1
CHAPTER ONE
1.0
INTRODUCTION
The monetary policy of a country deals with control of money stock
(liquidity) and therefore interest rate; in order to influence such macro
economics variables as inflation, employment, balance of payment,
aggregate output in the desired direction. There is no standard and ideal
structure of monetary policy target and instrument, the instrument varies
from country to country, depending on the size and stage of development of
the financial market.
Over the years, the objective of monetary policy have remained the
attainment
of
external
balance.
However
emphasis
on
techniques/instrument to achieve this objective have change over the years.
There have been two major phases in the pursuit of monetary policy
namely, before and after 1986. the first phase placed emphasis on the direct
monetary control, while the second relies on market mechanisms.
The monetary policy before 1986: the economic environment that
guided monetary policy before 1986 was characterize by the dominate of
2
the oil sector, the expanding role of the public sectors in the economy, and
over dependence on the external sector. In order to maintain price stability
and a healthy balance of payment position, monetary management depend
on the use of direct monetary instrument such as credit ceiling, selective
credit controls, administered interest and exchange rate, as well as the
perception of cash reserve requirement and special deposits. The use of
market – based instrument was not feasible at that point because of the
underdeveloped nature of the financial market and the deliberate restraint
of interest rate.
The most popular instrument of monetary policy was the insurance of
credit rationing guideline, which primary set rate on the change for the
component of commercial bank loan and advances to the private sector.
Globally the problem of the inflationary is not peculiar to Nigeria, but it is a
general problem confronting the majority, if not all countries of the world.
The attempt by Nigerian government to attain a higher level of economic
development at this period, generally lead to inflationary spiral in the
country.
3
But whether inflation in Nigeria is due to monetary mismanagement
on the part of the authorizes concerned or caused by interest structural
deficiencies, still remain uncertain. Many factors have been identified to be
responsible for inflationary pressure in the country. In a symposium of
inflation in Nigeria held at university of Ibadan in 1983, November, most of
the participant stressed on money supply, nature of government
expenditure limitations in real output and the inflation (imported) as the
major causes of inflation in Nigeria. In the case of formulating monetary
policy, it is of paramount importance to specify objectives and also
impossible to evaluate performances.
Analysis of the institutional growth and structure shows that the
financial growth rapidly in the mid 1980s and 1990s. the number of
commercial banks rose from 34 – 64 in 1995 and decline to 51 in 1998 while
the number of merchant banks increased only to 12 in 1986, to 54 in 1991
and subsequently decline to 38. in the network, the combined commercial
and merchant bank branches rose from 12,549 in 1996. There was also
4
substantial growth in the number of non – financial institutions especially
insurance companies.
The objective of monetary policy since 1986 remained the same as in
the earlier period namely; the stimulation of output and employment and
the promotion of domestic and external stability. In line with the general
philosophy of economic management under structural adjustment
programme (SAP). Monetary policy can be developed for encouraging
investment and controlling inflation, while fiscal policy can be effective to
reducing consumption of luxury and ostentation goods. But our major
concern will be to explore the efficiency of monetary policy in an economy
in controlling inflationary pressure in an economy like Nigeria.
It is generally believed by some economist that inflationary effect are
quite harmful to some business establishment. Thus could be so because
vender often lose in the sense that the valve of the money falls short of it
original purchasing power. The extent of the effect of inflation in Nigeria
could be appreciated from the following examples: in 1985, it stood at 5.5
5
percent, indicating an annual percentage increase of 20.1 percent compared
to 40.9 percent in 1989.
It has been accompanied with high level of unemployment rate at 4.3
percent in 1985 and 18.5 percent in 1989. Thus has force Nigeria to adopt
several monetary measures within and the problem of inflation as could be
seen from the associated increases in the cost of production during the
periods under consideration.
It is therefore under the above that we will like to adopt some of the
mix of policy instrument used and hence their efficiency as regard inflation
control.
