Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Monetary Policy and Inflation in Developing Economies:
Evidence from Nigeria’s Data
Kromtit Matthew
This study examines the effectiveness of monetary policy in controlling inflation in the Nigerian
economy using a data-rich framework. The stationarity state of the data series was tested using
the Augmented Dickey Fuller (ADF) Unit Root test to avoid spurious results; while the causal
relationship between inflation and monetary policy variables was determined using the Granger
Causality Test and the relevance of monetary policy indicators in explaining changes in the
general price level was investigated using the Ordinary Least Squares (OLS) technique which
contains annual data for the period 1986-2013. The Unit Root result revealed that inflation and
economic growth data series were stationary at level; while monetary policy rate, broad money
supply and exchange rate were stationary at first difference implying the short-run effect of
monetary policy variables on inflation in Nigeria. The Granger Causality result indicated that a
uni-directional relationship exists between inflation (INF) and monetary policy rate (MPR)
running from MPR to INF and between economic growth (proxied by Gross Domestic ProductGDP) and INF running from INF to GDP; that independence was suggested between broad
money supply (M2) and INF as well as between exchange rate (ER) and INF at 5% level of
significance. The OLS result found that monetary policy rate has an insignificant positive impact
on inflation; broad money supply impacts negatively and insignificantly on inflation; ER
insignificantly impacts negatively on INF; and economic growth was found to significantly impact
positively on INF in Nigeria. Thus, the results provide evidence of the price puzzle and confirm
that monetary policy is not effective in stabilizing prices in Nigeria. Thus, it is recommended that
monetary policy in Nigeria would be effective in taming inflation if financial inclusion is
strengthened and new non-bank models are sought in ensuring that the monetary authority has
good control of money supply and other monetary indicators.
Key Words: Monetary Policy, Inflation and Nigeria.
JEL Classification: E43, E51, E52, E58, G2, O4.
Field of Research: Monetary Economics
I. Introduction
The core idea of monetary policy has been construed to mean price stability at
the expense of other key performance indicators like economic growth that
culminates to job creation which measures the growth performance of a nation,
stable broad money supply as well as prime lending and exchange rates which
determine financial sector‟s stability in an economy . This is why the main objective of
monetary policy in Nigeria has been to ensure price and monetary stability. This
is mainly achieved by causing savers to avail investors of surplus funds for investment
through appropriate interest rate structures; stemming wide fluctuations in the
exchange rate of the naira: proper supervision of banks and related institutions to
ensure financial sector soundness; maintenance of efficient payments system;
____________________________________________________________________
Mr. Kromtit Matthew Jesse, Department of Economics, University of Jos, Plateau State, Nigeria, Phone:
+2348038221767, Email: kromtitm1@gmail.com, kromtitm@unijos.edu.ng
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
applying deliberate policies to expand the scope of the financial system so that
interior economies, which are largely informal, are financially included. Financial
inclusion is particularly important in the sense that the larger it is the larger is the
interest rate sensitivity to production and aggregate demand and so the more
effective monetary policy is in stabilizing prices (Mbutor, 2010).
Consequently, the effectiveness of monetary policy in taming inflationary trends
in developing economies such as the Nigerian economy has been in doubt although
appreciable progress has been made in this regard since the introduction of
various financial sector reform programs in 1986. Goshit (2006) undertook a
theoretical examination of the causes of financial sector‟s instability in Nigeria and its
implications for the development of the economy and reported that ensuring a sound
and stable financial sector has been a difficult task to the Central Bank of Nigeria
and other regulatory and supervisory authorities. This is due to rapid financial sector
liberalization, loose monetary policy and excessive fiscal spending, banking
malpractices, undue political interference in banking operations as well as poor
internal governance of the financial institutions. This study views an effective
monetary policy as the major tool of enhancing financial sector‟s stability in Nigeria
through the stabilization of prices. Thus, the Nigerian monetary policy framework has
continued to face several challenges. No wonder, the CBN is increasingly focusing
more on the aspect of price stability, recognizing its relevance in
macroeconomic stability for sustainable output and employment growth. In
contrast, economists have disagreed, however about whether price stability and
money supply should be the central objective of macroeconomic policies or
whether these policies should serve broader monetary policy goals (Nwosa,
Olaiya and Amassoma, 2011).
For Nigeria and other developing countries, growth policies are better
delivered as full packages since fiscal and monetary policies are inextricable,
except in terms of the instruments and implementing authorities. However,
monetary policy appears more potent in correcting short term macroeconomic
maladjustments because of the frequency in applying and altering the policy
tools, relative ease of its decision process and the sheer nature of the sector which
propagates its effect to the real economy – through the financial system. This is
why investigating the effectiveness of monetary policy under market mechanisms in
controlling inflation in the Nigerian economy is relevant.
