increase in the price/cost of the commodity/production where there are no suitable
alternatives (Thomas, 2006). This type of inflation is becoming more common today than
before, as evident in the rising price of housing, energy and food. It is often reflected in
price/wage spirals in firms, whereby workers try to keep up their wages with the change
19
in the price level and employers of labor pass on the burden of higher costs to consumers
through increase in prices.
The third type, referred to as structural inflation, is the built-in inflation, usually induced
by changes in monetary policy. Within these broad typologies of inflation, there are other
types of inflation with varying determinants, effects and remedies, which are classified
based on the intensity, severity and persistence of the price increase. Thus, we have: (a)
Hyperinflation (an extreme acceleration of yearly price increases of 3 percentage points),
(b) Extremely high inflation (ranging between 50 per cent and 100 per cent); (c) Chronic
inflation (15 to 30 per cent and lasting for at least 5 consecutive years); (d) High inflation
(with rates between 30 per cent and 50 per cent a year); (e) Moderate inflation (when the
rates of increase in the general price level ranges from 5 per cent to 25/30 per cent); (f)
and Low inflation (when the changes in the consumer price index ranges from 1 per cent
to 5 per cent).
For any inflation below zero, a country is regard as experiencing deflation (vegh, 1992
and Piana, 2001). It is pertinent to note that there exists no binding restriction on the
ranges of these classifications of inflation. The classification is usually determined by the
inflation histories of the respective countries. There are basically six identified costs of
inflation in the literature. These include: (i) Shoe leather costs, (ii) Menu cost, (iii)
Unintended changes in tax liabilities, (iv) Arbitrary redistribution of wealth, (v)
Uncertainty, (vi) and increased variability of relative prices. The shoe leather costs occur
when economic agents have an incentive to minimize their cash holdings and prefer to
hold cash in interest bearing accounts due to the loss in the value of currency. Menu costs
of inflation itemizes all the inconvenience that individuals and firms face as price lists are
updated frequently and price labels are changed. This diverts the attention of economic
agents from other more productive ventures. Unintended changes in tax liabilities, say a
reduction may be treated as real gains when incomes are unadjusted. This arises because,
with a progressive taxation, rising nominal incomes are unadjusted. This arises because,
with a progressive taxation, rising nominal incomes are taxed more. Wealth is
redistributed between debtors and creditors, which may otherwise be unacceptable, with
unexpected or incorrectly anticipated inflation. Uncertainty becomes a cost, when in
20
periods of volatile inflation, investors/firms may be reluctant to invest in new equipment;
individuals will be unwilling to spend as they are unsure of what government would do
next.
Through increased variability in relative prices, rising inflation would reduce the
competitiveness of a country in the international market for goods and services. The
negative effect of this on the balance of payments cannot be overemphasized.
2.1.1. The Phillips Curve
Two major goals of interest to economic policy makers are low inflation and low
employment, but quite often, these goals conflict. The adoption of monetary and /or fiscal
policy moves the economy along the short-run aggregate supply curve to a point of
higher output and a higher price level. As higher output is reordered, this is followed by
lower unemployment, as firms need more workers when they produce more and viceversa. This trade-off between inflation and unemployment is described as the Phillips
curve. This was an empirical discovery by Phillips (1958), which showed an inverse
relationship between wage and unemployment rates, using United Kingdom data plotted
over the period 1862-1957. The discovery is strengthened by the fact that movement in
the money wages could be explained by the level and changes of unemployment. An
argument in favour of the Phillips curve is the extension that establishes a relationship
between prices and unemployment. This rests on the assumption that wages and price
move in the same direction. The strength of the Phillips curve is that it captures an
economically important and statistically reliable empirical relationship between inflation
and unemployment.
However, the Phillips curve is not without its critique. A major criticism of the Phillips
curve is that’s it does not take into account the interactions in the underlying or structural
behaviour of consumers and firms in the economy, but rather captures empirical
regularities between unemployment and inflation rates based purely on correlations in
historical data. The Lucas Critique, for instance, opined that this may not be entirely
exploited by the monetary authorities if inflationary expectations shift in a particular
21
direction, which does not align with historical data. Perhaps, the greatest weakness of the
Phillips curve is its lack of theoretical underpinnings. No known study has derived a
Phillips curve from first principles, beginning with the fundamental concerns and
constraints of consumers and firms. This is not to say that the empirical relationship
makes no sense. For instance, labour costs account for about two-thirds of the total cost
of production, so that pressure in the labour markets should strongly influence changes in
wages and prices. As fuehrer (1995) stated, “still, some feel that this lack of rigorous
theoretical foundations is fatal flaw; yet many find this deficiency less life-threatening”.
Second, in the trade-off that exists between trying to keep the rate of inflation down and
achieving a lower unemployment rate, (two objectives which governments desire to
pursue simultaneously), has raised concerns that some given level of unemployment rate,
that would be consist with some level of inflation has to be determined, if both objectives
have to be pursued. Nevertheless, controversies rage on. This is primarily because the
Phillips curve of the UK appears to be a special case, which remains to be validated
unambiguously in other western industrialized economics. This has rendered it an
inconclusive guide to policy as to how inflation may be tackled, even in the highly
industrialized economics. So far, issues pertaining to what rates of unemployment and
inflation are to regarded as tolerable, or what levels are to be regarded as consistent with
the broad policy objective of full employment remain unresolved. Despite these
shortcomings, the Phillips curve is still being used as a basis for forecasting inflation.
2.1.2 The Monetarist
The monetarists, following from the Quantity Theory of Money (QTM), have
propounded that the quantity of money is the determinant of the price level, or the value
of money, such that any change in the quantity of money produces an exactly direct and
proportionate change in the price level. The QTM is traceable to Irving Fisher’s famous
equation of exchange:
MV = PQ ……………………………….(1)
22
Where M stands for the stock of money; V for the velocity of circulation of money; Q is
the volume of transactions which take place within the given period; while P stands for
the general price level in the economy. Transforming the equation by substituting Y (total
amount of goods and services exchanged for money) for Q, the equation of exchange
becomes:
MV = PY ………..………….(2)
The introduction of Y provides the linkage between the monetary and the real side of the
economy. In this framework, however, P, V and Y are endogenously determined within
the system. The variable M is the policy variable, which is exogenously determined by
the monetary authorities. The monetarists emphasize that any change in the quantity of
money affects only the price level or the monetary side of the economy, with the real
sector of the economy totally insulated. This indicates that changes in the supply of
money do not affect the real output of goods and services, but their values or the prices at
which they are exchanged only. An essential feature of the monetarist model is its focus
on the long-run supply-side properties of the economy as opposed to short-run dynamics
(Dornbusch, et al, 1996).
Nevertheless, the model’s general weakness is found in its inadequacy to explain general
price movement. The truism of direct proportion between change in the quantity of
money and change in the price level cannot be accepted in today’s world (as there are
other factors involved such as infrastructural and structural factors).
Second, it is technically inconsistent to multiply two-non-comparable factors as M relates
to a point of time (static concept) and V to a period of time (dynamic concept).
Furthermore, the velocity of circulation of money, V is highly unstable and would change
with variations in the stock of money of money income. Thus, it is unrealistic to assume
V to be constant and independent of M.
In as much as the QTM analyses the relation between M and P in the long-run, it has
been criticized for neglecting the short-run factors which influence this relationship. For
instance, the Lucas “surprise” shock posits that expectations are important in explaining
relationships among variable and changes in policy could affect those expectations.
23
Contrary to the monetarists’ position that price levels vary in proportion to changes in
monetary growth, Lucas opined that only unanticipated changes of money supply
generate price variations that economic agents may misconstrue as relative price
movements, which leads to price and output increase. In succinct terms, the Lucas
“surprise price” shock assumes a positive correlation between output and inflation such
that unexpected monetary expansion exerts a real effect on the economic effects. The
QTM also gives undue importance to the price level, as if changes in prices were the
most critical and important phenomenon of the economic system, overlooking factors
such as the rate of interest as one of the causative factors between money and prices.
Also, it places a misleading emphasis on the quantity of money as the principal cause of
changes in the price level during the trade cycle.
Thus, it has been argued that prices may not rise, despite an increase in the quantity of
money during a depression; and they may not decline with reduction in the quantity of
money during a boom. In addition, low prices during a depression are not caused by
shortage of money, and high prices during a boom are not caused by abundance of
money. Thus, the quantity theory is at best an imperfect guide to the cause of the trade
cycle in the short period.
2.1.3 The Keynesians
The Keynesians opposed the monetarists’ view of a direct and proportional relationship
between the quantity of money and prices. According to this school, the relationship
between changes in the quantity of money and prices is non-proportional and is indirect,
through the rate of interest. The strength of the Keynesian theory is its integration of
monetary theory and value theory on the hand and the theory of output and employment
through the rate of interest on the hand. Thus, when the quantity of money increase, the
rate of interest falls, leading to an increase in the volume of investment and aggregate
demand, thereby raising output and employment. In other words, the Keynesians see a
link between the real and monetary sector of the economy an economic phenomenon that
describes equilibrium in the goods and money market) IS-LM). Equally important about
the Keynesian theory is that they examined the relationship between the quantity of
money and prices both under unemployment and full employment situations.
24
Accordingly, so long as there is unemployment, output and employment will change in
the same proportion as the quantity of money, but there will be no change in prices. At
full employment, however, changes in the quantity of money will induce a proportional
change in price. Thus, this approach has the virtue of emphasizing that the objectives of
full employment and price stability may be inherently irreconcilable (Olofin, 2001).
Several weaknesses of the Keynesian postulations have been documented. For instance,
Keynesians assume prices as fixed, so that the effect of money appears in terms of
quantity of goods traded rather than their average prices. Keynesians also assume that
monetary changes are largely absorbed by changes in demand for money. They fail to
appreciate the true nature of money and assume that money could be exchanged for
bonds only. However, it is known that money can be exchanged for many different types
of assets like, securities, physical assets, human wealth etc.
The Neo-Keynesian theoretical exposition combines both aggregate demand and
aggregate supply. It assumes a Keynesian view on the short-run and a classical view in
the long-run. The simplistic approach is to consider changes in public expenditure or the
nominal money supply and assume that expected inflation is zero. As a result, aggregate
demand increases with real money balances and, therefore, decreases with the price level.
