EFFECTIVENESS OF MONETARY POLICY IN STIMULATING ECONOMIC GROWTH IN NIGERIA

ABSTRACT

Effectiveness of monetary policy in stimulating economic growth

This study investigates the effectiveness of monetary policy in stimulating economy growth in Nigeria using AK production Function and Vector Autoregressive (VAR) model. The empirical evidence depicts that economic growth in Nigeria is influenced by money supply, electric power consumption, gross fixed capital formation and trade openness. This shows that monetary policy is effective in maintaining economic growth on the long run. The impulse response function revealed that economic growth (GDP) respond to itself and does not respond to other variables like Consumer Price Index (CPI), Broad Money Supply (M2), Interest Rate (IR), Exchange Rate (ER) in some period, while in some period economic growth (GDP) respond to itself and other variable. The Granger causality test showed that there exist unidirectional, bilateral and independence causality. Thus Nigerian government through  its  monetary  authorities  should  fine-tune  the  economy  by  incorporating  other policies that will influence economic growth not only in the long run but also, in the short run period. This will go a long way in contributing to higher sustainable economic growth.

CHAPTER ONE INTRODUCTION

1.1    BACKGROUND INFORMATION

An  issue  which  has  occupied  the  minds  of  government  for  decades  is  the effectiveness of monetary policy in influencing economic variables. Despite the lack of consensus among economists on how it actually works and on the magnitude of its effect on the economy, there is a remarkable strong agreement that monetary policy has some measure of effects on the economy (Udegbunam, 2003). Monetary policy refers to the combination of measures designed to regulate the  value, supply and cost of money in an economy, in consonance with the level of economic activities. It can be described as the art of controlling the direction and movement of monetary and credit facilities in pursuance of stable price and economic growth in an economy (CBN, 1992).

Over the years, the objectives of monetary policy have remained the attainment of internal and external balance of payment. However, emphases on techniques/ instruments to achieve those objectives have changed over the years. There have been two major phases in the pursuit of monetary policy in Nigeria since the inception of the Central Bank of Nigeria, namely before and after 1986 structural adjustment programme (SAP). The first phase (1959-

1986) placed emphasis on direct monetary controls, while the second phase (1986-date)

relies on market mechanisms or market-based controls.

The era of direct controls was a remarkable period in monetary policy management in Nigeria, because it coincided with several structural changes in the economy; including the shift in the economic base from agriculture to petroleum, the execution of the civil war, the oil boom and crash of the 1970s and early 1980s respectively and the introduction of the structural adjustment programme (Chukwu, 2009; Garba 1996). The economic environment that guided monetary policy before 1986 was characterized by the dominance of the oil sector, the expanding role of the public sector in the economy and over-dependence on the external sector  in  order  to  maintain  price  stability and  a  healthy balance  of  payments position, monetary management depended on the use of direct monetary instruments such as credit ceilings, selective credit controls, administered interests and exchange rates, as well as

the prescription of cash reserve requirement and special deposits. During this period CBN’s monetary policies  focused  on  fixing  and  controlling  interest  rates  and  exchange  rates, selective sectoral credit allocation, manipulation of the discount rate and involvement in moral suasion. Reviewing this period, Omotor (2007) observes that monetary policy was ineffective   particularly   because   the   CBN   lacked   instrument   autonomy   and   goal determination, being heavily influenced by the political considerations conveyed through the ministry of finance. The CBN (2010) also posited that the use of market-based instruments was not feasible at that point because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rate. The most popular instrument of monetary policy was the issuance of credit rationing guidelines, which primarily set the rates of change for the components and aggregate commercial bank loans and advances to the private sector.

The structural adjustment programme (SAP)  adopted in July, 1986 ushered in a new era of monetary policy implementation with market-friendly techniques in Nigeria, It was designed to achieve fiscal balance and balance of payments viability by altering and restructuring the production and consumption patterns of the economy, eliminating price distortions reducing the heavy dependence on crude oil exports and consumer goods imports, enhancing the non-oil export base and achieving sustainable growth. The capacity of the CBN to carry out monetary policy using market friendly techniques was later reinforced by the amendments made to the CBN act in 1991 which specifically granted the CBN full instrument and goal autonomy. In line with the general philosophy of economic management under SAP, monetary policy was aimed at inducing the emergency of a market-oriented financial system for effective mobilization of financial savings and efficient resource allocation. The main instrument of the market based framework is- the open market operations. These operations are conducted wholly on Nigerian Treasury bills (TBs) and repurchase agreement (REPOs) and are being complimented with the use of reserve requirements,  the  cash  reserve  ratio  (CRR)  and  the  liquidity ratio  (RL).  These  set  of instruments are used to influence the quantity based nominal anchor (monetary aggregates) used for monetary programming. On the other hand, the minimum rediscount rate (MRR) is being used as the price-based nominal anchor to influence the direction of the cost of funds

in the economy. As a companion to the use of the MRR, the CBN latter introduced the monetary policy rate (MPR) in 2006.