Since mid 1980s, inflation has become so serious and contentious a problem in
Nigeria and other developing economies. Though inflation rate is not new in the
Nigerian economic history, the recent rates of inflation have been a cause of great
concern to many. During the period under review (1986–2013), there has been a
dwindling trend in the inflationary rates leading to major economic distortions. The
continued over valuation of the naira in 1980s, even after the collapse of the oil
boom engendered significant economic distortions in production and
consumption as there was a high rate of dependence on import which led to
balance of payment deficits. This resulted to taking loans to finance such deficits.
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
An example was the Paris Club loan, which was a mere Five Billion, Thirty nine
million dollars ($5.39billion) in 1983 rose to twenty one billion, six million
dollars ($21.6billion) in 1999 (CBN 2001).
The Economic Recovery Emergency Fund of 1986 where one percent (1%) of
workers‟ salaries was deducted monthly to build the funds was meant to curb
inflationary trends in Nigeria. This gradually and greatly reduced the purchasing
power of the working class. But the policy measures failed as the prices of goods
and the profits of corporate bodies were not controlled. Therefore, as prices rose,
the labour unions agitated for higher wages resulting in further higher prices
(Agba, 1994).
Suffice to ask: how effective is monetary policy in controlling inflation in Nigeria?
The relevant indicators that best explain inflation in the Nigerian economy could be
measured in terms of the levels of monetary policy rate, broad money supply,
exchange rate and economic growth. These indicators form the relevant variables
for this study.
1.1 RESEARCH OBJECTIVES
From the foregoing, the study generally seeks to investigate the effectiveness
of monetary policy in controlling inflation in Nigeria as it relates to its
implementation under market mechanisms. This broad objective would be
achieved by using a data-rich framework to:
(i)
(ii)
Determine the causal relationship between monetary policy and inflation in
Nigeria via these variables: monetary policy rate, broad money supply,
exchange rate and economic growth. The choice of these variables is
derived from the monetary policy objectives of the Central Bank of Nigeria
(CBN, 2011).
Estimate the impact of monetary policy on inflation in Nigeria via the
aforementioned relevant variables.
1.2 RESEARCH HYPOTHESES
Sequel to the objectives identified, the following hypotheses form the bedrock upon
which the study is based:
(i)
(ii)
There is a causal relationship between monetary policy and inflation in
Nigeria.
Monetary policy has a significant impact on inflation in Nigeria.
1.3 STRUCTURE OF THE STUDY
To verify the aforementioned hypotheses, the study is structured into five sections.
Section one is the introduction which summarizes the background to the study, the
research problem, objectives and hypotheses. On the other hand, section two reviews
relevant literature by giving conceptual clarifications, discussing the theoretical
framework for the study and reviewing empirical evidences. While section three
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
discusses the methodology which is purely qualitative and quantitative in nature; section
four reports the findings and section five concludes with recommendations.
II.
LITERATURE REVIEW
2.1 CONCEPTUAL FRAMEWORK
2.1.1 The Concept of Monetary Policy
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 (CBN, 2011) .
Sani, Amusa and Agbeyangi (2012) defined monetary policy as the combination of
measures taken by monetary authorities (e.g. the CBN and the ministry of finance) to
influence directly or indirectly both the supply of money and credit to the economy and
the structure of interest rate for economic growth, price stability and balance of payment
equilibrium. 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. Monetary policy can either be expansionary or contractionary,
depending on the overall policy thrust of the monetary authorities. Monetary
policy is expansionary when the policy adopted by the central bank increases the
supply of money in the system and contractionary, when the actions reduce the
quantity of money supply available in the economy or constrains the growth or ability of
the deposit money banks to grant further credit. The primary objective of monetary
policy is the realization of stable non-inflationary growth. This gives the citizens
confidence in the future value of their money, so that they can make sound
economic and financial decisions. Low and stable inflation also helps to prevent
inflationary boom and bust cycles that could result in a recession and higher
unemployment (CBN, 2011).
2.1.2 The Concept of Inflation
By definition, inflation is a persistent and appreciable rise in the general level of
prices (Jhingan, 2002). Not every rise in the price level is termed inflation. Therefore, for
a rise in the general price level to be considered inflation, such a rise must be constant,
enduring and sustained. The rise in the price should affect almost every commodity and
should not be temporal. But Demberg and McDougall are more explicit referring to
inflation as a continuing rise in prices as measured by an index such as the
Consumer Price Index (CPI) or by the implicit price deflator for Gross National Product
(Jhingan 2002). Thus, a practical definition of inflation would be persistent increase in
the general price level at arate considered too high and therefore unacceptable
(Ogboru, 2010).