Neo-Keynesian theory focuses on productivity, because, declining productivity signals
diminishing returns to scale and, consequently, induces inflationary pressures, resulting
mainly from over-heating of the economy and widening output gap. From the neoKeynesian perspective, budget balancing and restraints on spending do not control
inflation, and persistent budget deficits do not cause inflation. What causes by excessive
present consumption versus investment.
A major development under this theory is the concept of ‘potential output’, which at
times is referred to as the natural output. This level of output also corresponds to the
natural rate of unemployment. According to the neo-Keynesians, inflation depends on the
level of potential output or natural rate of unemployment is generally unknown and tends
to change over time.
25
The neo-Keynesians recognize the fact that most economic decisions are made under
conditions of uncertainty. However, given their preoccupation with the dynamics of
growth and long-run considerations, it is logical to expect that they cannot successfully,
abstract from the reality of uncertainties surrounding dynamic analysis.
2.2
Empirical Literature
A review of the literature on inflation in industrialized, emerging market, and developing
economies is the focus of this section. It seeks to reveal the dominant theoretical
underpinning for assessing the dynamics of inflation and the methodology for forecasting
its future trajectory.
De Brouwer and Ericsson (1995) investigated inflationary developments in Australia,
between the 1980s and 1990s. Their results showed that the structure of the inflationary
process in Australia did not appear to have changed. Rather, the recent fall in inflation
was explained in terms of changes in those factors that determine inflation. Stock and
Watson (1999) used the conventional Phillips curve (unemployment rate) to investigate
forecasts of U.S. inflation at the 12-month horizon, they found that inflation forecasts
produced by the Phillips curve generally had been more accurate than forecasts based on
other macroeconomic variables, including interest rates, money and commodity prices
but relying on it to the exclusion of other forecasts was a mistake. Forecasting relations
based on other measure of aggregate activity could perform as well or better than those
based on unemployment, and combining these forecasts would optimal forecasts.
In the case of India, Callen and Chang (1999) in their study of inflation adopted a
multiple indicator approach. They used percentage changes in three different price
indices: the wholesale price index (WPI); the consumer price index (CPI); and the GDP
deflator as measures of inflation in order to determine which of them provided the most
useful information about future inflationary trends. The WPI was used in the analysis
because it had a broader coverage and was published on a more frequent and timely basis
than the CPI. However, the CPI remained important because it was used for indexation
purposes for many wage and salary earner (including government employees). The
sample period used in the estimation work was 1982 Q2 to 1998 Q2. The findings
26
indicated that exchange rate and import prices were relevant for inflation. It was
concluded that while the broad money target has been de-emphasized, developments in
the monetary aggregates remain an important indicator of future inflation.
Williams and Adedeji (2004) examined price dynamics in the Dominican Republic by
exploring the joint effects of distortions in the money and traded-goods markets on
inflation, holding other potential influences constant. The study captured the remarkable
macroeconomic stability and growth for the period 1991 to 2002. They found that the
major determinants of inflation were changes in monetary aggregates, real output, foreign
inflation, and the exchange rate. The authors observed that inflation was influenced only
by imbalances in the money market
Examining determining factors of inflation, from 1998 to June 2005, in Pakistan, Khan
and Schimmelpfennig (2006) showed that monetary factors were the main drivers of
inflation, while “wheat support price” affects inflation in the short-run. A monetary
perspective that included monetary variables such as money supply, credit to private
sector, the exchange rate, as well the “wheat support price” a supply-side to private
sector, the exchange rate, as well the “what support price” as a supply-side factor was
adopted. The findings indicated that monetary factors played a dominant role in recent
inflation affecting inflation with a lag of about one year and increases in the wheat
support price influence inflation in the short-run. The conclusion of the study was that
wheat support price mattered for inflation over the medium term only if accommodated
by monetary policy. The study confirmed that a long-run relationship existed between the
CPI and private sector credit.
Aron and Muellbauer (2000) examined inflation and output for South Africa. They
confirmed the importance of the output gap and the exchange rate for forecasting
inflation; and the influence change in the current account surplus to GDP ratio, which
was also sensitive to short-term interest rates. However ,a rise in interest rates increased
inflation in the short-run ,via a rise in mortgage interest payments (a component of the
consumer price index).On the demand side, there were important negative interest rate
effects, though these had been altered by changes in the monetary policy regime. The
27
trade surplus and government surplus to GDP ratios, which also responded to interest rate
changes and improvements in the terms-of-trade, all had a positive effect on future
output.
Lim and Papi (1997) attempted to shed some light on the determinants of inflation in
Turkey by analyzing price determination within the framework of a multi-sector
macroeconomics model during 1970-1995.The choice of the sample period was dictated
by the desire to take a long-term view, while the rationale for quarterly data, as opposed
to annual data, was to capture short-term inflation dynamics. The main findings were that
monetary variables played a central role in the inflationary process. Public sector deficits
contributed to inflationary pressures and inertia factors were important. The authors
concluded that policy maker commitment to active exchange rate depreciation on several
occasions in the past 15 years had also contributed to the inflationary process. Their
conclusions were broadly in line with the results from the other developing countries,
albeit perhaps with the exchange rate having a stronger role in the case in several other
countries.
In Africa, several studies have been conducted on the dynamics of Inflation. Durevall and
Ndung’u (1999), analyzed the dynamics of inflation in Kenya during 1974-1996, a period
characterized by external shocks and internal imbalances. The study found exchange rate,
foreign prices, and terms of trade as having long-run effects on inflation, while money
supply and interest rate only had short-run effects. Past inflation was also very important
in the Kenyan economy up to 1993, when about 40 percent of current inflation was
transmitted to the next quarter. In the study by Ubide (1997) for Mozambique, results
from the analysis of a decomposition of the components of CPI, showed that the rate of
inflation was determined by seasonal behavior and a collection of irregular events,
corresponding mainly to agro-climatic conditions.
In Nigeria, although a number of studies on inflation exist, there is no consensus on
which theory of inflation determination is the most adequate. These studies explored all
the dominant theories under a variety of modeling techniques. While some favor the
28
structuralists, others adopted the monetarists, and some, the fiscalists approach; still
others examined a combination of these theories. Odusola and Akinlo, (2001) showed
that inflation in Nigeria was largely determined by the absence of fiscal prudence on the
part of government, parallel exchange rate shocks and output. Asogu (1991) noted this
view and concluded that industrial output, net exports, current money supply, exchange
rate changes and domestic food prices were key determinants. Other Nigerian scholars
like Fakiyesi (1996), Adamson (2000) and Masha (2000), concluded that growth in broad
money, rate of exchange of the Naira vis-à-vis the Dollar, growth of real income, and
price volatility were some of the variable that influence inflation behaviour in Nigeria.
Overall, the empirical studies have not been conclusive as to the causative factors of
inflation. However, there seem to be a consensus that entrenched fiscal imprudence may
worsen inflation.
2.3
Stylized Facts of Inflation in Nigeria
2.3.1 Components and Structure of Consumer Price Index
In Nigeria, inflation is derived from the consumer Price Index (CPI). The National
Bureau of Statistics (NBS), formerly known as the Federal Office of Statistics (FOS), is
responsible for the computation of this index and reports it in its monthly publication, the
“Statistical News”. Officially, the CPI is called the “Composite Consumer Price Index”
since it combines the rural and urban CPIs. The composite CPI measures the average
level of retail prices of goods and service consumed by households living in all parts of
the country. Information for the computation of the CPI, including the weights is
obtained through surveys. The regular survey monitors and records price developments,
while the survey to obtain the weights for the computation of the base period is
conducted periodically. This is because of the huge resources required in reviewing the
weights.
The NBS first revised the base period of the CPI from 1960 to 1975 following its
National Consumer Expenditure Survey (NCES) of 1974/1975 when it commenced the
computation of the indices of rural and urban basis. The generated rural and urban CPIs
29
were subsequently used to compute the composite CPI. Further consumer expenditure
surveys were conducted in 1980/1981 and 1996/1997, consequent upon the desire to
update and improve the basket of goods used for the compilation of the CPI to reflect the
reality of the evolution of purchasing power and the consumption patterns of the average
consumer in Nigeria. This led to further revisions of the base period of the composite CPI
to 1985 and May 2003, respectively.
After each NCES, the mix commodity groups in the inclusion of new items/groups and
re-computation of weights are based on newly provided data on expenditure. For
instance, the 1985-based CPI basket was reviewed to indicate new commodity groups
such as medical care and health expenses, recreation, entertainment, education and
cultural services, which were not included when the 1975 base was used. The recently
compiled May 2003 base-year CPI is essentially, based on the classification of individual
consumption by purpose (COICOP). With the approach, the old indices were revised,
new weights derived and the baskets structured into 12 commodity groups are obtained
both for urban and rural areas. The components and weights of the composite CPI basket,
representing 64.4 per cent of the consumption basket. Consequently, factors affecting
food prices would be crucial in understanding the determinants of inflation in Nigeria.
In recent times, a number of countries, particularly those that have adopted price stability
as the main objective of monetary policy and have explicit inflation target, have
developed measures of “underlying or core” inflation. This measure attempts to
fluctuations from the index. A distinguishing characteristic of these two types of inflation
is that while non-core is generated by supply shocks, such as: drought, cyclone, oil price,
etc, the core component is mainly influenced by demand shocks (Essien, 2002). Core
inflation can be measured by merely removing (that is, excluding), in an ad hoc manner,
the unwanted component or noise from the index used in computing the inflation rate. In
Nigeria, until recently, core inflation was measured by excluding the farm produce
component of CPI from the basket.
However, a second measure of core inflation excludes both farm produce and energy. As
shown in the table below, the two core components, (all items less farm produce and all
30
items less farm produce and energy) are equally important in the basket at about 41 and
34 per cent, respectively. Generally, while food component has declined in recent times,
from about 70 percent to 63.76 percent, the core component has increased.
An important variable in the consumer basket is the housing, water, electricity, gas and
other fuel group. Transport and communication is equally important. The least item in
terms of weight in the basket is education.
