ABSTRACT

Motivated by the rising inflation in Nigeria, this study examined the impact of monetary policy and inflation in Nigeria from 1986 to 2016. The increasing inflation rate and its vices in Nigeria questions the effort and policies that have been made to combat it or the degree of its implementation, and therefore the need to examine the impact of monetary policy on inflation control. The study employed annual time series data using Error correction model and Johansen co-integration to ascertain the specific objectives of the study. The study employed data from CBN Statistical Bulletin, National Bureau of Statistics, and the World Bank indicators, Economic journals and articles. The findings of the study suggest that monetary policy rate and interest rate has a significant and positive impact on inflation while broad money supply has a positive inelastic relationship with inflation and liquidity ratio has a negative inelastic relationship with inflation. Also the results show that there exist a long run relationship between the variables in the researcher’s model and inflation. Finally the results suggest that an increase in MS2, MPR and interest rate causes an increase in inflation, while an increase in liquidity ratio causes a decrease in inflation. The study therefore recommends that policies be formulated to exploit the impact of monetary policy on inflation control in Nigeria in an attempt to reduce the inflation rate.

CHAPTER ONE: INTRODUCTION

• Background to the Study

The monetarist sees monetary policy as the basic tool for controlling level of inflation in any economy in contrast to the view of fiscal school of thought. Iyoha (2004) monetary policy refers to the attempts to achieve the nation economic goals of full employment without inflation, rapid growth and the control payment equilibrium through the control of the economics supply of money and credit while Anyanwu (1993), says it means a deliberate effort by the monetary authorities (the central bank) to control the money supply and credit conditions for the purpose of achieving certain broad economic objectives like low or natural rate of inflation five percent (5%). The issue of monetary policy and its management is vested in the Central Bank, whose objective is to regulate a nation’s economic activities and control the level of inflation to ensure economic growth and a stable macroeconomic environment. According to Otmar (2009), Central Banks should maintain price stability by keeping inflation low and stable; and price stability is normally specified in terms of stabilizing the index of consumer prices in one form or another; while money supply is undermined by increases in consumer prices. Monetary policy is referred to as either being expansionary or contractionary as it largely depends on the country’s economic situation. Expansionary policy is when the monetary authority uses its tools to stimulate the economy. An expansionary policy increases the total supply of money in the economy more rapidly than usual. It is traditionally used to try to combat unemployment in a recession by

lowering interest rates in the hope that easy credit will entice businesses into expanding. Also, this increases the aggregate demand (the overall demand for all goods and services in an economy), which boosts growth as measured by gross domestic product (GDP). Expansionary monetary policy usually diminishes the value of the currency, thereby decreasing the exchange rate.

The opposite of expansionary monetary policy is contractionary monetary policy, which slows the rate of growth in the money supply or even shrinks it. This slows economic growth to prevent inflation. Contractionary monetary policy can lead to increased unemployment and depressed borrowing and spending by consumers and businesses, which can eventually result in an economic recession; it should hence be well managed and conducted with care.

The instruments of monetary policy generally affects the level of aggregate demand through the supply of money, cost of money, and availability of credit. Two major instruments of monetary policy are the Quantitative, General, or Indirect Instruments which includes (Bank rate, Open Market Operation, Reserve requirements). They are meant to regulate the overall level of credit in the economy through commercial banks. The second one is the Qualitative, Selective, or Direct Instruments which include (Margin requirements, Consumer credit). They aim at controlling specific types of credit in the economy.

The outcomes of monetary policy in Nigeria have been influenced by the general macroeconomic environment, in 2002 in order to free monetary policy implementation from the problem of time-inconsistency and minimize policy over-reaction due to shocks, the CBN commenced a two-year medium-term monetary framework. This was in recognition of the fact that monetary policy actions affected the ultimate objectives with substantial lags. The overall framework remained monetary targeting and market-driven while the new technique focused on a medium term horizon as against the erstwhile short term. In 2006, a new monetary policy implementation framework was introduced with the Monetary Policy Rate (MPR) replacing MRR as the nominal anchor. The new system operates an interest rate corridor with the lending and deposit facilities as the upper and lower corridor, respectively, in order to entrench a policy rate that would effectively signal the direction of monetary policy and smoothen the volatility in the money market rates. The MPR was to be the mid-point on which the corridor oscillated. The MPR was initially fixed at 10.0% with a corridor of 3.0% above the MPR for lending facility and 3.0% below the MPR for deposit facility.