In an inflationary economy, it is difficult for the national currency to act as
medium of exchange and a store of value without having an adverse effect on
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
income distribution, output and employment (CBN, 1984). Inflation is characterized
by a fall in the value of the country‟s currency and a rise in her exchange rate wit h other
nation‟s currencies. This is quite obvious in the case of the value of the Naira (N), which
was N1 to $1 (one US Dollar) in 1981, but has now fallen to N160 to $1 in 2013
(http://www.oanda.com/convert/classic). This decline in the value of the Naira coincides with
the period of inflationary growth in Nigeria, and is an unwholesome development that
has led to a drastic decline in the living standard of the average Nigerian.
There are three approaches to measure inflation. These are the Gross
National Product (GNP) implicit deflator, the Consumer Price Index (CPI) and the
wholesome or producer price index (WPI or PPI). The period to period changes in
these two latter approaches (CPI and WPI) are regarded as direct measures of inflation.
There is no single-one of the three that rather uniquely best measures inflation. The
Consumer Price Index (CPI) approach, though it is the least efficient of the three is used
to measure inflation rates in Nigeria as it is easily and currently available on monthly,
quarterly and annual basis (CBN, 1991).
This study views inflation as a function of monetary policy. This means that
keeping inflation at tolerable level depends on the effectiveness of monetary policy.
2.2 THEORETICAL FRAMEWORK
2.2.1 Theories of Money: The Quantity Theory of Money
The theory guiding this study is the famous quantity theory of money
propounded by Fisher (1911) (Adenuga, Taiwo and Efe, 2000). The theory in its
simplest form depicts that changes in the stock of money supply will be translated
into equi-proportionate change in the general price level (inflation rate). This is based
on the assumption that at full employment, the level of transaction (national
output) and velocity is constant, or at least change slowly. Thus, inflation will be directly
proportional with the quantity of money stock. The starting point of the quantity theory
of money is the popular identity:
MV=PY-----------------------------------(1)
Where M = money supply, V = velocity of money in circulation, Y = real national output,
and P = aggregate price level. From equation 1, we can derive another equation as
follows:
P=MV/Y or V=PY/M----------------------(2)
Sequel to the above, the proportional relationship between the money stock and
general price level (inflation) can be shown in the elasticity of the price level with
respect to the money supply is:
Epm=∂P/∂M.M/P--------------------------(3)
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Differentiating equation 1 totally yields:
M∂V+V∂M=P∂Y+Y∂P----------------(4)
But Y and V are constant at full employment. i.e. change in Y and V is zero at full
employment. Thus equation 4 yields:
V∂M=Y∂P------------------------------(5)
∂P/∂M=V/Y----------------------------(6)
Substituting equation 6 into 3 yields:
Epm=V/Y . M/P--------------------(7)
From equation 2, V=PY/M. Substituting this into equation 7 yields:
Epm=1/Y . PY/M. M/P=1--------------(8)
Equation 8 above depicts that there is a direct proportional relationship between
the general price level (inflation) and the growth rate of money supply, when velocity
and output are constant. i.e., in a regression of inflation on money supply growth,
the coefficient of money is estimated to be unity (1). The proportionality relationship
imply that a perm anent increase in money growth leads to an equal increase in
the rate of inflation (general price level).
2.2.2 Theories of Inflation: The Demand-Pull Approach
There are several theories of inflation. However in this study, demand pull theory
was used to justify the Keynesian approach to inflation. The demand pull theory, which
is the traditional and the most common type of inflation results, forms the aggregate
demand exceeding the supply of goods and services in an economy. The shortage in
the supply could result from underutilization of resources due to inadequate spare
parts resulting from high interest and exchange rates or the inability of the
production to be increased rapidly rise. The demand-pull theory is sub-divided in to
the monetarists and Keynesian views (Jhingan, 2002) but the Keynesian view utilized
for this study. According to John Keynes and his followers (the Keynesian view),
demand-pull inflation occurs when aggregate demand exceeds aggregate supply at full
employment level of output that is attributing inflation to the relationship between the
aggregate expenditure (C+I+G) and full employment level of output (Agba, 1994). This
implies that only an increase in price above the full employment can be called inflation.
Therefore, as long as an economy has not reached the level of full employment, any
increase in money supply or the price would exhaust itself in raising the level of
employment and output a nd not the general price level in the economy
(Adenuga, Taiwo and Efe, 2000) . They (Keynesians) emphasized non monetary
influences such as government process (CBN, 1991), Keynes then explained
inflation through the inflationary gap, which exists when the aggregate demand
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
exceeds the level of output at full employment level (Adenuga, Taiwo and Efe, 2000) ,
this implies that once an economy has reached the point of full employment, any slight
increase in aggregate demand over the available output will obviously lead to a rise in
price. If such demand persists, the result is inflation.
2.2.3 The CBN’s Monetary Policy Framework and Instruments
As conditions in the economy worsened in 1986, concerted efforts were made to
eliminate unnecessary economic controls and to free the economy (Ojo, 2000). This
prompted the introduction of the Structural Adjustment Programme (SAP) in July 1986.