Table 1: Percentage contribution of Items in the CPI Basket of Goods
Core (All Items less Farm produce)
40.95
Core (All Items less Farm Produce and Energy)
Food
33.59
63.76
Food & Non-alcohol Beverage
64.41
Alcoholic Beverage, Tobacco and Kola
2.06
Clothing and Footwear
3.21
Housing Water, Electricity, Gas and Other Fuel
18.10
Furnishings & Household Equipment Maintenance
3.82
Health
1.36
Transport and Communication
4.35
Recreation & Culture
0.89
Education
0.21
Restaurant
1.29
Miscellaneous Goods & services
0.30
2.3.2 Institutional Framework and the Mandate of Price Stability
One of the statutory responsibilities of the CBN is the formulation and implementation of
monetary policy, with the overriding objective of maintaining stable prices consistent
with the achievement of sustainable economic growth. Monetary policy formulation
entails setting intermediate and operating targets in tandem with the assumed targets for
GDP growth, inflation rate and balance of payments. Monetary policy in Nigeria is based
31
on the assumption that there is a stable relationship between monetary variable (such as
money and domestic credit), which falls under the purview of the monetary authorities,
and non-monetary variables (such as real output and prices).
Prior to the liberalization of the banking system, the CBN relied on administrative
measure like credit ceilings, cash and liquidity ratios, credit guideline, etc in the conduct
of its monetary policy. Following liberalization, the monetary policy framework shifted
in 1993 to the indirect approach. The open market operations thus became the primary
instrument for the conduct of monetary policy supported by discount window operations
and reserve requirements. The minimum rediscount rate (MRR) complemented with the
repurchase (REPO) rate is the key that sets the monetary policy stance. In recognition of
the lag effects of monetary policy, the CBN, since fiscal 2002 shifted to a medium-term
framework. Under this framework, money growth targets that are consistent with
inflation and real output growth targets are set over a two-year period. In December 2006,
a new monetary policy framework, which relies on short-term interest rate as a major
operating target was adopted. The monetary policy rate (MPR) replaced the MRR in the
new framework and, thus became the anchor rate for other interest rates. The success of
monetary policy depends largely on the autonomy of the central bank.
However, the achievement of these overall macroeconomic objectives was greatly
hindered owing to the limited operational autonomy of the CBN. The instrument
autonomy granted to the CBN in 1998, which repealed the CBN (Amendment) Decree
No 3 of 1997 enabled the Bank to deploy monetary instruments at its disposal for the
conduct of monetary policy. In 2007, a new CBN Act, which gave the Bank broader
independence, was enacted to include the provision of a transparent and credible
framework to lock-in inflationary expectations through the adoption of inflation targets as
the nominal anchor for monetary policy.
2.4
Relationship between Inflation Rate and Key Macroeconomic Variable
A study of the quarterly movements in the rate of inflation (decomposed into headline,
core and non-core) and key macroeconomic variable from 1981 to percentage change in
32
their logarithmic form is essential. Core inflation is defined as headline inflation less farm
produce, while non-core refers basically to food inflation. Though bank reserves displays
sharp oscillations, inflation rate responds less sharply. What is clearly seen is that in
periods when bank reserves were high, the various measures of inflation generally
maintained a rising trend. Though these variables move in sympathy, the lag at which
inflation responds to changes in bank reserves varies for different periods.
The relationship between government expenditure and inflation rate is also of interesting
note. Inflation tends to co-vary with government expenditure with a shorter lag.
Beginning from 2002, however, inflation rate responds to increase in government
expenditure with a lag of about one to two quarters. The relationship between the
exchange rate and various definitions of inflation is also of interest. Prior to the
liberalization of the domestic currency, inflation rate led changes in the exchange rate.
The relationship between market interest rates and inflation rate is also interesting to
study. The market interest rates savings, deposit, and prime lending rates move in the
same direction. Similarly, the market interest rates co-vary with the three variants of
inflation, though the relationship with the prime lending rate is most discernible. Core
inflation responds more to changes in prime lending rate than headline and non-core
inflation. The respond lag of all three variants of inflation varied over the period under
consideration, ranging from one to three quarters.
Credit to the private sector appears to move inversely with inflation; this is particularly
most visible with core inflation. The reason for the inverse relationship is that private
sector credit is expected to boost output production and reduce the pressure on prices.
Suffice to note that private sector credit can also be used to boost aggregate consumption
and not necessarily investment. However, between 1990-1992 and 2000-2002, growth in
credit to the private sector co-varied directly with inflation rate. This could be due to the
pass-through effect of the lending rate. Aggregate demand (Gross Domestic Product
expenditure), on the other hand, appears to vary directly with inflation rate. Though, all
three variants of inflation move n tandem with changes in the aggregated demand, food
inflation seems to be the most responsive to changes in the aggregate demand. This could
be explained by the relatively high proportion of food in the consumer basket.
33
The trend in output growth (overall and agricultural GDP) vis-a vis the various variants
of inflation rate appears to be an inverse relationship between the inflation rate and output
growth. Basically, it could stressed that while headline and core inflation respond more to
change in real output, non-core inflation varies most prominently with Agricultural GDP.
Beginning from 1999, however, the pattern of relationship between output growth and
inflation becomes less discernible.
2.5
Trends in Inflation and Policy Response in Nigeria
Cases of high inflation did not occur until the early 1970’s when inflation rose sharply
from a very low level. Prior to that time, headline was relatively stable, averaging 3.5 per
cent between 1960 and 1970. Post independence industrial policy, increase in
government expenditure to finance the civil war, low levels of production during the war,
post-war reconstruction, and the Adebo/Udoji wage increase following the oil boom,
were some of the factors that induced high inflation at that time. However, in the last
Twenty Five years (1981-2005), episodes of high inflation have become more frequent.
For instance, during the collapse in the oil market in the early 1980’s headline rose from
the moderate levels of 16 percent in 1980 to peak at 38 per cent by mid-1984. Similarly,
non-core inflation rose substantially during that period reaching 42.2 per cent by mid1984. Core inflation also rose rapidly during that time a spike in 1983. The sharp increase
in headline and core inflation were attributable to the persistent output gap and the
austerity measure introduced in 1983 to stem the imminent collapse of the economy,
factors such as import restriction and foreign exchange constraints led to severe shortages
in supply of goods and services. The increase in the non-core component was adduced to
non-monetary factors, Dutch-disease syndrome as well as rigid control on the marketing
of agricultural commodities.
Even though inflation decelerated from 1985, it was becoming increasing obvious that
monetary tightening and the fiscal measures adopted were inadequate given the
magnitude of the problem confronting the Nigerian economy. Thus, by 1986, Nigeria
adopted the Structural Adjustment Programme (SAP), which saw a more liberalized
34
economic environment. However, the balance of payments crises that precipitated the
adjustment programme persisted. For the first time in a long while, there was a fuel price
adjustment in 1988, and a significant depreciation of the exchange rate. Monetary policy
became accommodating as government strived to give SAP a human face following the
onset of adjustment fatigue and resistance to the programme. Even though government
expenditure was kept rather stable, the financial markets were clearly affected and both
long and short-term interest rates rose sharply. Consequently, inflation began to rise and
by 1988, headline inflation peaked at 61 percent on an annualized basis, while core
inflation showed a similar trend reaching 50 per cent. Following this development, the
confidence that there would be an improvement in the rising inflations situation did not
materialize.
In a bid to intervene and reverse the ugly trend, the monetary authority began the
withdrawal of public sector funds from the commercial banks, with a view to tightening
liquidity in the system. Nevertheless, fiscal expansion largely financed by ways and
means advances culminated in an all-time peak in non-core inflation of 69.9 percent in
1989. Persistent inflation inertia continued to increase the rate of growth in the price
level. This was largely attributed to the frequent increases in administered prices on
petroleum products, monetization of the Gulf war windfall, and deteriorating political
environment with series of industrial actions in the early1990’s. Growth in money supply
and fiscal deficit accelerated rapidly. In addition, the management of the agricultural
output boom was also poor. This situation was compounded by nominal adjustment of the
exchange rate, following the March 1992 devaluation. The result was high inflation in all
its components.
By 1993, it was clear that the macroeconomic policies pursued were no longer
sustainable and needed drastic change. In response to the ensuing macroeconomic
instability, government reverted to a guided de-regulation in 1994. Interest rate again was
administratively fixed. The exchange rate regime was changed and the autonomous
foreign exchange market (AFEM) was introduced in 1995, while fiscal measures were
introduced to curtail deficits. However, because these measures were taken at a time
35
when there were excess money supply, scarce foreign exchange, severe shortages in
commodity supply, as well a continual labour and political unrest following the
annulment of the June 1993 elections, there was a remarkable rise in the rate of inflation.
Analysis of the non-core inflation in the early 1990s revealed that the adverse conditions
of that period caused a huge increase in its level, as it recorded a high of 63.6 per cent in
late 1994. Headline inflation rose rapidly by 1995 to reach an all-time high of 72.8 per
cent though it decelerated gradually to single digit by 1997. In the same vein, core
inflation, which began a gradual ascent in early 1990, peaked at about 69 per cent in mid1995 before slowing down in 1997. The deceleration in inflation rate during this period
could be attributed to the favourable fiscal balance between 1995 and 1997 coupled with
non-accommodating monetary policy stance during that period. The administratively
fixed exchange rate regime, tight monetary policy, increased credit to the private sector,
and low interest rates, were factors that aided in stabilizing domestic prices. Thus,
inflation remained at single digit until 1999.
The low inflation rate regime did not last for too long, with the resurgence of spikes in
headline and core-inflation between 1999 and 2000. Policy reversals and inconsistency,
the general election of 1999, wage increase, and banking sector distress were mainly
responsible for the downturn and by 2001; headline inflation rate had risen to 18.9 per
cent. In recent times, particularly, with the second term of the Obasanjo administration in
2003, macroeconomic reform programme. Monetary policy has become more proactive,
while the fiscal authorities have supported the implementation of monetary policy
through frequent consultations. Inflation has, however, remained at moderate levels. The
persistence of structural rigidities, the general election of 2003 and the continued effect of
fuel price hike are some of the factors that have been adduced for the inability to reduce
inflation to single digit. However, the government has mounted an elaborate food
programme that would promote food crop production and export as well as pay more
attention to the development of the small and medium scale enterprises to promote wealth
creation and increase output. The exchange rate has also been relatively stable, with
36
significant real appreciation. With these developments, inflation inertia has been curtailed
and high inflation may be a thing of the past, if sustained.
Overall, the following stylized facts emerge from the preceding presentations:
·
Monetary expansion, which reflects either demand for credit by the domestic
economy or government fiscal expansion is a major determinant of inflation.