1.1. STATEMENT OF THE PROBLEM
Many attempts being made by the Nigeria authorities to attain higher
rate of economic growth and development have generally being
accompanied by certain degree of price increase in recent years, the
phenomenon developed into several and prolonged inflation and stag
6
inflation. Indeed, it is increasingly being recognizes that a process of rapid
economic growth is likely to provoke inflationary pressures. However,
whether the problem of inflation in this country is due to mismanagement
of monetary policy tools or structural deficiencies still remain a controversial
matter.
During the last decade the problem of inflation and deflation to
economic growth and development have been extensively discussed. The
problem is not peculiar to Nigeria but has assumed a global phenomenon. It
is generally agreed worldwide that inflation is socially unjust. Inflation also
affects general economic behavior and the pattern of resource allocation. By
distorting price relations and undermining general confidence, prolonged
inflation tends sector; and thus slackens growth.
Furthermore, inflation discourages private saving and encourages
speculation among the various economic units. Another consequence is that
it result to balance of payment difficulties and reduces the external valve.
Nigeria being a market economy and therefore having its national economic
management strategies largely informed by Neo-classical and Keynesian
7
persuasions have sought over the decide for the solution to this problem
through the adoption of the analysis and recommendation of these school
of thoughts.
Economic aggregate as; national income, savings, investment and
consumption expenditure have been experimental upon to varying degrees
with respect to taxes public expenditure, savings campaign, credit controls
wages adjustments and all the conceivable anti- inflation measures affecting
the propensities to consume, save and invest which all combined should
determine in general level.
All the measure so far adopted were
inadequate in solving the
problem of inflation in the country. The suffering of masses are unending
as daily price surges occur indeed a more for reaching solution to the
problem is needed hence, this study seek to find what control has monetary
policy on inflation.
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1.2
OBJECTIVE OF THE STUDY
It is necessary to state the primary objective of this research having
identified the ruling monetary policy instrument in Nigeria and some the
economic objective that they are expected to influence.
These objectives include:
1. to investigate the major causes of inflation in Nigeria during 1980s
2. To investigate if the Nigeria monetary policy is efficient or not in the
achievement of certain objectives of the economy and inflation
control in particular.
3. To see if the non-realization of the economic objective is due to
chosen instrument or inappropriate application of the instrument.
4. To recommend policy solution based on the above finding.
The policy recommendation based on the above findings will be used
as a guide in the further application of monetary policies.
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1.3
STATEMENT OF HYPOTHESIS
Based on the statement of the problem and the purpose of
study, the following hypothesis were formulated.
1.
H1:
there is a positive and significant relationship between the
stock of money supply and inflation rate in the economy.
HO: There is no positive and significant relationship between
stock of money supply and inflation rate in the economy.
2.
H1:
There is inverse and significant relationship between
inflationary rate and economic growth.
HO: There is no inverse and significant relationship between
inflationary rate and economic growth.
1.4
SIGNIFICANCE OF THE STUDY
Full employment, equilibrium balance of payment, economic growth
and price stability are the four primary goals of any economy which Nigeria
is not an exception.
10
It is therefore the aim of this study first and foremost to study the
efficiency of monetary policy in controlling inflation in Nigeria. The
important of this study to policy makers cannot be over- emphasized in the
economy considering the alarming rate of inflation increment over the years
especially in the 90s.
This study will therefore be of immense help to policy makers,
government and it agent, ministers of finance, investors – both foreign
indigenous and the entire Nigeria populace.
This study will also study the type of inflation, causes and ways of
controlling it and it impact on economic development of Nigeria.
1.5 SCOPE OF THE STUDY
Since inflation arises when aggregate demand exceed aggregate
supply, we shall focus our attention at examining the control monetary
policy has on thus primary variables.
11
In this a year period is adopted 1984 to 1985. We hereby try to
analyze the causes effect of Nigeria inflation in terms of some qualifiable as;
money supply, real output etc.