The purpose was to ultimately institute a more efficient market system for the allocation
of resources, with the implication that excessive controls of the previous two decades
would be gradually eliminated or reduced to levels that would not inhibit economic
development.
At the start of SAP, traditional instruments were fine-tuned to deal with the
excess liquidity in the economy. In August 1986, the CBN, for instance, required banks
to deposit in a non-interest bearing deposit account at the Bank, the naira
equivalent of all outstanding external payment arrears. Also, the 10 per cent ceiling
imposed on the rate of credit expansion by banks fixed in January 1986 was reduced to
8 per cent in July and maintained until August 1.
Several measures were also added to stem the growth of excess liquidity. There
was the abolition of the use of foreign guarantees/currency deposits as collateral for
naira loans which implied that deposit money banks were no longer to grant domestic
loans denominated in naira on the security of foreign guarantees or deposits held
abroad and in domiciliary accounts with the banks. In May 1989, the Federal
Government directed that all public sector accounts be withdrawn from the banks. Its
immediate impact was the reduction in banking system liquidity. A reverse policy took
place in 1999 when the retail functions of the CBN were transferred to the DMBs. Other
policy measures included: Rationalization of sectoral credit controls so as to give a
larger measure of discretion to banks in respect of credit operations in 1986 and 1987;
abolition of all mandatory credit allocation mechanisms by the CBN from October 1996;
adjustment of CRR to embrace the total deposit liabilities (demand, savings and
time deposits) of banks instead of the earlier method of computing the CRR based
on demand deposits alone; deregulation of interest rates; reintroduction of the use of
stabilization securities in 1990; enhancement of commercial bank„s minimum paid-up
capital from N20 million to N50 million in 1992, N500 million in 1999 and N1.0
billion from January 2001; and shift to the use of OMO in 1993 with intention to
migrate from direct controls of monetary management to an indirect or marketbased approach.
Following recent developments in the economy, particularly in the financial
sector, it became necessary to review the conduct of monetary policy and
strengthen the machinery of monetary policy to achieve set targets and
objectives. In particular, the relationship between the Minimum Rediscount Rate (MRR)
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
and other rates in the market became weak and the significance of using the MRR as
the anchor for other short -term interest rates was eroded. Also, the persistent failure
to meet stipulated monetary policy targets continued unabated (CBN, 2006).
Consequently, in December 2006, the Bank introduced the current framework for
monetary policy implementation with the objective of addressing the persistent
interest rate volatility and making the money market more responsive to monetary
policy interest rate changes, especially the overnight interbank interest rate. The
containment of interest rate volatility was to be addressed through the application of
some policy measures including averaging of reserve requirements over a
maintenance period of two weeks and the use of Standing Lending and Deposit
Facilities to define an interest rate corridor around the monetary policy rate (MPR)
which would drive interest rates in the money market.
2.3 EMPIRICAL EVIDENCES
Inflation is one of the most important economic variables that can distort
economic activities of any country. As a result, there exist a large number of empirical
studies on the determinant of inflation. Khan and Schimmelpfennig (2006) ( Adenuga,
Taiwo and Efe, 2000) studied factors that explain and help forecast inflation in Pakistan.
A simple inflation model was specified that included standard monetary variables
(money supply, credit to the private sector), an activity variable, the interest and the
exchange rates, as well as the wheat support price as a supply -side factor. The study
performed comprehensive analysis of data and estimated the Vector Error
Correction model. Impulse response function of CPI inflation, private sector credit
growth and wheat support price was estimated.
In Nigeria, Oyejide‟s 1972 study constitutes a pioneering attempt at
providing an explanation of the causes of inflation in Nigeria, most especially
from the structuralists‟ perspective. Specifically, he examined the impact of deficit
financing in propagating inflation processes in Nigeria and concluded that there was a
very strong direct relationship between inflation and the various measures of deficit
financing that were in use between 195 7 and 1970. In a commissioned study for the
Productivity, Prices and Incomes Board of Nigeria, Ajayi and Awosika (1980) found
that inflation in Nigeria is explained more by external factors, most especially the
fortunes of the international oil market and to a limited extent by internal influences. It is
therefore imperative to investigate the effectiveness of monetary policy in taming
inflation as a means of preventing both external and internal influences of inflation in the
Nigerian economy.
III.
METHODOLOGY
3.1 SOURCES OF DATA AND VARIABLES
The pieces of information used for this study were from secondary sources: the
Central Bank of Nigeria (CBN), National Bureau of Statistics (NBS), Journals, the
internet and other documentary sources. The data which covers the period 1986-2013
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
were sourced on the relevant variables used in the study as identified in section one.
The reasons for choosing these variables were also adduced earlier in the section while
the choice of the period of the study is due to the fact that it witnessed quite a number of
financial sector reforms geared towards the realization of monetary policy targets.