·
There is a co-movement between aggregate demand and inflation but with a lag
·
Increase in real output, particularly food output has a dampening effect on inflation.
·
High inflation seems to be associated with the long-run depreciation of the exchange
rate. However, there appears to be inconsistency in the evolution of exchange rate
and inflation between 1986 and 1996.
This write up has discussed the concepts of inflation, the factors determining inflation as
well as stylized facts on inflation in Nigeria. The disaggregated nature of the analysis
embodies the fact that inflation, for a country like Nigeria, has both non-core components
and non-core components, which are driven by demand shocks.
The composition of the CPI basket is found to be skewed towards foods as it constitutes
63.76 per cent, while the core component is 40.95 per cent. Thus, factors affecting food
production are critical determinants of inflation in Nigeria. A decomposition of the CPI
according to trend, seasonal factors, and irregular variations shows a strong trend for all
types of inflation and a strong seasonal component for food inflation.
It is pertinent at this point to note that monetary policy in Nigeria is conducted in an
environment characterized by uncertainty and frequent changes in economic policy. Also,
the development of an adequate framework for inflations is complicated by inconsistent
policies and variations in environmental conditions either of a climatic nature or crises.
Form the analysis, the following can be deduced:
·
Trend has a significant positive relationship with core and headline inflation,
while food inflation shows significant seasonal variations. The significant
37
seasonal component exhibited by food inflation confirms that it responds mostly
to the predictable conditions of weather, which affects farms produce.
·
Inflation inertia is prevalent and persistent. Thus, there is a backward looking
behaviour by economic agents in setting future prices. For instance, when
producers expect inflation, they raise their prices and inflation tends to rise and
producers keep raising their prices, as evidenced from the lag effect.
·
Other key variables to consider when designing policies aimed at controlling
inflations are: the exchange rate and the level of output.
Overall, policy issues based on the analysis include the following:
●
There is the need to take cognizance of the lag effect in the design of monetary
policy in order to ensure that policy targets are effectively monitored. In
particular.
Monetary policy needs to be more forward looking to achieve price stability.
Developments in monetary aggregates still provide important information about future
inflation, however, the type of aggregates used need to be re-examined. Even when the
Bank finally adopts inflation targeting, information about future inflationary development
can still be gleaned from them. Headline inflation, which is well understood by the
general public, affects households instantly and should continue to be used as a measure
of inflation. The use of underlying inflation, which core inflation represents, may not be
adequate except its definition takes care of other variable components of the CPI basket,
such as energy.
2.5.1 Definitions of Variables
CPI- It is the composite consumer price index of the rural and urban price indexes. It
can be decomposed as core and non-core consumer prices indexes.
Headline Inflation- It is the annualized (year-one-year) inflation rate computed using the
CPI. It is computed for each quarter as the growth rate over the corresponding
quarter of the preceding year.
38
Core Inflation- Its computation is based on the core component (all items less farm
produce and energy) of the composite CPI. In this paper, however, core inflation
is derived from core CPI defined as “all items less farm produce”. The quarterly
series is derived as the growth rate of the present quarter over the corresponding
quarter of the preceding year.
Non-core Inflation: Its computation is based on the food component of the composite
CPI. The quarterly series is derived from the food CPI as the growth rate of the
present quarter over the corresponding quarter of the preceding year.
Real GDP: It is the gross domestic product at constant basic prices. In this paper, it is
defined as the value of productions that took place in the Nigerian Economy
within a quarter at 1990 basic prices
GDP: It is the gross domestic product of agriculture (crop production, livestock and
fishing only) at 1990 basic prices.
Interest Rate: Prime lending rate is used as a proxy for the money market interest rates.
The prime lending rate is the interest rate which banks charges on loans and
advances to high net-worth and credit worthy customers.
Nominal Exchange Rate: It is the quarterly average price of the US dollar in terms of
the naira
Potential Output: Potential (natural) output is the optimal level of production that an
economy can attain without overheating the system.
Output Gap: It is the difference between the economy’s actual output and its potential
output. The gap is positive when actual output exceeds the economy’s potential
and vice versa.
Lag: A lag is the amount of time it takes for a variable to respond to changes in its
explanatory variables (factor)
39
Short-Run: The short-run is a period too brief to change the quantity of the explanatory
variables; at least one is fixed while the others can be varied. In the model: Yt = a
+ β0Xt+ βt Xt-1 + β2 Xt-2 + ∙∙∙ + βkX1+ Vt the short-run is before k periods,
whereby at least one explanatory variable is fixed while the others can be varied.
Long-Run: The long-run is a period long enough to vary the quantity of the explanatory
variables. In the model: Yt = a + β0Xt + βtXt-I + β2 Xt-2 + ∙∙∙ + βkXt + vt the longrun is after k periods, whereby all the explanatory variable Xt-I (i=0,I,…..,k) can
be varied.
Data: Data coverage, on quarterly basis, spanned 1981 Q1 to 2005Q4. Quarterly series
on gross domestic product (RGDP and GDPF) and government expenditure
(GEX) were derived through a process a process of disaggregation of the annual
data series.
2.6
The Conceptual Basis for Monetary Management
Hilbert (1993) stated that an examination of the relationship between money, output and
prices is necessary in order to provide the conceptual basis for monetary control in an
economy. According to Onyido, (1998) although Economists all over the world appear
divided on the nature of this relationship, there is a fair amount of consensus on a number
of broad issues relevant for policy, and thus, there is a general agreement that changes in
money stock or money supply impacts on the nominal and real interest rates as well as on
output in the short-run. To a large extent, therefore, the design and application of
monetary policy instruments in order to achieve economic objective has been based on
this stated agreement. Thus, according to Ahmed, (1991,)the monetary authorities are
interested in monitoring monetary developments with a view to bringing the growth of
the money stock in line target in order to maintain internal and external balance, as well
as ensure sustainable growth.
It is, therefore, important to explore the relevant issue in monetary analysis as the basis
for understanding the factors that influence the stock of money and the need to control it.
According to Nwude (2009), the monetary authorities use monetary targeting to achieve
40
the objectives of monetary policy. Monetary targets include intermediate variables such
as the rate of growth of money supply, growth in the volume of aggregate credit, the level
and structure of interest rates and exchange rates. The aim of targeting the growth of
money supply is that it is closely linked with inflation and balance of payments position.
The volume of aggregate credit is a determinant of money supply. The level and structure
of interest rate affect the basic conditions of the money market, while the exchange rate
links the domestic economy with the external sector.
Monetary indicators, on the other hand, are those variables that signal to the monetary
authorities the monetary conditions of the economy and therefore the direction and
effectiveness of the monetary policy. They include movements in monetary base, bank
reserves and short run interest rates. Monetary base will influence changes in money
supply, aggregate credit and long-run interest rates. The level of bank reserves balances
has similar effect while short run interest rates will influence long –run interest rates,
aggregate credit and money supply.
Monetary policy influences the availability and cost of money in the economy. In
ensuring monetary stability, the central bank through the deposit money banks
implements policies that guarantee the orderly growth and development of the economy
through appropriate change in the level of money supply. The reserves of the banks are
influenced by the central bank through its various instruments of monetary policy. These
instruments include the cash reserve requirement, liquidity ratio, open market operations
and primary auction of treasury bills. Also, the CBN uses the discount window operations
to influence the movement of bank reserves. All these activities affect the banks in their
credit operations and thus influence the cost and availability of loanable funds. Thus, the
financial market provides a useful channel for the effectiveness of the monetary policy.
An efficient and well-organized market will therefore enhance the speed of monetary
policy transmission.
However, the existence of a large informal market in the Nigerian economy is detrimental
to effective financial intermediation as well as hampers the effectiveness of the
application of monetary policy instruments. When a large amount of money is outside the
41
banking system as the case in Nigeria, the ability of CBN to influence financial and
monetary conditions through the manipulation of deposit money banks’ reserve balances
using indirect monetary policy instruments is impaired. In this regard, Nnanna (2001),
identified the existence of dualistic financial markets as a serious constraint to monetary
policy management in Nigeria.
The best contribution that monetary policy can make to ensure economic growth in
Nigeria is to maintain steady medium-term price stability. Such a policy outcome will be
beneficial, as it will minimize the adverse effects of inflation. Price stability will not only
create a climate for higher economic activity over the medium term, but also will reduce
the economic and social inequalities caused by the asymmetric distribution of the costs of
inflation among the various economic agents.
2.6.1 Inflation Rate
According to Academic’s Dictionary of Banking (2007), Inflation depicts a persistent
increase in the general price level, The emphasis here is on the word “persistent”, which
implies a fall in the purchasing power price index (CPI) over a period of time. The rise in
the prices of goods and service is generally measured by the rise in the consumer price
index (CPI) over a period of time, Federal Office of statistics (2008).
Why control Inflation? The growing interest on price stability as a major goal of
monetary policy is an acknowledgement of the observed phenomenon that low inflation
provides a base for sustained economic growth and development. Monetary policy seeks
to limit money supply growth to a level that is consistent with the desired level of output
and prices. However, Inflation is difficult to tackle largely because any meaningful
attempt to curb it entails a trade-off among other important macroeconomic and social
objectives such as increased employment, economic growth and such safety nets in the
short-run.
Whatever the type, inflation is to a large extent a monetary phenomenon in the sense that
it cannot be sustained without an accommodating increase in money supply. If money
supply rises beyond the absorptive capacity of the economy, domestic prices will
42
increase.
Inflation is costly. It arbitrarily benefits debtors and hurts creditors by decreasing the
nominal value of outstanding debt. It discourages savings and investment by creating
uncertainty about future prices. It forces businesses and individuals to spend time and
resources predicting future prices and hedging against the risk of unexpected changes in
the price level. It distorts relative prices and undermines the efficiency of the market
pricing mechanism.
What level of Inflation Rate is a Most Appropriate?
Soludo, (2009) pointed out that in theory “optimal’ inflation rate has to be greater than
Zero. But determining the ‘right’ rate for a particular economy at any point in time is a
complicated issue. In practice, low inflation of 2-3% for developing countries.
Conversely, high level of inflations promotes uncertainty, discourages savings and
investment. Excessively low inflation tends to cause cyclical downturns that last
unnecessarily longer. A little inflation may make it easier for firms to reduce real wages
necessary to maintain employment during economic downturns. At very low levels of
inflations, nominal interest rates would also be low, limiting a central bank ability to ease
policy in case economic activity experiences a downturn.