Inflation is a sustained increase in the average price of all goods and services produced in an economy.  Money loses purchasing power during inflationary periods since each unit of currency buys progressively fewer goods. During inflationary periods, cost of holding money is increased causing inefficient use of real resources in transaction therefore inflation weakens the purchasing power of money and sink the standard of living of the citizenry. Inflation is a disease that must be eradicated if a country must experience growth. It arbitrarily redistribute income, wipe out savings, erodes the income of fixed income earners, leads to distortions of price and bring about misallocation of society economic resource. Charles Onyeiwu (2012). The effect of high inflation are generally considered to be harmful on the economy. That is why the achievement of price stability has always been one of the fundamental objectives of macroeconomics policy in both developed and less developed countries. (Orubu 1996).

For the past decades, the inflation trend in Nigeria had constituted one of the devastating problems since late 1980s. The Nigerian economy faced socio-economic stagnations traceable to inflationary spiral particularly in the 1980s when inflation increased to a double digit. The analysis of the non-core inflation in the early 1990s reveals inflation rate of 63.6% in late 1994. Headline inflation rose rapidly by 1995 to reach an all-time high of 72.8%, though it decelerated gradually to a single digit in 1997. In the same vein, core inflation which began a gradual ascent in early 1990, peaked at about 69.0% in the mid-1995 before slowing down in 1997. Since, then inflation remained at single digits between 1998 and 2001. In 2003, macroeconomic stability was restored, following the gains of a comprehensive and consistent economic reform program. The low inflation rate regime did not last for too long with the resurgence of spikes in headline and core-inflation between 2000 and 2001. Headline inflation rate remained at double digits between 2002 and 2005 as it recorded 12.9%, 14%, 15%, and 17.9% in the respective years. However, it decelerated dramatically to 8.24% and 5.38% in 2006 and 2007 before rising astronomically to 11.60% and 12.00% in 2008 and 2009 in that order, although fell marginally to 11.8% ,10.84%, 12.22%, 12.3%, 8.48%, 8.06%, 9.02% in 2010, 2011, 2012, 2013, 2014, 2015. As at December 2016, the inflation rate stood at 18.04%.  (International Monetary Fund, International Financial Statistics and data files).

The causes of Nigerian inflation for some time period could be traced to several studies such as Baro (1995), Moser (1995), Bruno and Easterly (1998), Awogbemi and Ajao (2011) among others. Changes in money supply, credit to government by banking system, government deficit expenditure, industrial production and food price indices are underlined factors that contribute to inflationary tendencies in Nigeria. Increase in government expenditure financed by monetization of oil revenue and credit from banking system could also be responsible for the expansion of money supply which in turn (with lagged effect) contributes to inflationary tendencies. Inflation is a household word, but few give attention to the dimension of causes and impact of its effects. It is undoubtedly one of the most highly treated subjects in economic researches and literature. Its effects and causes are many, vary and well treated in literature. See Okpara and Nwaoha (2010), Fullerton and Ikhide (1998), Odusunya and Atanda (2010), Egwaikhide et al (1994), Jhingan (2004), Batini (2004), Owoye (2007), Asogu (1999) among others. In Nigeria, like in most developing countries, there exist acute structural supply constraints that limit the expansion of output even in the face of high demand. Such structural rigidities, according to Todaro and Smith (2009, p. 755), imply that ‘any increase in the demand for goods and services generated by rapid money creation will not be matched by increases in supply’. The resultant effect is that such excess demand pushes prices up and leads to inflation. Thus, the assumed direct linkage between lower interest rates, higher investments and expanded outputs may not always exist. Specifically, higher interest rates would probably affect individuals’ and institutions’ demand for financial assets and credit, with higher interest rates tending to increase asset prices and inhibit credit growth. With conventional monetary policy exerting very little direct influence on developing nation’s economic activity.  In Nigeria, one of the cardinal objectives of Central Bank of Nigeria is to maintain price stability in the economy. This is done by ensuring that rate of inflation is maintained within a certain bound to enable a strong economic activity in all facets of the economy. In this context, one of the main principal tools of monetary policy being used by the Central Bank of Nigeria to control economic activities is the monetary policy rate, introduced in December, 2006. “The Monetary Policy Committee of the Central Bank of Nigeria introduced MPR to replace the MRR which from past experience had not been sufficiently responsive to CBN’s policy initiatives, especially in tackling the problem of excess liquidity in the system. MPR hinges on an interest rate corridor, provides for the CBN lending facility as well as the acceptance of overnight deposit from operators at specified rates. Under MPR, the CBN discount window could be accessed by market operators (Discount Houses and Deposit Money Banks), that are in need of funds to meet liquidity shortages and those with excess liquidity could deposit the funds overnight”. (Central Bank of Nigeria, Communique no. 48, 2006).

