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The study investigates the demand for money in a debt constrained Nigerian economy with the twin objectives of determining the impact of real money balances on economic growth as well as examining the impact of debt repayment ratio on real money balances in Nigeria. Using annual time series data running from 1981 to 2015, the study estimated two multiple linear regression equations. The result indicates among other things that real money balances have a significant positive impact on economic growth and the debt repayment ratio is negatively related to real money balance in Nigeria. The study recommends the effective utilization of monetary policies to check economic growth in Nigeria by pursuing policies that increase the real money balances in domestic economy.









  • Background to the Study

The concept of “money demand” has over the years attracted the interest of great economists. Unlike the demand for goods it is not restricted to one market but also involves other markets (Money market, capital market commodity market and foreign exchange market), hence it has a direct bearing on monetary policy and so relevant to the study of macro-economics. The focus on the demand for money is attributed to the fact that monetary policy will only be effective if the demand for money function is stable. Stability of the demand for money is crucial in understanding the behaviour of critical macro-economic variables (Essien, Onwioduokit and Osho, 1996).

The level and stability of the demand for money has received enormous academic attention because an understanding of its causes and consequences can usefully inform the setting of monetary policy. It is vital to investigate and test the stability of money demand since its instability is a major determinant of liquidity preference. The concept of “money demand” has over the years attracted the interest of great economists (Nachega, 2011).

Monetary policy is a deliberate action of the monetary authorities to influence the quantity, cost and availability of money credit in order to achieve desired macroeconomic objectives of internal and external balances. The action is carried out through changing money supply and/or interest rates with the aim of managing the quantity of money in the economy. The importance of money in economic life has made policy makers and other relevant stakeholders to accord special recognition to the conduct of monetary policy. The Central Bank of Nigeria is the organ that is responsible for the conduct of monetary policy in Nigeria.

Thus, faced with the objective of maintaining price stability, the Central Bank of Nigeria (CBN) strives to promote and maintain monetary stability through efficient management of debt and exchange rate stability. In essence, appropriate demand and supply management policies by the CBN necessary for economic development requires money to be stable and functional (Nwafor, Nwakanma, Nkansah and Thompson, 2007).

The demand and supply and debt management policies adopted by the government over the years that aimed at achieving money demand functions includes open market operation (OMO), Monetary Policy Rate (MPR) and other intervention instruments such as Cash Reserve Ratio (CRR). CBN uses OMO as the primary means of implementing monetary policy. The usual aims of open market operations are; to supply commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks, to manipulate the short-term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply (CBN, 2015).This involves meeting the demand of base money at the target interest by buying and selling government securities, or other financial instruments. Monetary target, such as inflation, interest rates, or exchange rates, are used to guide this implementation. Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserve either in cash or as deposits with the central bank o0f Nigeria. To compliment OMO, the CRR was also used to manage liquidity in the system in order to smoothen the liquidity cycle, and reduce pressure on the exchange rate (CBN, 2015). The CBN Monetary Policy Rate (MPR) is determine by the CBN Monetary Policy Committee Periodically. The MPR is the official bench mark rate of the CBN and the rate at which it lends money to commercial banks. CBN uses the above policies to influence markets’ decision and the economy at large in order to deliver on its core mandates of price and exchange rate stability (CBN, 2015).

Monetary targeting is a monetary policy strategy that aims to promote price stability through the intermediate goal of monetary growth. Therefore, considerable effort has been made in the empirical literature- for both industrialized and developing countries-m to determine the factors that affect long- run demand for money and assess the stability of the relationship between these factors and various monetary aggregates (Nachega, 2001).In sum, with the presence of structural changes in the economy such as the structural adjustment programme (SAP) of 1986, political instability, political crises, the global economic and financial crisis which started in 2008 and innovations in the financial sector, it remains imperative to question whether monetary targeting remains relevant in the conduct of monetary policy.

1.2 Statement of the Problem

The Central Bank of Nigeria has over the years sought a predictable and stable money demand function. This is due to the fact that a stable money demand function contributes to broader economic growth and rising standard of living. Thus, the re-examination of the question whether demand for money has remained stable during the financial reforms which started in 2005 in Nigeria is imperative. It is often suggested that financial market reforms could lead to an unstable demand for money and changes in money velocity with attendant consequences for monetary policy implementation. In countries where the central bank targets a money aggregate, for instance using reserve money to implement monetary policy, the effectiveness of monetary policy rests on the stability of the monetary transmission mechanism as well as velocity of money. When this relationship is subjected to unexpected shifts, monetary targets lose their transparency and are less able to accurately signal the appropriate stance of monetary policy. This argument has been used as a reason for moving to inflation targeting, which does not rely on the stability of money demand, but instead uses a broad range of information to assess the monetary policy stance (Dagher and Kovanen, 2011).