Low and stable inflation is, therefore, the best contribution monetary policy can make to
efficient allocation of resources, economic development and growth. Experience, from
Germany and U.S., indicates that it is easier for a central bank with a reputation for low
inflation to play an effective role in stabilizing business cycles. In the current economic
situations, it is possible for Nigeria to strive to achieve an inflation rate that is consistent
with the high growth over a 3-years period. In general, Central Banks take the inflation
and output targets as given by the political authorities. In the 2009 Federal Government
of Nigeria Budget for example, the target inflation rate is 8.2% while the GDP growth
rate is 8.9%. The question ‘appropriate’ rates is left to policy makers and economic
managers to decide.
43
2.7
Appropriate Exchange Rate
Exchange rate is the price of one currency expressed in terms of some other currency. It
determines the relative price of domestic and foreign goods. It also determines the
strength of the external sector. Exchange rate regime can be fixed or floating. Within the
floating regime, there could be variants (managed float versus freely flexible).
2.71. FIXED EXCHANGE: Proponents of fixed exchange rate system:
· Emphasizes its simplicity
· Transparency
· Ease of operation
· Ability to impose discipline on domestic monetary policy and effective control over
inflationary pressures; however, opponents of fixed rates argued on its:
· Inability to deal with fundamental structural changes in a developing economy.
· Lack of freedom to conduct independent monetary policy under capital mobility,
thus a country cannot simultaneously have a fixed exchange rate and have freedom
for independent monetary policy.
· Inability to adjust quickly to the challenges in changing international environment
especially to shocks to the balance of payment.
2.7.2
Determining an Exchange Rate Regime
The particular exchange rate system appropriate for the nation has been the subject of
debate among economists for a long time.
Generally, there are some important considerations in the determination of an exchange
rate regime for a country:
v
Import and Export volumes
v
Level of external reserves
v
General price level
v
It should reflect the resources endowments
v
It should reflect the actual and potential comparative advantage
v
It should also consider the ability to take advantage of rapidly shifting demand and
supply conditions; countries which are primary producers or natural resources rich
44
may face volatile/inelastic demand for their products
v
Choice may be deliberate to steer the economy from import dependent to export-led
economy (Indonesia, China, etc)
2.7.3 What Drives the Naira Exchange Rate Movement?
1.
Exchange rate in Nigeria is determined by the supply and demand for foreign
exchange.
Key benefit of flexible exchange rate regime is to adjust in the face of external
shocks.
Major currencies around the world have adjusted in the face of dwindling resource
flows (UK pound sterling; South Africa Rand; South Korea Won; Ghanaian Cedi;
India Rupee and many more).
2.
The supply of foreign Exchange in Nigeria are mainly derived from:
a.
Export proceeds from oil, and other non-oil exports
b.
Foreign Direct Investment (FDI) and portfolio inflows
c.
Remittances
d.
Aid and foreign borrowing
e.
Other miscellaneous inflows
Nigeria is an open economy that depends heavily on oil exports for foreign exchange
receipts and on imports for consumption and production of goods.
Demand for foreign exchange in Nigeria increased recently due mainly to:
Ø
Demand by foreign investors in the stock market who are exiting
Ø
High level of imports, and likely to increase due to declining prices of goods abroad
because of recession and drop in freight costs
Ø
Demand by Nigerians wanting to invest in cheaper assets abroad (stocks, houses,
etc)
Ø
Demand for foreign exchange to meet maturing debt obligations
Ø
Foreign banks and institutions recalling existing loan facilities in the wake of global
credit crunch
Ø
Demand by speculators who believe that the exchange rate may deprecate further in
future given the developments in the oil price.
45
2.7.4 Recent Developments in Exchange Rate Movement In Nigeria
·
Exchange rate was generally stable from 2006 until Dec. 2008
·
For the first time there was a convergence of rate among the various segments of
the foreign exchange market.
·
The average rate of the naira appreciated, with an average rate of 128.65 to a dollar
at WDAS in 2006.
·
Stability/mild appreciation was sustained throughout 2007 and most of 2008 due to
large foreign exchange inflows and deliberate policy not to allow rates to appreciate
massively, thereby accumulating huge reserves.
·
Nigeria avoided Real Exchange Rate appreciations despite the large capital inflows
--- this was contrary to the experience of the 1970s
·
However, by mid-December 2008 the naira depreciated by approximately 14.5% to
N 134% /$ at the inter-bank segment.
2.7.5 Why the Pressure on the Exchange Rate?
·
Fall in oil price (from a peak of $147 to about $34 in recent months)
·
De-accumulation of foreign reserves as a result of decline in oil prices
·
Limited foreign trade finances for banks-credit line may have dried-up for some
banks
·
Declining capital inflow in the economy-falling portfolio inflows, FDI and other
remittances
·
High import dependence of the economy
2.7.6 Exchange Rate Adjustment as an Opportunity
The following are the timely adjustment needed to avoid the disastrous consequences of
delayed response or the 1982 experience.
1.
Preserve the External Reserves (Russia lost about one quarter of its reserves in
6wks due to delayed adjustment; South Korea lost hundreds of billions, etc
2.
If the Reserves are allowed to be run down completely, the exchange rate would
then adjust in a most drastic form which other countries have experience (for
example Ghana the in the 1970s ; and many others)
46
3.
With cheaper import prices, it would be cheaper to import everything than produce
them in Nigeria, and imports would wipe out domestic industries, thereby
increasing unemployment.
Exchange rate adjustment is therefore a defense for local jobs; and it ensures that
Government budget continue to functions. For example, it will be recalled that in 1982
“the oil price shock” coupled with “fixed exchange rate” generated so much unpleasant
consequences some of which are:
·
Abandoned projects all over Nigeria
·
Salary arrears
·
Massive retrenchment of civil servants, and unemployment
·
Austerity measures, including queuing up for the “Essential Commodities”
·
Massive import bans
·
Resort to import licensing, and even making it illegal to be found with foreign
currency.
It was in realization of this that led the monetary authorities to advise that the 2009
Federal Government Budget be made a deficit budget even with zero capital spending at
$45 per barrel.
A scenario where capital expenditure spending was projected at $34 or less without
exchange rate adjustment can only better be imagined.
2.7.8
Performance of the Foreign Exchange market in Nigeria:
Nwude (2009) noted that the change from administratively determined, to market based
exchange rate was with a view to achieving a stable and realistic exchange rate for the
naira. However, continued demand pressure and dwindling foreign exchange earnings
exacerbated pressure on the foreign exchange market, thus resulting in a continued
depreciation of the naira. A realistic exchange has not emerged under any of the regimes
of exchange rate management in Nigeria due to macroeconomic rigidities inherent in the
economy. While the supply sources are highly lopsided, the misalignment of the
exchange rate has created an army of foreign exchange users who frivolously and
47
fraudulently procure foreign exchange from official sources for round-tripping into the
parallel market. Besides, political exigencies have not permitted the emergence of a truly
market exchange rate. In a high import dependent economy like Nigeria, this remains a
dicey area for policy success.
2.8
Interest Rates
Activities in the money market affect the structure of interest in any market based
economy like Nigeria. Given that high interest rates discourage investments which is
contrary to the CBN’s monetary policy, the bank through the use of its Minimum
Rediscount Rate (MRR) which had been renamed MPR, influences the direction of
market rates which in turn impact on the activities in the money market. Similarly,
money market indicators, such as, liquidity, Interbank rates and investment profiles also
dictate the CBN’s monetary policy actions.
2.8.1
Appropriate Interest rate -What Interest Rate is and does
Interest rate is a reward for accumulating financial assets and foregoing current
consumption, which influences the willingness to save. It is also a cost of capital, which
influences the demand for loanable funds by different types of borrowers (lending rate).
Interest rates generally affect people’s decision or behavior with respect to consumption,
savings and investment. It compensates lenders for loss of purchasing power and the risks
they take; and at the same time provides financial intermediaries with the profit that
keeps them in business. Interest rate is a signal that directs funds to where they can earn
the highest returns, or to where they can do the most for the economy.
2.8.2
Is there an appropriate level of Interest rates?
Soludo (2009) asserts that economists assume that in the long run, nominal interest rates
will tend toward the level consistent with the fundamentals in the economy (equilibrium
or natural real rate of interest) plus an adjustment that reflects the effects of expected
long-run inflation. Bomfim (1997), he states that this natural rate of interest (the interest
rate consistent with output potential and stable inflation) takes a long-run perspective in
that it refers to the level expected to prevail in, say the next five to ten years. The rate
48
tells the truth about the availability of resources for meeting present and future consumer
demands, allowing production plans to be kept in line with the preferred pattern of
consumption.
Real interest rate movements, more than rates, influence business decisions about
investment, spending and consumers decisions, about purchases of durable goods and,
therefore, economic growth. The gap between the natural rate and the real rate is related
to the trend in inflation and if the real rate, (determined by credit market conditions and
people’s inflations expectations), is below the natural rate, (determined by production
capabilities), a boom in investment-type spending ensures, eventually driving prices
higher as resources use tightens. The contrary also holds. The real rates of interest is used
to determined whether the nominal rate charged is sufficient to compensate for
depreciation of the loan fund as a result of inflation. Thus, real rates of interest have been
adjusted to compensate for the effects of inflation. Real rates of interest are important
analytical tools for bankers because they help to ensure that they do not let inflation erode
the value of their lending portfolios. With negative-real rates of interest, the value of a
loan portfolio cannot be maintained.Therefore appropriate nominal interest should be at
the level that must ensure low positive real interest rate.
2.8.3 Are Ceilings On Interest Rates Good For An Economy?
What happens with interest rate ceilings depends on where the ceiling is relative to the
market rate.
A.
1.
When the ceiling is above the market rate of interest:
It has no effect at all and market forces of supply and demand are not bound by the
ceiling.
2.
The interest rate that rules in the market (equilibrium price) and quantity of credit
are unchanged.
B.
However, when the ceiling is below the market rate of interest, it affects the
market outcome thus:
1.
Decrease in the quantity of credit supplied; (credit is not made available despite the
fact that there is demand for it).
49
2.
Adverse selection
3.
Increase in non-interest fees and charges and therefore higher effective interest rate.