1.6
LIMITATION OF STUDY
The limitation of our study centers around time, availability of material
and money. The time limit with which this study has to be completed is little
more than three months.
Theses limitation not with standing the researcher has made every
effort to ensure in realization of the research objectives.
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CHAPTER TWO
LITERATURE REVIEW
2.1 THEORITICAL LITERATURE
Monetary policy refers to that measure or action undertaken by the
government in order to achieve her economic objectives using monetary
instrument of control over bank lending and the rate of interest.
It is government deliberate attempt to influence aggregate demand in
an economy by regulating cost and availability of credit. the government can
influence both cost availability of credit by following measures designed to
affect the economy’s supply of money, these include open market
operation, special deposit, direct control over lending by bank and other
financial institution and various form of request.
Anyanwu (1993), defines Monetary policy as a policy designed to
affect inflation in an economy, through supply of money, cost of money and
availability of credit.
13
From the above, it can be seen that monetary policy is concerned with
the relation of the volume of money in circulation at any point in time.
2.1.1 AN OVERVIEW OF NIGERIAN MONETARY POLICY
Nigeria is an economic entity and as an economic entity; it has certain
objectives just like other countries to attain. In an attempt to find solution to
economic problems, most countries adopt policy measures to regulate and
control the volume, cost and direction of money and credit in the economy
in order to achieve some specified macro economic policy objectives.
In other words, expansion and contraction of the volume of money in
circulation for the purpose of achieving certain declared national objective is
known as Ekong rightly puts it (1986:11) “ monetary policy is a deliberate
effort by the government aim at controlling the quantitative and qualitative
supply of money with a view to attain specific objectives.” Since 1985, the
importance of Monetary policy vis-à-vis fiscal policy has changed, reflecting
development in economic theory particularly monetarism, as well as
changes in the macro economic and financial connections nationally and
internationally.
14
Monetary policy consist of actions by the government of a certain set
of economic objective. “It is the deliberate action on the part of the
monetary authorities (the central bank and the minister of finance to control
the money supply and general credit availability as well s the level of its cost
that is the rate of inflation”).
The aim of the policy makers is to exercise this control in certain ways
dictated by the governments’ economic objective because they constitute
an important source of money and because they play quite a significant role
in making credit available. Commercial banks are usually the main vehicle of
monetary policy.
Monetary policy is used to influence the level of output, employment,
prices rate of economic growth, and the balance of payment of an economy,
because there is a belief that there is a relationship between the real
variables and the monetary variables. However, this is valid only for a highly
monetarized economy. If the economy is not highly monetarized, the
efficiency of monetary policy is restricted. For instance, in an under
developed economy where a large proportion of output is produced in a
15
subsistence sector, the level of output in that sector would be independent
of the supply of money. Monetary policy therefore, would not be efficient in
determing the output level of the subsistence sector.
Monetary policy is expected to influence the level of money supply to
a level of stability in such a way that the strength of the money supply and
the valve of the domestic product should match. Excess of it causes inflation
leading to some economic problems such as rise in prices. In this situation
the economy cannot function because price increases, income remain
stable; therefore there is a decrease in the real income. As a result, that is
now money in nominal terms and in real terms.
When there is inflation, people move from productive activities to
speculative activities. For instance, instead of establishing industries, one
buys land and house because their valve will always increase. People move
away from activities that will generate employment resulting to
unemployment. The purpose of monetary policy is to ensure an appropriate
level of money supply in the economy.
16
In advanced economics which posse’s technical phases of the trade
cycle such as expansion, boom, recession and depression; monetary policy
measures can be applied to stimulate the economy into greater activity
during the period of expansion. They can be set to cool an overheated
economy during boom period and for prolonging the phase of property.
When recession set in, monetary policy could be applied to slow down the
economy from rolling down quickly into depression.