Also the debt reduction policies of Obasanjo from 1999 to 2007 to some extent helped matters but corruption and lack of infrastructures throughout his tenure undermined seriously efforts to restore macroeconomic stability.

The monetarist, led by Milton Friedman believes that inflation is always and everywhere a monetary phenomenon.

On the whole, the effectiveness of monetary policy to effectively control inflation depends on the operating economic environment, the institutional framework adopted and the choice and mix of the instrument used. (Nnanna, 2001).

1.2       Statement of the Problem

With the observed trend of inflation in Nigeria over the years, and comparing it with some monetary policies that has equally been implemented and also considering Philips theory that inflation and unemployment have inverse relationship, inflation has continue to increase and it has been an issue of concern to the authorities since the late 1960s. Thus, through the 1970s and well into the first millennium of the 1980s, anti-inflation policy became a regular feature of government overall economic policy agenda. Inflationary pressures heightened substantially after the adoption of Structural Adjustment Programme (SAP) in 1986, with inflation rate rising as high as 38% and 49% in 1988 and 1989 respectively. Despite a mild reduction in 1990 with a single digit inflation rate of 7%, the inflation rate climbed up steadily to about 44.9% in 1992 and as high as 72.8% in 1995. As at December 2016, the inflation rate stand at 18.04%. However, in Nigeria despite the efforts made to reduce inflation, which include the use of combination of several measures ranging from wage freezes, price controls, direct involvement of government in the procurement and distribution of essential commodities, a fiscal and monetary strategies etc. Inflation has been on the increase and  maintaining a double digit figure such that the economy is characterized with eroded real income, value of savings are equally wiped away, high rate of unemployment, poor standard of living, low per capita income. It is based on these that the researchers seek to find the role played by monetary policy instruments in influencing inflation in the country.

1.3       Research Questions.

This study seeks to answer the following questions

1. What is the significant impact of monetary policy on inflation in Nigeria?
2. What is the short run relationship between money supply and inflation in Nigeria?
3. What is the long run relationship between money supply and inflation in Nigeria?

1.4       Objectives of the Study

The broad objective of the study is to investigate the trend of monetary policy and inflation in Nigeria. The specific objectives include:

1. To examine the significant impact of monetary policy on inflation in Nigeria.
2. To examine the short run relationship between money supply and inflation in Nigeria.
3. To ascertain if there is a long run relationship between money supply and inflation in Nigeria.

1.5       Statement of the Hypotheses

For a resounding and efficient research work analysis, the research hypothesis that would be tested in the course of this research is stated below:

H0₁:   There is no significant contribution of money supply to variance on inflation in Nigeria.

H1₁:  There is a significant contribution of money supply to variance on inflation in Nigeria.

H0₂: There is no significant short run relationship between money supply and inflation in Nigeria.

H1₂: There is a significant short run relationship between money supply and inflation in Nigeria.

H0₃: There is no significant long run relationship between money supply and inflation in Nigeria.

H1₃:  There is a significant long run relationship between money supply and inflation in Nigeria.

1.6 Significance of the Study

The findings of this research work will be find significant in the following ways:

1. Federal and state ministries of finance would find the results of the study useful for reviewing the existing monetary policies.
2. National policy makers and some governmental agencies will find the results useful as to how to tackle monetary problems like inflation in Nigeria.
3. It will also be a guide to those who may wish to add up more economic journal on this topic. It will also add to the economic literature of Nigeria.

1.7       Scope and Limitations of the Study

The study is delimited to the impact of monetary policy on inflation control in Nigeria. It covered the period of thirty-one (31) years, spanning across 1986 – 2016. The year under review was chosen because it was the year for the inception of Structural Adjustment Programme (SAP) in Nigeria and n (year span) should be equal to or greater than 30years. In the course of carrying out this study the researcher encountered some problems which imposed some limitations on the study. The paucity of relevant information and statistical data placed a heavy limitation on this work. Also the time available for this work was very limited as the time for this research was combined with our academic work, financial constraint was also a limitation as a result of high transportation cost, cost of typing and photocopy of some materials and other miscellaneous expenses. Despite these limitations the researcher tends to work assiduously to carryout and present a thorough and extensive work on the above topic.

1.8     Organization of the study

The study is divided into five chapters. Chapter one presents the Introduction, Chapter two presents the related literature review. Chapter three is the research method while chapter four is the presentation of results and discussion of Findings. Chapter five is summary of the study, conclusion and policy recommendations followed by the list of Referenced Materials and the various appendixes of the study.

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