Therefore, it is not ideal to have a low interest rate regime when the rate of inflations is
high and rising. In times of rising inflation, nominal rate adjusts to reflect changes in the
prices level if real interest rate is to remain constant. Thus, holding real rate constant, a
rise in inflations rate will result in a proportionate increase in the nominal interest rate. A
rise in the nominal rate has the tendency of driving up the inflation rate where borrowing
is used to finance production.
Moreover, rising inflations leads to higher expectations about further increase in
inflation. Lenders will hedge against future inflation by charging higher nominal interest
rate.
Very Low interest rates can produces some adverse effects
(i)
Depreciations of the exchange rate due to speculative outflows of capital owing
to the relative attractiveness of assets denominated in foreign currencies.
(ii)
Low rates of interest induce increase in aggregate demand, which may become
excessive and in the face of inadequate supply and idle capacity lead to higher
inflations
(iii)
Low rates of interest induce increase in aggregate demand, which may become
excessive and in the face of inadequate supply and idle capacity lead to higher
inflation.
(iv)
“The crisis” underlying cause was the combination of very low interest rates and
unprecedented levels of liquidity” - - - Foreign Affairs, Jan/Feb. 2009,P.5
2.8.4
What Drives Interest Rates
A.
Inflation Expectations:
·
If the rate of inflation is expected to increase, the nominal interest rate needs to be
sufficiently high to induce positive real interest rates, so that there is an incentive
for savings.
·
Lenders/Savers will want to be compensated for inflations and will push the
50
nominal interest rate up to get the desired real rate of interest.
B.
Volume of Savings:
·
Higher volumes of savings drive down interest rate and promote investment.
Conversely lower volume increase interest rate and lowers investment.
·
The domestic interest rates, in conjunction with the rate of return on foreign
financial assets, and the expected change in exchange rate determine the allocation
of accumulated savings among domestic financial assets, foreign assets and goods
that are hedged against inflation.
·
Raising the levels of long-term savings is therefore vital for achieving the desired
level of interest rates as well as sustaining high investment and output growth.
C.
Fiscal Deficits:
·
Government fiscal deficits financed by the banking system crowd-out the private
sector.
·
Real interest rates rise as the government attracts funds away from the private
sector.
·
High interest rate has the effect of reducing the private sector’s demand for capital.
·
Government fiscal deficit as a percentage of GDP in Nigeria has dropped
significantly, averaging less than 1% in the last three years, but will rise
significantly in 2009.
D.
Risk Profile
·
Borrower’s (including sectoral) risk profile and the pricing of risk by the DMBs
play an important role in determining the level of interest rates charged by banks.
·
Where a borrower/sector or project is assessed to be high risk, a higher than
“normal” nominal interest rate is charged.
·
This explains why some customers are charged a higher interest rate than others
under similar conditions.
51
2.8.5 Interest Rate in Nigeria
·
Prior to 1986, there was administrative fixing of rates, but
Ø
It failed to achieve the desired policy objective of promoting investment and growth
in the real sector.
Ø
Resulted often it real low interest rates when inflation picked up, thereby
discouraging savings and the financial sector remained grossly underdeveloped
Ø
Perpetuated inefficient pricing and misallocation of resources
Ø
Discouraged competition
·
Market determined interest rates introduced with the deregulated of the financial
sector in 1986
Ø
But interest rate deregulation was partial between 1987 and October 1996 when
“Full” deregulations was implemented
Ø
Allowed banks to determine their deposit and lending rates according to market
conditions
Ø
The CBN’s policy rate, the MPR, indicates the rate that reflects economic
conditions, particularly the rate of inflation and economic conditions, particularly
the rate of inflation and liquidity situation in the banking system and signals where
the other short-term market interest rates could rule. It helps to formulate yield
curve and influence long-term experiences of interest rates.
·
Lending rates have tended downwards in Nigeria in recent times, yet they have
remained “high” in real terms (See table below).
52
2003
2004
2005
2006.
3.83
3.13
2007
2008
3.55
3.03
BANKS DEPOSIT RATES
Savings
3.45
7 Days
3.85
6.00
5.45
5.29
4.6
5.59
5.69
1 Month
10.7
10.45
10.00
9.36
10.26
11.30
3 Months
10.75
10.60
10.53
9.76
10.25
11.83
6 Months
11.00
10.45
10.38
9.29
9.74
11.55
12 Months
10.95
10.55
10.82
8.34
8.10
11.24
Over 12 Months
10.00
9.70
8.68
8.28
9.47
11.78
LENDING RATES: 2003
2004
2005
2006
2007
Prime
18.25
18.05.
17.95
16.92 16.94 16.01
Maximum
22.50
20.75
19.49
18.43 18.36 18.25
12.00
10.75
9.28
8.29
8.90 10.57
Interbank Call Rates 10.00
9.75
8.26
7.38
7.85 11.86
Spread:
2003
2004
2005
Savings- Max lending 16.25
15.85
Av. Term Dep Rate
2006
15.67
2008
2007 2008
15.30
14.82 15.22
Consolidated-Max lending 11. 10.85.
10.99
10.88
10.23
8.76
Ave Term Dep-Max lending 10. 10.75.
10.21
10.15
9.46
4.68
Source: CBN Bulletin and Annual Report, 2007-2008
Causes of “High” Lending Rate
·
Cost of funds
·
Interest rate on deposits
·
Cost of doing business by banks, including power, security, water, taxes, etc
·
Monetary policy stance (e.g. CRR, LR)
·
Differential pricing and re-pricing of risk by banks
·
Individual borrower’s risk
·
Sectoral Risk
53
·
General business environment (Systemic)
·
Excessive Demand Pressure relative to supply of loan able funds
·
Low savings rate means lower supply of loanable funds
·
Reduced supply of foreign credit lines
·
Government’s deficits means that government competes for credit with private
sector
·
2.9
Growing business opportunities put pressure on demand
Achieving the Trinity
According to Soludo (2009), no Central Bank has got the magic wand to control these
three prices simultaneously, without resorting to direct regulation.But it must be
emphasized that direct control is a failed policy.The exchange rate and interest rate can
be kept low and stable only if we succeed in keeping inflation low and stable over time. If
the Central Bank artificially keeps the interest rate low, the economy must be prepared to
live with a depreciated exchange rate. This is because in most monetary policy regimes,
interest rate is used as a policy instrument while low inflations and stable exchange rates
are objectives of policy. In most economics, interest rate is varied to fight inflation and
positive real is the norm.For interest rate to fall on sustained basis inflation must fall and
inflationary expectations must be low. If interest rate and exchange rate are controlled as
we did in Nigeria in 1970s- 80s, and then we should be prepared to live with any level of
inflation outcome that will result from such.
Therefore, the conclusions that can drawn are as follows:
Under a high inflations environment, a low nominal interest rate regime is not only
inconsistent but is also not feasible, as creditors would demand a high interest rate to
compensate them for parting with their funds and the erosion of the purchasing power
induced by the high inflation.
In such circumstances, the policymaker desirous of achieving low and stable inflation
(price stability) will be compelled to raise its base policy rate to:
§
Signal a tight monetary policy stance
54
§
Influence (drive-up) market interest rates to constrain aggregate demand (through
lower consumption and investment spending) and ultimately lower inflation
Over time, this outcome will expectedly elicit a lower interest rate regime when all
adjustment must have taken place. A low interest rate regime in an environment of
high inflation leads to an inefficient use/allocations of financial resources, as “suboptimal” investments which do not promote economic growth will be undertaken.
Furthermore, a high inflation environment is inconsistent with a “strong” and stable
currency.
In an open economy such as Nigeria, a high domestic price level (high inflation) relative
to those of the trading partners accompanied by a highly appreciated domestic currency
vis-avis trading partners currencies will induce the following:
§
Reduce the country’s competitiveness in the international market
§
Discourage imports
§
Discourage foreign investment, portfolio and other inflows
§
Encourage capital outflows
§
Encourage foreign exchange arbitraging and emergence of a thriving parallel market
for foreign exchange
§
Deplete external reserves
Thus, in order to ameliorate such adverse developments, the policymakers desirous of
bringing sanity to the economic system will deploy the instruments available to it, such as
pursuing an interest rate policy that will significantly moderate inflation, encourage
domestic savings, encourage capital inflows and mitigate capital outflows.
Thus, there is an inherent trade-off in trying to strike an appropriate balance among the
three key price variables-interest rate, exchange rate and inflation rate.
This is the reality of the situation that every economy, whether developed, emerging
market or developing, has to contend with.
What are the necessary and sufficient conditions for the achievement of low and stable
exchange and interest rates in Nigeria?
55
·
Definitely, moral suasion (preaching) will not do it
·
Controls over an extended period is also a failed policy
·
We need the following:
Ø
Stable and low inflations rate
Ø
A diversified productive and export base which will enhance the supply of foreign
exchange; improving business environment and productivity
Ø
We need to improve the physical and social infrastructure of the economy which
would reduce the cost of doing business
Ø
Fiscal prudence must be practiced by the 3-tiers of government and full
implementation of the Fiscal Responsibility Act
Ø
Banks must improve their operational efficiency by limiting their overhead cost.
In his contribution, Uchendu (2009)remarked that in spite of the successes of monetary
policy in recent times, it is recognized that challenges still exist. These include:
Liquidity Surfeit: This has been one of the major challenges of monetary policy in
making maintenance of price and exchange rate stability elusive, especially given the
cash-based nature of the economy. More so, the expansionary profile of fiscal policy has
continued to constrain the impact of monetary policy.
Sustenance Of Current Monetary Policy Initiatives: Recent monetary policy
initiatives like transparency requirements on Deposit Money Banks, stoppage of payment
of interest on Deposit Money Banks deposits etc may require firmness on the part of the
CBN in view of anticipated pressures from an early review.
Narrowing The Spread Between Savings And Lending Rates: Narrowing the spread
between savings and lending rates remains a challenge for monetary policy. There has
been some improvements following recent banking reforms, but there is still room for
improvement, and this should be a key concern in the years ahead.
Financing Real Sector Investmentss: Given the dual mandate of the CBN, monetary
policy must be tailored to promote real sector lending. With the large capital base now at
bank’s disposal, it is envisaged that the required capacity would be available to finance
56
long-term investments in the real sector in such areas as power plant; telecommunication;
oil and gas; railway etc. Monetary policy must however be such that enable this to
happen. The recent move by the MPC to stop paying interest on banks deposits are in
part aimed at thus credit market.