The evolution of Nigeria Monetary policy is reliable of the
establishment of CBN in 1958, the stage was set for a new era in which
Monetary policy could be used as an instrument of economic management.
The predecessor of the central bank, the west African Board (WACB) was in
no position and to pursue discretionary Monetary policy and under
circumstances, fiscal policy and price control were the main instrument of
economic control”.
In Nigeria, these objectives include: maintenance of price stability,
reduction in the rate of inflation, increase in employment, acceleration of
economic growth rate, attainment of healthy balance of payment position,
17
greater income, greater saving. Higher standard of living, income
redistribution and greater investment. These objectives may be cross
purpose. However, at any particular time, if it is possible to identify the
major problem area to which policy instrument should be addressed. During
the period shifted from relative tightness to relative easy and back to
relative tightness. The main factor that influences policy formation was the
state of the economy.
2.1.2 ADMINISTRATION OF MONETARY POLICY IN NIGERIA
Monetary policy for consideration by the president is proposed by the
central bank of Nigeria (CBN) through a memorandum usually titled,
monetary and credit policy proposal which is for a particular fiscal year. The
memorandum, an input of all the policy departments of the CBN, is coordinated by the research department.
The input takes into account the views and suggestions of financial
system operations, the business community and other interested members
of the public. It also considers the prevailing economic objectives that
18
appear most, appropriate to pursue in the immediate future. The
memorandum is initially considered by the committee of governors, the
highest management body for the day- to day administration of the CBN. It
is finally discussed, amended if need be and approved by the board of
directors of the CBN.
Thereafter, it is transmitted by the Governor of the CBN to the
president for consideration and approval. The president, after due
consultation with other organs of government, takes a decision of which
proposal to accept and announces them in the budget. The acceptance of
theses proposal outline for banks and other financial institutions by the CBN
in form of a monetary policy circular for compliance. Penalties for non
compliance with specified guidelines are also indicated in the circular.
As a monitoring device, the CBN conduct periodic and special
examinations of the books of all liensed banks which are also required to
submit regular returns on their operations to the bank. The examination and
returns from the financial institutions as well as current economic
development enable the CBN to asses compliance with the Monetary policy
19
circular. Routine amendments to the circular are undertaken by the CBN,
while fundamental changes must be discussed with the president
2.1.3 OBJECTIVE OF MONETARY POLICY
Monetary policy can be viewed as measures designed to regulate and
control the volume, cost and direction of money and credit in the economy
to achieve some specified economic policy objectives which can change
from time to time depending on the economic fortunes of a particular
country. Generally, the objectives of monetary policy include full
employment, rapid economic development, maintenance of price stability
and balance of payment equilibrium. In Nigeria, the over-riding aim of our
development effort remains that of bringing about an improvement in the
living condition of our people.
The board objective of monetary policy includes:
1.
The control of inflation and maintenance domestic price and
exchange rate stability
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2.
maintenance of healthy balance of payment position
3.
development of sound financial system
4.
Promotion of rapid and sustainable rate of economic growth and
development.
It is, however, not easy to achieve all the above stated objectives
simultaneously. At times, success is achieved at the expense of failure in the
others since the objectives may not be of equal importance for all times in
any economy, there is always the need to determine the main focus of
policy at any given point in time. Therefore, choice has to be made of a
desired combination of objectives, depending on the prevailing economic
circumstances.
It is however, pertinent to emphasize that Monetary policy is the only
supportive of the national economic development strategy and policy which
also call for the application of fiscal, exchange rate and other sectoral
policies. Consequently, Monetary policy need to be designed to attain a
realistic and consistent set of objectives within the general economic policy
framework of the country.