The velocity of money has been fluctuating in Nigeria. For instance, it was 5.4 in 1970, 2.5 in 1986, 4.6 in 1989, 4.6 in 2006, 2.6 in 2009, and 3.0 in 2011 respectively. This fluctuation in the velocity of money poses big challenge to the Central Bank of Nigeria in its monetary aggregate targeting in particular and monetary policy formulation in general. Again, it can be seen that the velocity of money in 1986 (2.3) and 2009 (2.6) was remarkable. These figures show that there was structural change during the two periods. During the Structural Adjustment Programme in 1986 and the “bailing out” of commercial banks in 2009, lots of money was injected into the economy. This led to a decreased velocity of money and after then increased to 4.6 and 3.0 in 1989 and 2011, respectively. However, some empirical evidence on regime shifts report contradicting results. For example, Kumar, Webber, and Fargher (2010) reported break dates in 1986 and 1992, whereas Chukwu, Agu, and Onah (2010) reported 1994, 1996, and 1997 and Omotor (2011) reported 1981, 1992 and 1994 respectively. Thus, one of the objectives here is to investigate the existence of a long-run broad money demand equilibrium relationship in the presence of structural breaks due to its significance for monetary policy.

If the money demand function is unstable and undergoes substantial instability as Keynes thought, then velocity is unpredictable, and the quantity of money may not be directly linked to aggregate spending, as it is in the modern quantity theory. In recent years, the rapid pace of financial innovations has led to substantial instability of the money demand function and this calls into question whether the theories and empirical analysis are adequate. It also has important implications for the way monetary policy should be conducted, because it casts doubt on the usefulness of the money demand function as a tool to provide guidance to policy makers (Mishkin, 2004). Thus, what is being sought in a stable demand for money function is a set of necessary conditions for money to exert a predictable influence on the economy so that the Central Bank’s control of the money supply can be a useful instrument of economic policy (Tahir, 1995).

Over the years, there is a mismatch between targeted money supply (M2) and actual demand for money (M2) by the CBN. For example, in 1991, 1994, 1996, 1998, 2000, 2003, 2005, 2008, and 2011, the targeted and actual broad money growth were 19.8% and 27.43%, 14.8% and 34.5%, 16.8% and 16.18%, 15.6% and   22.32%, 14.6% and 48.07%, 15% and 24.11%, 15% and 24.35%, 45%  and 57.88%, 13.75%  and 15.43%,  respectively (IMF and IFS 2016).First, in the aftermath of a recession in 2007, when many resources were underutilized, there was an increase in the money supply which lead to inflation as shown in figure 1.

Recent studies (Yamaden, Pandok and Bitrus 2011) found out that money demand function is stable in Nigeria.The question is, if the demand for money function is truly stable in Nigeria, why is the CBN unable to predict correctly the demand for broad money? This forms the bedrock this present research study.


Figure 1: Graph showing money supplytrendover the years (1960-2015)

Source: International Monetary Fund and International Financial Statistics (2016)

From the graph, between 1960 to 1995 during the military regime,the money supply in the country was at a trend and there was no huge rise in money supply in the country. While from 1997,there was a steady, continuous and geometric rise in money supply as compared to the previous years. This could be as a result of change in government from military to democratic regime. This implied that there was an increase in money supply after Nigeria entered democracy regime to foster economic growth. In the aftermath of a recession in 2007,when many resources were underutilized, there was an increase in the money supply to reduce the effect of global economic meltdown in the country between 2007 and 2014, there was a huge rise in money supply. This huge rise in money supply from 2007 to 2014 would have led to cause of naira losing value against dollars.

1.3 Research Questions

The following research questions were analyzed:

  1. What is the effect of real money balances on Nigerian economic growth?
  2. What is the impact of Debt repayment ratio on real money balances in Nigeria?

1.4 Objective of the Study

The broad objective is to examine the demand for money in a debt constrained Nigerian economy. The specific objectives are to:

  1. Investigate theeffect of real money balances on Nigerian economic growth.
  2. Examine the effect of Debt repayment on real money balances in Nigeria.

1.5 Research Hypotheses

The study hypotheses are:

H01: There is no relationship between real money balances and Nigerian economic growth.

H02: There is no significant relationship between Debt repayment ratio and real money balances in Nigeria

1.6 Significance of the Study

The study would be relevant to the Central Bank of Nigeria (CBN), policy makers and researchers. This is because, if the demand for real money balances has a consistent or stable relationship with its determinants, the changes in money stock would have predictable effects on income and output and the required change in the money stock to restore the equilibrium in the economy. In such a case, the Central Bank of Nigeria (CBN) can bring the desired changes in the economy by using monetary aggregates as a target variable. Thus, if the CBN relies on control of monetary aggregates as policy instruments, it must believe in a known and reliable connection between changes in that aggregate and changes in the arguments of the demand for money function, in order for its policy to have predictable effects.

1.7 Scope of the Study

The models were estimated using annual data ranging from (1980-2015) series. The choice of the period is informed by the availability of data which were sourced from CBN. The study will be an empirical study that intends to examine the demand for money in a debt constrained Nigerian economy.


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