Thus with the achievement of internal and external balances, the conditions in the financial market and institutions would create a high degree of confidence, such that the financial infrastructure of the economy is able to meet the requirements of market participants. Indeed, an unstable or crisis-ridden financial sector will render the transmission mechanism of monetary policy less effective, making the achievement and maintenance of strong macroeconomic fundamentals difficult. This is because it is only in  a period of internal/external stability that investors and consumers can interpret market signals correctly. Typically, in periods of high inflation, the horizon of the investor is     very short, and resources are diverted from long-term investments to those with immediate returns and inflation hedges, including real estate and currency speculation. It is on this background that this study would investigate the effectiveness of monetary policy in stimulating economic growth in Nigeria.

1.2      STATEMENT OF PROBLEM

With the increasing effort of developing countries like Nigeria to achieve economic growth, objectives of monetary policy in Nigeria have been to attain both price stability and exchange rate stability. The reality has however been far from expectations.

Nigeria has experienced high volatility in inflation rates, since the early 1970’s there have been four major episodes of high inflation, in excess of 30 percent. The growth of money supply is correlated with the high inflation episodes because money growth was often in excess of real economic growth. However, preceding the growth in money supply, some factors reflecting the structural characteristics of the economy are observable. Some of these are supply shock, arising from factors such as famine, currency devaluation and changes in terms of trade. The first period of inflation in the 30 percent range (12 months moving average) was in 1976 (CBN, 2009). One of the factors often adduced for this inflation is the drought in Northern Nigeria, which destroyed agricultural production and pushed up the cost of agricultural food items, a significant increase in the proportion of the average consumer’s

budget. In  addition, during  this  period, there  was excessive monetization of  oil  export revenue, which might have given the inflation a monetary character.

Moreso, in the late 1980’s following the Structural Adjustment program, the effects of wage increase created a cost-push effect on inflation. In the long run, it was the structural characteristics of the economy, coupled with the growth in money supply that translated these into permanent price increase. In 1984, inflation peaked at 39.6 percent at a time of relatively little growth in the economy. At that time, the government was under pressure from debtor groups to reach an agreement with the International Monetary Fund, one of the conditions of which was devaluation of the domestic currency. The expectation that devaluation was imminent fuelled inflation as price adjusted to the parallel rate of exchange. Over  the  same  period,  excess  money growth  was  about  43  percent  and  credit  to  the government had increased by over 70 percent (CBN, 2009). In other respects the cause of the inflation may also be adduced to the worsening terms of external trade experienced by the country at  that  time.  It  is  possible  therefore  that  Nigeria’s  inflationary episodes  were preceded by structural or real factors followed by monetary expansion.

The third high inflation episode started in the last quarter of 1987 and accelerated through 1988 to 1989. This episode is related to the fiscal expansion that accompanied the

1988 budget. Though initially the expansion was financed by credit from the CBN, it was later sustained by increasing oil revenue (occasioned by oil price increase following the Persian Gulf War) that was not sterilized. In addition, with the debt conversion exercise, through which “debt for equity” swaps took place, external debt was repurchased with new local currency obligations. However, with  drastic  monetary contraction  initiated by the authorities in the middle of 1989, inflation fell, reaching one of its lowest points in 1991 i.e.

13 percent (CBN, 2009). The fourth inflationary episode occurred in 1993, and persisted through the end of 1995. It coincided with a period of expansionary fiscal deficit and money supply growth. The authorities found it too difficult to contain the growth of private sector domestic credit and bank liquidity. Continuous fall of the inflation rate has been experienced since 1996  as  a  result of  stringent monetary policies of  the  Central bank. It  however, increased in 2001 and 2003, 2004, 2005, 2008 and 2009 to 18.9%, 14%, 15%, 17.9%, 11.6%, and 12.4% respectively (CBN, 2009).