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2.1.4 INSTRUMENT OF NIGERIAN MONETARY POLICY
In pursuing the objective of
price stability, inflation control, full
employment and accelerate economic growth the central banks uses some
method or instruments. The tools used can be broadly categorized into two
such as the qualitative or general controls which aim to regulate the total
quantity, amount or size or the volume of deposite or advances created by
commercial banks. They relate to the valve and the cost of banks credit in
general without regard to the particular sectors or economic activity in
which the credit is used. The general instrument of Monetary policy include
open market operation, discount and interest rate policy, moral suasion,
liquid asset ratio, special deposits. They can reduce the volume of bank
credit available to the economy.
The second category is the qualitative or selective control which aim at
controlling certain channels or to discourage them from lending for certain
purposes. They include aggregate credit ceiling, credit discrimination in
favour of indigenes, selective control and control on non – bank financial
institutions.
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2.1.5
OPEN MARKET OPERATION
The commencement of open market operation (OMO) in Nigeria at the end
of June, 1993 was preceded by years of preparations because the enabling
environment for the success of the scheme was non- existent. Even at its
commencement all the necessary condition has not been met. Open market
operation, in it classical form, is conducted mainly in the secondary market
government securities, the central bank directly induces changed in the level
of interest rates, the terms and availability of credit and ultimately, the
money supply. When the central bank sells securities in the market, the
transaction lead initially to contraction in the reserve that the bank have
available to meet their cash reserve requirements. The contraction in
reserve leads in turn to higher interest rate and a contraction in bank credit
and money supply.
Conversely, when the central bank buys securities in the market,
banks reserves increase and the ability to expand credit and money supply is
enhanced. The linkage between open market operation and reserve is made
clear by the accounting transaction that occurs when the central bank pay
23
for the securities it buys or is paid for the securities it sells. When the central
bank buy securities, it pay for them by crediting the reserve accounts held at
the central bank by the sellers bank. The sellers account at the bank in turn,
are credited. Conversely sales of securities buy the central bank involves
debit to bank reserve account at the central bank and debit to the buyers
account in their banks. Thus when the central bank purchases securities,
reserve increases and when it sells securities, reserves decline.
The central banks portfolio of securities in one of many sources of
reserves. Other sources includes central bank loans to banks and private
sector, central bank float, foreign asset and other assets. The factors
affecting reserves can be divided into two categories those that can be
control by the central banks.
The only factor most central banks can control closely is it portfolio of
securities. All the other factors cannot be closely controlled. Within the
framework of factors affecting reserves, the central bank follows a three
step procedure in conducting OMO as follows
24
1. Determination of the target level of reserves consistent with the
objective of monetary policy
2. Estimation of the net change in reserves that will occur due to
movement in controllable factors
3. Conduct of open market operation that increase or decrease security
holdings, enough to bring about the target level of reserve.
Owing to its character as a market based intervention mechanism, as well
as large slope of that if offers for price meal and gradual adjustment of
liquidity on a daily or weekly basis, open market operation would ultimately
be the dominant instrument of monetary policy in the regime of indirect
controls in Nigeria.
The flexibility that it provides permits its use in such a way as to undue
disruption and volatility in the financial markets. Moreover where there is a
large error in the forecast of supply, it demand for reserves occurs,
corrective action can be taken the next day or week. The optimal use of
open market operations therefore depend crucially on relevant data being
available over short intervals such as daily, weekly or fortnightly.
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2.1.6 THE DISCOUNT RATE AND INTEREST RATE STRUCTURE
The discount rate is the rate of interest, the central banks charges the
commercial banks on loan extended to them. If the policy makers wish to
reduce liquidity in the economy they may increase the discount rate. By
doing so cost the borrowing will increase and with these action policy
makers intend to increase liquidity and increase production, they reduce the
discount rate and borrowing becomes generally attractive.
Interest rate is a price of capital of the borrower and a return on capital
to the saver or lender. As an instrument of monetary policy it can be used to
combart inflation, case budget burden promote capital inflow and
discourage capital flight, as well as to avoid miss allocation of resources. It
can also be use to promote the growth of capital and monetary markets.