Fiscal Dominace: Another serious challenge to the conduct of monetary policy is the
continued fiscal dominance occasioned by expansionary fiscal operations of the three
tiers of government. Effective coordination between monetary and fiscal policies which
is now in place deserves to be sustained and strengthened.
Data problem:
The absence of reliable data on current basis, especially from the
Deposit Money Banks, makes timely, intervention in the money market difficult. The
CBN recently deployed new IT solutions which are intended to improve banking system
IT network connections. This, we hope, would improve the timeliness of data rendition
by banks to the CBN for the conduct of monetary policy.
Banking system surveillance: With the completion of the first phase of the banking
sector consolidation exercise and the emergence of bigger and stronger banks, the next
challenge is greater monitoring and supervision, in order to stem future occurrence of
banking distress in the country. This explains the monetary authorities’ shift to riskbased and rule-focused supervisory approach.
According to Okafor (2009), for monetary policy to be effective and efficient, the
following challenges such as Quality of Data, Conflicting Multiple Objectives of
Monetary Policy, Conflicting Government Policies, Expansionary Fiscal Operations of
the Three Tiers of Government, Liquidity Surfeit in the System, Developing Financial
System, Time Inconsistency, Balancing the Goal of Financial Stability and
Macroeconomic Stability, Structural Rigidities and Bottlenecks, Oligopolistic Banking
Sector and Market Segmentation needs to be addressed with commitment from the fiscal
authorities to avoid conflicting policy pronouncements and actions. The effectiveness of
monetary policy depends on having a quantity of money stock that drives the economy on
57
a non-inflationary growth path as it is the concern of the monetary authorities to ensure
growth of monetary aggregates that are consistent with prevailing economic
fundamentals. There is need for policy harmonization between the monetary and fiscal
authorities to facilitate the realization of the expected outcome.
Financial infrastructural development is fundamental to effective and efficient monetary
policy implementation and should be vigorously pursued and actualized. Monetary policy
formulation and implementation requires inputs from and support of all stakeholders to
be successful. Effective communication of policy decisions ensures that policy intents
and signals are correctly understood and interpreted by the markets and the public at
large. There is need to always balance short term and long term objectives of monetary
policy, through ensuring that the sequencing and prioritization of which objectives should
be given preference at a given time depending on the prevailing economic condition.
Overall, proper implementation of policy decisions is cardinal to successful monetary
policy outcomes which in turn justifices the relevance of policy instruments.
58
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Cukierman, A., Webb, S.B. and Neyapti, B (1992). “Measuring the Independence of
Central Banks and its Effect on Policy Outcomes”. The World Bank
Economic Review, Volume 6, Number 3.
De Brouwer, G and Ericsson, N.R (1995).Modeling Inflation in Australia”.Reserve Bank
of Australia Research Discussion Paper 9510, Economic Analysis and
Economic Research Departments, November.
Debelle, G.and Fischer, S. (1995). “How Independent should a Central Bank
Be?”.Fuhrer, J.C (Eds). In Goals, Guidelines, and Constraints Facing
Monetary Policymakers, proceedings of a Conference held at North
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Federal Reserve Bank of Boston), June.
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and
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62
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Research Design
The research aims at finding solution to the problem at hand, and to this end, various
techniques and strategies were employed. This chapter highlights the systematic
approaches used in data collection, procedures used for data retrieval and analysis of the
data collected. This chapter specifically deals with Research design, Sources of data,
Research instruments and method of data analysis. Research design has to do with the
development of strategies for finding out something (Anyanwu, 2000). For the purpose of
this study, the analytical approach consisting of survey and field study were employed.
This approach is considered necessary for an in-depth study about the subject matter.
3.2
Sources of Data
For this research to be effective and reliable, information about the subject matter must
be available and at the same time reliable. However, during the course of data collection,
these factors were taken into consideration. The study relies on data from secondary
sources. The data were collated from CBN Statistical Bulletin (Various), CBN Annual
Reports and Statement of Accounts and some published materials.
3.3
Method of Data Analysis and Technique for Analysis
Analytical research method was adopted in this work. Simple percentage will be used to
determine the effects of monetary policy instruments (targets) on three variables namely,
inflation rate, interest rate and exchange rate. Simple correlation co-efficient will be used
to determine the relationship between Actual Inflation rate and Monetary Policy Target
Inflation rate, Actual Interest rate and Monetary Policy Target Interest rate and Actual
Exchange rate and Monetary Policy Target Exchange rate.
63
REFERENCES
AnyanwuAham (2000) Research Methodology in Business and Social sciences, Owerri;
Canum Publishers Nig. Ltd.
Central Bank of Nigeria ;Annual report 2005, Banking Supervision Unit.
Fischer, Stanley (1997) “Financial system Soundness”. Finance and Development, march
1997, PP14 – 16
Odusola A.F. (2001). “Banking Crisis and macroeconomic performance in Nigeria”.Ph.d
Thesis, Department of Economics, University of Ibadan, Nigeria.
64
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.1
Introduction
The presentation and analysis of data relating to the subject of this research work is based
on the fact that; there are various views among economists on the exact mechanism by
which monetary policy affects the economy.
“What is certain, however, is that changes in money supply affect interest rates”.
The CBN’s policy rate, the MPR, indicates the rate that reflects economic conditions, the
rate of inflation and economic conditions, particularly the rate of inflation and liquidity
situation in the banking system and signals where the other short-term market interest
rates could rule.
4.2
Data Presentation
TABLE 4.2.1: Margin of Deviation between Actual Inflation Rate and Monetary
Policy Target Inflation Rate.
Year
Inflation Rate (Actual)
Inflation Rate (Targeted)
% Deviation
2000
6.9
5.0
38
2001
18.9
5.5
244
2002
12.9
8.10
59
2003
14.0
0.2
71
2004
15.0
8.2
83
2005
17.9
9.0
99
2006
8.2
6.0
37
2007
5.4
5.0
6.08
Source: CBN Annual Reports and Statement of Accounts (Various)
65
TABLE 4.2.2: Margin of Deviation Between Actual Interest Rate and Monetary
Policy Target Interest Rate.
Year
Interest Rate (Actual)
Interest Rate (Targeted)
% Deviation
2000
10.67
7.00
52
2001
9.98
7.00
43
2002
16.50
6.50
154
2003
13.04
5.00
161
2004
13.32
5.00
166
2005
10.82
5.00
116
2006
8.72
5.00
74
2007
8.10
5.00
62
Source: CBN Annual Reports and Statement of Accounts (Various)
TABLE 4.2.3: Margin of Deviation Between Actual Exchange Rate and Monetary
Policy Target Exchange Rate.
Year
Exchange Rate (Actual)
Exchange Rate (Targeted)
% Deviation
2000
92.69
89.73
3.29
2001
102.10
89.75
13.76
2002
111.94
94.00
19.08
2003
120.97
115
5.19
2004
129.35
120
7.5
2005
133.50
127.00
5.11
2006
132.14
127.00
4.04
2007
128.65
120.50
6.76
Source: CBN Annual Reports and Statement of Accounts (Various)
66
TABLE 4.2.4: Estimation for Regression Equation for Inflation Rate
Inflation
Inflation Rate
Rate
Year
(Targeted)
(Actual)
X2
XY
Y2
Y
X
2000
6.9
5.0
47.61
34.5
25
2001
18.9
5.5
357.21
103.95
30.25
2002
12.9
8.10
166.41
104.49
65.61
2003
14.0
8.2
196
114.8
67.24
2004
15.0
8.2
225
123
67.24
2005
17.9
9.0
320.41
161.1
81
2006
8.2
6.0
67.24
49.2
36
2007
5.4
5.0
29.16
27
25
∑x
= 99.2
∑y = 55
x
= 12.4
y
=
b = N∑xy - (∑X) (∑Y)
=
N=8
2
6.87
2
∑x 2 = 1409.04
∑xy
= 718.04 ∑y2 = 397.34
8(718.04) – (99.2) (55)
8(1409.04) – (99.2)2
N∑X – (∑X)
b
=
57.44.32 – 5456
11272.32 – 9 840.64
b
=
288.32
1431.68
a
=
y – bx
a
=
6.87 – 0.02 (12.4)
=
6.87 – 2.48
=
4.39
a
=
0.20
We can also calculate the correction between actual inflation rate and targeted inflation
rate as follows:
Coefficient of Correlation
Cor
=
N∑xy - (∑X) (∑Y)
67
{(N∑y2 - (∑y)2) + (N∑x2 - (∑x)2)}½
8(718.04) – (99.2) (55)
=
[(8(397.34) – (55)2 + (8(1409.04) – (99.2)2)]½
5,744.32 – 5456
=
[(3,178.72 – 3025) + (11,272.32 – 9,840.64)]½
=
288.32
792.7
=
0.36
The square correlation coefficient is or R-square is called the coefficient of
determination.