3.2 ANALYTICAL TECHNIQUES
Qualitative and quantitative methods of analyses were employed to assess the
effectiveness of monetary policy in controlling inflation in Nigeria. Thus, the Augmented
Dickey Fuller Unit Root Test was used to determined the stationary state of the data
series; the Granger Causality Test was employed to determined the causal relationship
between monetary policy and inflation while the Ordinary Least Squares (OLS)
technique was adopted as the instrument of estimating the impact of monetary policy on
inflation and hence its effectiveness in Nigeria. Strikingly, reviewing related conceptual
and theoretical issues as well as descriptive statistics gives a deeper insight and
enables us to draw reasonable
implications, conclusion and make sound
recommendations.
3.2.1 Unit Root Test-Test of Stationarity
To avoid misleading results, it is important to first determine the stationary state
of the data for the study. Thus, the Augmented Dickey Fuller test, also known as unit
root was adopted because it is much easier to apply and understand. The models
used for the test of the inflation data series (INF) run in the following forms:
∆INFt= ∂t-1+U1t-------------------------------------------------(9)
∆ INFt=β1t + ∂INFt-1+U2t--------------------------------------(10)
∆ INFt= β1t+ β2t+∂INFt-1+U3t---------------------------------(11)
Where, t is the time/trend variable, ∂ is the co-efficient of unit root, ∆ is the rate of
change in inflation and the U‟s are the error terms. The difference between equation
one and the other last two equations lies in the inclusion of the constant (intercept) (β 1t
) and the trend (β2t). Note that the stationary state of the other variables or data series
were also tested using similar models. In each case the null hypothesis is that ∂=0,
which is the same as saying that there is a unit root.
3.2.2 Granger Causality Test
The Granger technique (Granger, 1969; Gujarati, 2004) has been adopted to
determine the direction of causal relationship between monetary policy and inflation in
Nigeria. Granger proposed that for a pair of linear covariance stationary time series X
and Y; X causes Y if the past values of X can be used to predict Y more accurately than
simply using the past values of Y. Formally, X is said to cause Y if ∂ 21 (Yt: Yt-j , Xt-i)<
∂22(Yt: Yt-j), where ∂ represents the variance of forecast error and i, j =1,2,3,…,k.
The Granger causality test requires the use of F-statistic to test whether lagged
information on a variable say “Y” provides any statistical information about another
variable “X”; if not, then, “Y” does not Granger cause “X”.
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
3.2.3 Ordinary Least Square Technique
Notably, the Ordinary Least Squares (OLS) Technique of regression was used to
determine the impact of monetary policy on inflation in Nigeria. Although regression
analysis deals with the dependence of one variable on other variables, it does not imply
causation-that is, it is assumed that the variables in question are not bilaterally related,
the independent variables are not collinear, and the disturbance terms are normally
distributed and not serially correlated. Thus, the OLS technique is suitable because of
its simplicity and the validity of its assumptions.
3.3 MODELLING MONETARY POLICY AND INFLATION IN NIGERIA
In view of the nature of economic behavior, any realistic formulation of economic
models should involve some lagged variables among the set of explanatory variables.
Lagged variables are one way of taking into account the length of time in the adjustment
process of economic behavior, and perhaps the most efficient way of rendering them
dynamic. Thus, the causality models to be estimated here are specified under the
assumption that monetary policy and inflation in Nigeria affect each other with
(distributed) lags.
The general functional relationship between monetary policy variables identified
in the study and inflation in Nigeria is specified as:
INF= F (MPR, M2, ER, GDP)-------------------------------(12)
Where INF= inflation, MPR=monetary policy rate, M2= broad money supply,
ER=exchange rate and GDP=gross domestic product- which serves as a proxy to
economic growth. Equation four implies that inflation in Nigeria depends on the
aforementioned monetary policy variables.
Thus, the causal relationship between monetary policy and inflation in Nigeria is
determined using the models below:
INFt=∑ni=1αiMPRt-i+∑ni=1βjINFt-j+U4t-------------------------(13)
MPRt=∑ ni=1λMPRt-i+∑nj=1∂jINFt-j+U5t------------------------(14)
Where, it is assumed that the disturbances U4t and U5 are
uncorrelated.
Equations (13) and (14) postulate that current INF is related to past values of INF as
well as those MPR and that current MPR is also related to past values of MPR and INF.
Note that αi, βj, λi, ∂j, are parameters to be estimated.
The apriori expectation here is that the sets of INFt and MPRt would be statistically
significantly different from zero in the regression of the above models. Thus, if ∑α i≠0
and ∑∂j≠0, it implies a feedback or a bilateral causality between inflation and monetary
policy in Nigeria in terms of monetary policy rate
The Granger technique involves estimating the equations in (13) and (14). Therefore, as
a pair wise test, the null hypotheses for these models become:
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6


H0: ∑αi=0, that is, lagged MPR terms do not belong in the regression.