In Nigeria, interest was first used as an instrument of control between
1987 -1962. It was used as means of making short term investment of banks
in the Nigeria market more profitable enough to encourage them repatriate
short term funding kept abroad for retention in Nigeria.
26
In other period when interest rate was used as an instrument of
monetary policy, this was directed to reducing the cost of government
borrowing or at making credit for the private sector more costly. Interest
rate has been relatively stable in Nigeria compared with other countries. It
was revised upward in 1964 and 1977 to curtail credit to the private sector,
and in 1973 – 1976 to reflect the high liquidity position of the economy.
RESERVE REQUIREMENT
The reserve requirement, other wise known as the reserve ration, can
be manipulated by policy makers, to reduce the ability of commercial banks
to make loan to the public by simply increasing the ratio, or enhancing their
lending position by reducing the ratio. As simple, explanation of how it
works is as follows
Assume that the total deposit with the commercial banks is 10 million
naira, and the legal reserve ratio is 10 percent, then the commercial banking
system must deposit 1 million naira with the central bank. If the bank in
term decides to reduce money supply in the economy it may then increase
27
the legal reserve ration to say 20 percent. In this situation, a total of 2
million naira must be deposited with the central bank. This later action has
reduced the commercial banks ability to extend credit to their customers by
1 million naira.
Reserve requirement is one of the most powerful instrument of
monetary control. Changes in the required reserve ration have another
effect. A change in the required reserve ratio changes the ratio by which the
banking system can expand deposit through the multiplier effect. If the
required reserve ration increase, the multiplier decreases and thereby
reduces the liquidity position of the banking system cash reserve. Cash
reserve requirement was established between 1972 -1976 precisely to
reduce excess cash holding by commercial banks.
The commercial banks were required to maintain a minimum cash
deposit with the central bank ranging from 5 – 12 percent of their total
demand deposit and time deposit on which they are paid interest rate below
21/2 percent.
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LIQUID ASSETS RATIO
This is a system whereby the commercial banks are required to
diversify their portfolios of liquid asset holding. The use of this techniques
requires redefination of the composition of bank liquid asset portfolios at
different times to reduce or increase their credit base. Variable liquid asset
approach used was between 1959 and 1964 when the policy maker was
trying to
Another period the instrument was used between 1972 and 1976
when the government was pursing easy money policy. Since that period,
government long-term securities of about 3 years maturity were included in
the portfolio of bank liquid assets, this was to increase their ability to lend
the private sectors. However, the introduction has not made any significant
impact on commercial bank liquidity position.
2.1.7 CREDIT CEILING
Credit ceiling as used by CBN monetary policy formulation especially
since the early 1970s, are qualitative limit expressed in percentages to
ensure that domestic credit expansion and the monetary implication of the
29
balance of payment target will match the expected increase in the demand
for total liquid in the economy. The qualitative limits are derived from the
monetary survey of the banking system. The result from the survey becomes
meaningful since it
permit the matching of aggregate demand with
available resources. The level of the domestic credit consistent with target
changes in the net foreign asset, other asset (net) and the projected demand
for liquidity is optioned as a residual subtracting net foreign asset and other
asset from total liquidity.
The increase in domestic credit is then allocated between the public
and private sectors through an assumed banking system foraging of the
fiscal deficit. As presently practiced, the permissible change in credit to the
private sector is distributed quarterly for the year and the bases of the
observed seasonal behavior of demand or credit.
As well known, it has period difficult to achieve the monetary target
under the use of credit ceiling from their inception. Even during the period
of adjustment, the gaps between the target and the actual growth rates in
30
credit to government and the private sectors have been too long for
comfort.
Similarly, the gap between the targets and actual for intermediate
monetary variable (M1) have been disturbing. Without that, credit effective
in retraining monetary growth, especially at the initial stage of their
application. But their implementation tend to be ineffective with time.