Coefficient of determination
r2
=
(corA,T)2
=
(0.36)2 =
68
0.13
TABLE 4.2.5: Estimation for Regression Equation for Interest Rate
Interest Rate
Interest Rate
(Actual)
(Targeted)
X
Y
2000
10.67
2001
X2
XY
Y2
7.00
113.84
74.69
49
9.98
7.00
99.60
69.86
49
2002
16.50
6.50
272.25
107.25
42.25
2003
13.04
5.00
170.04
65.2
25
2004
13.32
5.00
177.42
66.6
25
2005
10.82
5.00
117.07
54.1
25
2006
8.72
5.00
76.03
43.6
25
2007
8.10
5.00
65.61
40.5
25
Year
∑x =
N=8
x
91.15
= 11.39
∑y = 45
y
b = N∑x - (∑X) (∑Y)
=
5.63
=
N∑X2 – (∑X)2
∑x 2 = 1091.86
521.8
8(521.8) – (91.15) (45)
8(1091.86) – (91.15)2
b
=
4174.4 – 4101.75
8734.88 – 830.32
b
=
72.65
426.56 =
a
=
y – bx
a
=
5.63 – (0.17) 11.39
=
5.63 – 1.94
a
0.17
=
Coefficient of Correlation (Cor)
Cor
=
N∑xy - (∑X) (∑Y)
2
{(N∑y ) - (∑y)2 + (N∑x2) - (∑x)2)}½
=
8(521.8) – (91.15) (45)
69
3.69
∑y2 = 265.25
[(8(265.25) – (45)2 + (8(1091.86) – (91.15)2)]½
4174.4 – 4101.75
=
[212.6 – 2025 + 8734.88 – 8308.32]½
=
72.65
261.28
=
Coefficient of determination =
r2
=
(0.28)2 =
0.28
R2
0.078
70
TABLE 4.2.6: Estimation for Regression Equation for Exchange Rate
Exchange
Exchange
Rate
Rate
(Actual)
(Targeted)
X
Y
2000
92.69
2001
X2
XY
Y2
89.73
8591.43
8317.07
8051.47
102.10
89.75
10424.41
9163.47
8055.06
2002
111.94
94.00
12530.56
10522.36
8836
2003
120.97
115.00
14633.74
13911.55
13225
2004
129.35
120
16731.42
15522
14400
2005
133.50
127.00
17822.25
16935.45
16129
2006
132.14
127.00
17460.97
16781.78
16129
2007
128.65
120.50
16550.82
15718.65
145202.5
N=8
∑x = 951.34
∑y = 882.98
Year
x
= 118.92 y
b = N∑x - (∑X) (∑Y)
2
= 110.37
=
2
∑x
2
= 114745.6
∑xy= 106872.32
8(106872.33) – (951.34) (882.98)
8(114745.6) – (951.34)2
N∑X – (∑X)
b
=
854978.64 – 840014.19
917964.8 – 905047.7
b
=
14964.45
12917.01
a
=
y – bx
a
=
110.37 – 1.15 (118.92)
=
110.37 – 1.9136.75
=
26.38
a
71
=
1.15
∑y2
99345.78
=
Coefficient of Correlation (Cor)
Cor
=
N∑xy - (∑X) (∑Y)
{(N∑y2) - (∑y)2 + (N∑x2) - (∑x)2)}½
8(106872.333 – (951.34) (882.98)
=
[(8(99345.78) – (882.98)2 + (8(114745.6) – (951.34)2]½
854978.64 – 840014.19
=
[7947566.24 – 779653.68 + 917964.8 – 905047.79]½
=
14964.45
3590414.78
=
0.0042
Coefficient of determination =
R2
r2
=
0.000018
4.3
DATA ANALYSIS
(0.0042)2
=
In this section, we described the mathematical and the formal method of derivation and
estimation of a linear function. The mathematical method used to estimate a function ie.,
to measure the average value of parameters, ‘a’ and ‘b’ from a data, is called regression
analysis or regression technique. An estimate for regression equation was conducted to
determine the parameters ‘a’ and ‘b’ from the following variable: Actual inflation rate
and Monetary policy target inflation, Actual interest rate and Monetary policy target
interest, and Actual exchange rate and Monetary policy exchange rate.
Table 4.1 – 4.3 show the margin of deviation (percentage derivation between Actual
inflation and Monetary policy target inflation, Actual interest rate and monetary policy
target interest rate, and actual exchange rate and monetary policy target exchange
rate.From table 4.4, the constant a = 4.39 is the intercept which gives the inflation rate
when monetary policy target inflation is zero. The constant b = 0.20 gives the scope of
the regression line. It showed the decrease inflation rate as a result of the introduction of
monetary policy rate. The computed correlation coefficient showed that a relationship
72
existed between actual inflation and monetary policy target inflation. Correlation
coefficient = 0.36. Again the coefficient of determination that was computed indicated
0.13 degree of relationship.
Table 4.5 showed an estimated regression equation for interest rate (actual) and monetary
policy target interest rate. The intercept (a) = 3.69 which is the represent interest rate
with zero monetary policy target interest rate. The scope ‘b’ as = 0.17, represent the fall
in actual interest rate as a result of money policy target interest. 0.28 relationship existed
between monetary policy target interest rate and the actual interest as indicated by the
correlation coefficient.
The coefficient of determination showed 0.078 degree of
relationship.
Table 4.6 gives an estimated regression equation for actual exchange rate and monetary
policy exchange rate. The parameter ‘b’ was 1.15 which showed a high variation from
other estimated constant ‘b’. This implies that monetary policy target exchange rate been
working so effective as expected. This could be as a result of the fact that Nigeria is not a
producing a economy but rather consuming economy. The constant ‘a’ was 26.38 and
0.0042 relationship existed between actual exchange rate and monetary policy exchange
rate. The coefficient of determination was 0.00018.
4.4
Test of Hypothesis
Test of Hypothesis One
Ho: The monetary policy instruments are relevant in the management of inflation rate,
exchange rate and interest rate in Nigeria.
We tested this hypothesis by looking at the various computations on inflation rate,
exchange rate and interest rate. From table 4.4 inflation rate was reduce by 0.20 as a
result of monetary policy instruments. In table 4.5, interest rate was reduced by 0.17.
This means that, any 1% increase in inflation and interest rate, monetary policy
instruments was able to reduce them by 20% and 17% respectively. Exchange rate also
follows the same pattern.
From the above analysis, one could confidently say that
73
monetary policy instruments are relevant in the management of inflation, interest rate and
exchange rate.
Test of Hypothesis Two
Ho: There is a linear relationship between actual inflation rate and monetary policy target
inflation, actual interest rate and monetary policy target interest rate and actual exchange
rate and monetary policy target exchange rate.
Given the computed results of coefficient of correlations on actual inflation and monetary
policy target inflation, actual interest rate and monetary policy interest rate and actual
exchange and monetary policy exchange rate, we are of the opinion that a linear
relationship exists between the variables under consideration. This was evident by the
0.36 correlation coefficient on actual and target inflation rates, 0.28 correlation
coefficient on actual interest and target interest rates and 0.0042 relationship that existed
between actual and target exchange rates. Our position that a linear relationship exist
between the variable under consideration were supported by the results on coefficient of
determination which gives the extent of the degree of the relationship. The result showed
that coefficient of determination of 0.13, 0.078, 0.00018 on inflation, interest rate and
exchange rate respectively. Based on the above analysis, we conclude that a linear
relationship exist between actual inflation rate and monetary policy inflation rate, actual
interest rate and monetary policy interest rate and exchange rate (actual) and monetary
policy exchange rate.
Test of Hypothesis Three
Ho: There are causative factors that made monetary policy ineffective in checking
inflation, interest and exchange rates.
In our literature review, we identified some causative factors that renders monetary
policy ineffective in checking inflation, interest and exchange rates. These causative
factors include: liquidity surfeit, large spread between savings and lending rates, lack of
real sector lending / investments the problem fiscal dominance, absence of reliable data,
74
conflicting government policies, structural rigidities etc. based on the above listed
problems, we concluded that, there are causative factor that makes monetary policy
ineffective in checking inflation, interest and exchange rates as expected.
75
CHAPTER FIVE
SUMMARY OF FINDING, CONCLUSIONS AND RECOMMENDATIONS
5.1
Summary of Findings
The findings of this study include the following:
1.
From the test of hypothesis, we found that monetary policy instruments are
relevant in the management of inflation, interest and exchange rates in Nigeria.
2.
Test of hypothesis two showed that a linear relationship exist between actual
inflation and monetary policy target inflation rates, actual interest rate and
monetary policy interest rate and actual exchange rate and monetary policy target
exchange rate.
3.
Again, test of hypothesis three showed that, there were causative factors that
made monetary policy ineffective in checking inflation, interest and exchange
rates.
4.
From review of literature, we observed that monetary policy in Nigeria was
conducted in an environment characterized by uncertainty and frequent changes
in economic policy.
5.2
Conclusion
This research project focused on the monetary control framework.
It provided the
conceptual basis for monetary management with detailed emphasis on the application of
inflation rate, exchange rate and interest rate as a policy tool to regulate the movements in
the money stock. The research work identified an array of monetary and credit policy
instrument to monetary authorities (the CBN), classified them into direct and indirect
tools, and their appraisal was also carried out.
The hypotheses that were formulated were tested and they proved that monetary policy
instruments are relevance in the management of the Nigerian economy and that there was
a linear relationship between the variables under consideration.
However, with the
recommended suggestions if applied will help improve the management of the country’s
monetary policy and at the same time improve the aggregate economy of Nigeria.
76
5.3
Recommendations
Based on the findings of this study, the study recommends as follows;
(1)
Firstly, there is need to ensure macroeconomic stability, which implies the
insulation of monetary policy from the presence of financing the government
fiscal deficit. Uncontrolled financing of the by the CBN increases bank reserves
and level of excess liquidity in the banking system. This calls for effective coordination between fiscal and monetary policies. Where fiscal deficits through the
CBN become inevitable, there must be a limit as well as willingness on the part of
government to refrain from pressurizing the bank to keep interest rates low to
minimize fiscal costs.
(2)
Secondly, the need for a healthy and competitive banking and financial system
cannot be over emphasized as financial institutions constitute an obvious channel
through which monetary policy impulses are transmitted to the real sector o the
economy. In this regard, the restructuring of ailing financial institution is
necessary in order to instill the confidence of the public in the system, promote
the banking habit and enhance the ability of the CBN to manage. Fostering
competition also entails liberalizing licensing conditions and removing banners to
entry.
(3)
Thirdly, apart from ensuring the safety and soundness of the financial institutions
from the prudential point of view, the regulatory and supervisory framework
needs to be continuously reviewed and strengthened to embrace the activities of
non-bank financial intermediaries (NBFIs) which create claims against
themselves and add to the aggregate liquidity, purchasing power, demand and
inflationary pressures. With financial liberalization and the rapid expansion in
both the number and size of this category of institutions, the monetary impact of
NBFIs cannot be ignored; Hence, this research work strongly recommends of
regulation and supervision with a view to plugging the leakages in the effects of
monetary policy and thereby enhance its effectiveness/relevance.
(4)
Fourthly and lastly is the need to bolster the technical ability of the CBN. The
effectiveness/relevance of monetary policy instruments in the management of
77
Nigerian economy depends largely on the quality and timeliness of information
available to the apex bank. Reliance on indirect monetary policy instruments
requires the CBN to be able to generate data on its balance sheet and that of the
banking system, as well as project the demand and supply of reserves and their
effect on broader credit and monetary aggregates.
Allied to these, is the pertinent issues of independence for the CBN which will
enable it employ appropriate policy instruments and vary interest rates in the most
professional manner, as well as respond promptly to emerging challenged, for the
achievement of desired monetary policy goals.
78
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