H0: ∑∂j=0, that is, lagged INF terms do not belong in the regression.
This implies that the alternative hypothesis in each case is that the lagged terms belong
in the regressions. To test these hypotheses, we apply the F-test given by:
F=
(RSSR-RSSUR)/t-1
- (15)
RSSUR/n-k
Where RSSR= the restricted residual sum of squares and RSSUR= the unrestricted
residual sum of squares which follows the F-distribution with (t-1) and (n-k) degree of
freedom; t= the number of lagged terms and k= the number of parameters estimated in
the unrestricted regression. This follows that when we regress current INF on all lagged
INF terms and other variables if any but do not include say, the lagged MPR variables,
we obtain the RSSR. While when we regress including the lagged MPR terms, we obtain
the RSSUR. It is important to note here that models similar to thirteen and fourteen were
employed to determine the causal relationship between inflation and the other variables
of monetary policy.

Decision Rule: If the computed F value exceeds the critical F value at a chosen
level of significance, we reject the null hypothesis, in which case, the lagged terms
belong in the regression.
To statistically ascertain the extent to which monetary policy impacts on inflation, we
derive a multiple linear regression model from the models above with MPR, M2, LR, ER
and GDP as explanatory variables and INF as dependent variable. The econometric
model is specified thus:

INFt=a0+a1MPRt+a2M2t+a3ER+ a4GDP+U6t………………………(16)
Where a0 is the intercept; a1, a2, a3, a4, and a5 are the coefficients to be estimated;
while U6t is the disturbance term which is N (0, ∂2). The signs of the slopes of MPR,
M2, ER and GDP are expected to be positive. This implies that increases in the
variables would increase inflation in the economy.
By taking the logarithm of equation eight to reduce the indices of the variables to
the same index and to avoid estimation problems, the equation to be estimated
becomes:
LOG(INF)=
(17)
a0+a1LOG(MPR)+a2LOG(M2)+a3LOG(ER)+a4LOG(GDP)+U6t-----------
IV.
EMPIRICAL FINDINGS AND DISCUSSION
Appendix I shows the data on the relevant variables used for the study. Using
Eviews 7 software to analyze the data set based on the problem modeled, the results
obtained are summarized in appendices II- VI.
The unit root result in appendix II shows that inflation and GDP data series were
stationary at level. This is because the ADF statistic (-3.70) in absolute terms is greater
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
than the critical value (-3.59) at 5% level of significance. The result further indicates that
MPR, M2 and ER were stationary only after first differencing at 5% level of significance.
Therefore, the unit root result suggests that MPR, M2, ER and GDP have a short-run
effect on INF in Nigeria.
The Granger causality test result in appendix III shows that a uni-directional
relationship exists between INF and MPR running from MPR to INF and between GDP
and INF running from INF to GDP. This implies that monetary policy rate GrangerCause inflation and inflation Granger-Cause economic growth in Nigeria within the study
period-all at 5% level of significance. However, the result further reveals that
independence is suggested between M2 and INF as well as between ER and INF at 5%
level of significance.
Using the OLS estimates in Appendix IV, equation seventeen becomes:
LOG (INF) = 3.494137052 + 0.05050581986*LOG(MPR) - 0.07268345811*LOG(M2) 0.0960311616*LOG(ER) + 0.1736813127*LOG(GDP)-----------------------------------(18)
This implies that MPR insignificantly impacts positively on INF as a unit increase in
MPR would result to a 0.05 increase in INF-this conforms to apriori expectation.
However, the result also shows M2 impacts negatively on INF insignificantly. This
negates the proposition of the quantity theorists that an increase in money supply would
increase proportionately the level of prices.
In addition, the OLS result indicates that ER insignificantly impacts negatively on
INF. This does not conform to economic theory as increases in ER are expected to
increase inflation. Similarly, GDP was found to significantly impact positively on INF.
This is in line with the proposition that increases in economic growth is associated with
increased prices in a developing economy like Nigeria.
The co-efficient of determination indicates that only 22.2% change in INF could be
attributed to changes in MPR, M2, ER, and GDP within the study period. This implies
that inflation in Nigeria could be attributed to non-monetary forces and other variables
other than the ones specified in this study. Notably, this corroborates the findings of
Ajayi and Awosika (1980). However, the F-statistic reveals that MPR, M2, ER, and GDP
could jointly and significantly impact on INF in Nigeria.
The serial correlation LM and the Jarque-Bera normality tests results in appendices
V-VI indicate that the residuals are not correlated and they are normally distributed. This
is because the Breusch Godfrey and the Jarque-Bera p-values respectively are greater
than 0.05. Therefore, this underlines the robustness and the reliability of the estimates
of the model used in the study.
V.