Structural factors have proven to be important in the inflation spiral. Reduction in oil revenue (a  supply shock) led  to a  reduction in real income, with serious distributional implications. As workers pushed for higher nominal wages, while producers increased mark- ups on costs, an inflationary spiral followed. In addition to these factors the government also had a transfer problem in order to meet debt obligations. The failure of monetary policy in curbing price stability has caused growth instability as Nigeria’s record of development has been very poor. In marked contrast to most developing countries, its GDP was not significantly higher  in  the  year  2000  that  it  was  35  years  before.  As  many economic indicators shows, Nigeria’s economy has experienced different growth stages. The GDP growth rate recorded negative growth in the early 1980’s (-2.7 in 1982, 7.1 in 1983 and -1.1 in 1984). The growth rate increased steadily between 1985 and 1990 but fell sharply in 1986 and 1987 to 2.5% and -0.2%. Except in 1991 when a negative growth rate of -0.8% was recorded, 1990’s witnessed an unstable growth. However, the growth rate has been relatively high since 2001

The movement in the monetary aggregates and changes in price level in Nigeria between 1960 till date have been so dramatic. The CBNs intermediate monetary target between 1988 and 1991 was the narrow money supply (M1) from 1992 the broad money (M2) became the intermediate money target. But despite the various monetary regimes that have been adopted by the central bank of Nigeria over the year to face global competition among other things inflation still remains a major threat to Nigeria’s economic growth, also despite the fact that the central bank of Nigeria have excellent statistical and data tools expertise of bankers, policy makers and economist to predict results, it is never possible to exactly  predict  the  market  nature,  overcome  external  factors  like  weather,  calamities, political upheavals etc. to name a few that can cause a significant gap in demand and supply.

An examination of the long-term pattern reveals the following secular swings: 1965-

1968 Rapid decline (civil war years), 1969-1971 Revival, 1972-1980 Boom, 1981-1984

Crash,  1985-1991  Renewed  growth,  1992-2010  wobbling  (CBN,  2010)  based  on  the available evidence, it is not evident that monetary policy improves the performance of the real economy Okafor (2010), Adesoye Maku and Atanda (2012), Onyeiwu (2012) This study intend to examine the extent to which monetary polices on Nigeria have lifted the countries

economic growth. In other words, this paper takes up the challenge of finding how monetary policies have impacted on economic growth in Nigeria: this study intends to address the following research questions.

I         Does money supply impact on economic growth in Nigeria

II        Does economic growth respond to shocks in monetary policy variable

III      What is the causal relationship between monetary policy and economic growth.

1.3   OBJECTIVES OF THE STUDY

I       To determine the impact of money supply in stimulating economic growth

II      To determine the response of economic growth to shocks in monetary policy variable III       To establish the casual relationship between monetary policy variable and economic growth.

1.4      HYPOTHESIS

І.  Ho Money supply has no significant impact on economic growth

ІІ. Ho Economic growth does not respond to shocks in monetary policy variable

ІІІ.   Ho There is no causal linkage between monetary policy variables and economic growth in Nigeria

1.5     SIGNIFICANCE OF THE STUDY

The effectiveness of monetary policy in stimulating economic growth has raised so much dust, for researchers, economist, as well as policy makers in Nigeria.

One of the crucial challenge faced by policy makers is how effective money supply stimulate economic growth, this study will go a long a way to show us not only how effective money supply stimulates economic growth, but would also suggest to us other variables that stimulate economic growth. The study would also show us how some selected monetary policy variables respond to each other and the direction of causality.

The outcome of this study would also assist and serve as a lee way to prospective researchers, the monetary policy committee and members of the academic in the provision of

framework  upon  which  further  research  on  the  effectiveness  of  monetary  policy  in stimulating economic growth can be carried out.

1.6 SCOPE OF THE STUDY

This work investigates how monetary policy stimulates economic growth in Nigeria the study covers the period, 1960 to 2011.

1.7 LIMITATION OF THE STUDY

Every good work has its limitations and so this work is not an exception, though the study was well carried out, it has its limitations in that it focused entirely on monetary policy effectiveness on economic growth without checking its ineffectiveness on economic growth and without taking into consideration of fiscal policy and other fiscal policy variable, as both fiscal and monetary policy normally works together.

1.8 ORGANISATION OF THE STUDY

Chapter one, presents the background information, statement of problems, objectives of the study and hypothesis, significance of the study, the limitations of the study and organisation of the study.

Chapter two, contains the conceptual framework, review of literatures, constraint of monetary policy and limitations of previous study.

Chapter three, discusses the analytical framework, methodology, data and their features. Chapter four, presents us with data analysis and empirical results.

Chapter five, summarises and conclude the work with relevant policy recommendations.

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