CONCLUSION AND RECOMMENDATIONS
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
From the study, it is evident that even though monetary policy rate impacts positively
on inflation; broad money supply impacts negatively on inflation; exchange rate impacts
negatively on inflation and economic growth positively impacts on inflation in Nigeria.
Monetary policy, therefore, is ineffective in taming inflation in Nigeria. This is because
the positive impact of monetary policy rate on inflation is insignificant; the growth of
money supply does not translate into increase in prices and exchange rates changes
tend to affect inflation negatively. More so, this could be largely due to the large number
of the non-bank public in the country.
The study therefore recommends that financial inclusion must be strengthened as
a goal by all policy makers as the fight against inflation story would remain
incomplete without participation by the poorest of the poor. However policy makers in
the government and at the CBN should continue to emphasize the role of the banks,
even as it is clear that market failure has arisen in meeting the goal of financial
inclusion precisely because of a mismatch of the needs of the formal financial
sector and the low income consumer. It is time to look for new non -bank based
models that can fill in the gaps; a complete overhaul of the financial infrastructure,
especially in the rural areas is necessary to attract the informal servers of financial
services into the formal financial sector; the regulation of policies on financial inclusion
that focus on the distribution channels of financial services and retail agent banking are
also necessary to increase access to finance and monetary authority‟s control of money
supply.
REFERENCES
Adenuga, I.A; Taiwo, B.H and Efe, E.P, 2000. Is inflation purely a monetary
phenomenon? Empirical investigation from Nigeria (1970-2009). European
Scientific Journal.
Agba, V. A, 1994. Principle of macroeconomics, Concept Publication Ltd, Lagos.
Ajayi, S.I. and K. Awosika, 1980. Inflation in Nigeria: domestic or imported. Paper
commissioned for the Productivity, Prices and Incomes Board, Ibadan, January.
CBN, 1991 Monetary Policy Department: http://www.cenbank.org.1 Central Bank of
Nigeria Statistical Bulletin for several issues: http://www.cenbank.org/
Central Bank of Nigeria, 2001. Annual reports and statement of accounts, Abuja,
Nigeria.
Central Bank of Nigeria, 2006. How does the Monetary Policy Decisions of the Central
Bank of Nigeria Affect You? Monetary Policy Series.
Central Bank of Nigeria, 2011. Understanding monetary policy series 1, Abuja, Nigeria
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Goshit, G.G, 2006. Financial sector‟s instability: causes and implications for the
Nigerian economy. Jos Journal of Economics 3(1): 89-103
Granger, C.W.J, 1969. Investigating causal relations by econometric models and cross
spectral methods. Econometrica. 37(3).
Gujarati, D.N, 2004. Basic Econometrics. 4th ed. New York, McGraw-Hill.
Jhingan, M. L, 2002. Macroeconomic theory. 10thEdition, Vrinda Publications Ltd, New
Delhi.
Mbutor, M.N, 2010. Can monetary policy enhance remittances for economic growth in
Africa?: the case of Nigeria. Journal of Economics and International Finance ,
2(8):156-163
Nwosa, P.I; Olaiya, S.A and Amassoma, D, 2010. An appraisal of monetary policy and
its effects on macroeconomic stabilization in Nigera. Journal of Emerging Trends
in Economics and Management Sciences (JETEMS) 2 (3): 232-237
Ojo, M.O, 2000. Principles and practice of monetary policy in Nigeria, Lagos: Nigeria
Oyejide, T.A, 1972. Deficit financing, inflation and capital formation: an analysis of the
Nigerian experience, 1957–1970. Nigerian Journal of Economic and Social
Studies, 14(1): 27–43.
Sanni, M.R, Amusa, N.A & Agbeyangi, B.A, 2012. Potency of Monetary and Fiscal
Policy Instruments on Economic Activities of Nigeria (1960-2011), Journal of
African Macroeconomic Review, 3(1)
www.oanda.com/convert/classic
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Appendix I: Monetary Policy Rate and Key Performance Indicators in Nigeria
Year
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Inflation
(%)
5.4
10.7
38.3
40.9
7.5
13.0
44.5
57.2
57.0
72.8
29.3
8.5
10.0
6.6
6.9
18.9
12.9
14.0
15.4
17.9
8.4
5.4
11.5
12.6
13.8
10.9
10.3
8.5
Monetary Policy Rate
(MPR) (%)
10
12.75
12.75
18.50
18.50
14.50
17.50
26.00
13.50
13.50
13.50
13.50
14.31
18.00
13.50
14.31
19.00
15.75
15.00
13.00
12.25
8.75
9.81
7.44
6.13
9.19
12.00
12.00
Money Supply (M2)
(N‟M)
27, 389.8
33, 667.4
45, 446.9
47, 055.0
68, 662.5
87, 499.8
129, 085.5
198, 479.2
266,944.9
318, 763.5
370, 333.5
429,731.3
525, 637.8
699, 733.7
1, 036,079.5
1, 315, 869.1
1, 599, 494.6
1, 985, 191.8
2, 263, 587.9
2, 814, 846.1
4, 027, 901.7
5, 809, 826.5
9, 166, 835.3
10, 780, 627.1
11,525,530.34
12, 436,823.8
14, 075,786.9
18,190,346.8
Exchange Rate
(N/$1)
2.0206
4.0179
4.5367
7.3916
8.0378
9.9095
17.2984
22.0511
21.8861
21.8861
21.8861
21.8861
21.8861
92.6934
102.1052
111.9433
120.9702
129.3565
133.5004
132.1470
128.6515
125.8331
118.5669
148.8802
150.2980
153.8616
157.4994
154.7
Economic Growth (%
∆Nominal GDP)
0.0013
43.48
36.33
45.18
23.4
16.7
70.6
28.4
31.6
114.8
39.8
3.7
-3.3
17.9
43.5
3.1
46.3
22.8
34.5
27.7
27.4
11.3
17.6
1.7
2.3
11.7
8.38
4.57
Source: CBN Statistical Bulletin & Annual Reports, Various Issues;
www.cbn.gov.ng
Appendix II: Unit Root Test Result
Variable
ADF
Critical Values (5%)
INF
-3.70
-3.59
MPR
-5.43
-2.99
M2
-4.24
-2.99
ER
-3.31
-2.99
GDP
-3.06
-3.59
Source: Author’s computation using Econometrics-View 7
Order of
Integration
I(0)
I(1)
I(1)
I(1)
I(0)
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Appendix III: Pairwise Granger Causality Test Result
Null Hypothesis
Obs F-Statistic Prob
Decision
MPR does not granger Cause INF 26
4.97919
0.01699
Reject
INF does not Granger Cause 26
2.09381
0.14820
Accept
MPR
M2 does not Granger Cause INF
26
0.79150
0.46622
Accept
INF does not Granger Cause M2
26
0.12826
0.88031
Accept
ER does not Granger Cause INF
26
2.20635
0.13498
Accept
INF does not Granger Cause ER
26
1.90700
0.17338
Accept
GDP does not Granger Cause INF 26
0.21843
0.80558
Accept
INF does not Granger Cause GDP 26
4.18604
0.02951
Reject
Source: Authors’ computation using Econometrics-View 7; Note: α=0.05 level of
significance, Fα=4.28
Appendix IV: Ordinary Least Squares Result
Dependent Variable: LOG(INF)
Method: Least Squares
Date: 08/20/09 Time: 00:27
Sample: 1986 2013
Included observations: 27
Excluded observations: 1
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(MPR)
LOG(M2)
LOG(ER)
LOG(GDP)
3.494137
0.050506
-0.072683
-0.096031
0.173681
2.674680
0.553355
0.201844
0.285886
0.074155
1.306376
0.091272
-0.360098
-0.335907
2.342140
0.2049
0.9281
0.7222
0.7401
0.0286
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.342409
0.222847
0.669673
9.866170
-24.72055
1.345957
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
2.723447
0.759643
2.201522
2.441492
2.863860
0.047393
Source: Author’s computation using EconometricsView 7
APPENDIX V: Breusch-Godfrey Serial Correlation LM Test
F-statistic
Obs*R-squared
2.491991
5.386152
Test Equation:
Dependent Variable: RESID
Probability
Probability
0.108065
0.067672
Proceedings of 4th European Business Research Conference
9 - 10 April 2015, Imperial College, London, UK, ISBN: 978-1-922069-72-6
Method: Least Squares
Date: 08/20/09 Time: 01:48
Presample and interior missing value lagged residuals set to zero.
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOG(MPR)
LOG(M2)
LOG(ER)
LOG(GDP)
RESID(-1)
RESID(-2)
0.250245
-0.211518
0.040772
-0.079707
0.011633
0.409982
-0.281972
2.514212
0.537641
0.194651
0.280924
0.071262
0.218078
0.232948
0.099532
-0.393418
0.209462
-0.283732
0.163247
1.879977
-1.210454
0.9217
0.6982
0.8362
0.7795
0.8720
0.0748
0.2402
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.199487
-0.040667
0.628411
7.897996
-21.71677
1.968468
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
5.77E-16
0.616010
2.127168
2.463126
0.830664
0.560164
Source: Author’s computation using Econometrics-View 7
APPENDIX VI: Normality Test
6
S eries: Residuals
S ample 1986 2013
Observations 27
5
4
3
2
1
Mean
Median
Maximum
Minimum
S td. Dev.
S kewness
K urtosis
5.77E -16
0.025514
1.055722
-1.164553
0.616010
-0.136924
2.270268
Jarque-B era
P robability
0.683439
0.710548
0
-1.0
-0.5
0.0
0.5
1.0
Source: Author’s computation using Econometrics-View 7