Nigeria experience has revealed problems relating to the varying
composition of credit, the enforcement of the ceiling and the relative
efficiency of the control system.
On the composition of the credit limit, many items of credit were in
the past excluded from the credit ceilings, for justifiable reasons, but this
action gradually eroded the effectiveness of ceilings. Some of these
expectations could cancel excessive credit operations. Another possible
source of excessive credit expansion has been allowed large ceilings enable
them grow. The rapid growth in the number of new banks since 1986 would
have added some impetus to this development.
31
It should also be noted that credit guideline exclude the increasing
large number of non-bank financial institutions like insurance companies,
pension and provident funds, credit and co-operative societies and financial
institution has increased tremendously.
The above factors have created problem of enforcement which could
be worsened by the lags in obtaining and processing data from the banking
system. Banks are currently given up to the end of the subsequent months
to render returns on their operations for a particular month.
Since a lot of time is needed and reconcile the data, defaulting bank
would not be detected promptly and could therefore continue defaulting.
Another problem of enforcement arises from the growing problem of bad
and doubtful debt which, before the introduction of the prudential
guidelines, were compounded by many banks with due and unpaid interest.
This not only created uncertain assets but could help bank to exceed credit
ceiling very easily.
The credit guideline have encouraged efficiency in the banking system.
Permitting banks irrespective of their efficiency, to grow by the same ratio
32
as stated in the guidelines trends to restrict competition in the system. It
protects the weaker banks while it prevent the growth of the more efficient.
This practice also favor the larger banks with the turnover which permits
them to accommodate new borrowers. Under the circumstances, dynamic
banks that aggressively mobilize savings may not be adequately rewarded.
Credit ceiling also promote the growth of credit and general
operations of the unregulated markets. There have been incessant
allegations of banks circumvent the ceiling by acting as brokers between
owners and borrowers of fund which tend to diminish the efficiency of the
financial system.
EXCHANGE RATE
Internationally, the performance of the national currency as measured
by the stability of the exchange is usually regarded as a variable indicator of
the attractiveness of the economy.
According to M.A.Uuebo, Nigeria has experimented with three
approaches in the naira exchange rate. They are pegging, managed float and
import, and weighted basket.
33
Under the pegging system, the naira was pegged to dollar. This
became necessary because of the collapse of the `gold standard` in a
monetary system which hitherto guaranteed global exchange rate stability.
A change becomes necessary as it was realized that conditions in the United
State of America which affected the movement in the value of dollar were
different from those in Nigeria.
Consequently, as from April 1974, the naira exchange rate was
allowed to float. At the same time, a policy of gradual appreciation of the
naira was adopted, taking into account factors such as the balance of
payment, rate of domestic inflation, and changes in the value of currencies
of Nigeria’s major trading partners. The managed float also had the problem
that is not guided by developments in the international exchange market.
Since 1978, a new import weighted basket of seven currencies have been
adopted in determining the naira exchange rate. The approach has the
advantage of monishing overtime exchange rate fluctuations, inflating the
development in international exchange market, as well as reflecting the
development in the economy of our major trading partners.
34
2.1.8 STABILIZATION SECURITIES/SPECIAL DEPOSITS
This technique may be employed if the prevailing economic condition
does not favour the use of other instruments. In this approach the central
bank may require the financial institution to make special deposits or buy
special securities from it. The idea of special deposits was evolved in 1976,
when the central bank which issued with commercial banks, based on
increase in their savings deposit account within N20,000 limits. However,
stabilization securities were excluded from the count in computing their
statutory liquidity ratios. The main goal of the exercise was to reduce the
excess liquidity position of the commercial banks.
MORAL SUASION
The policy maker sometimes uses the less tangible techniques of
moral suasion to influence the lending policies of commercial banks. Moral
suasion simply means employment of the policy makers of friendly
persuasion statements, public pronouncement or outright appeals. In this
way they explain how excessive expansion or contraction of bank credit
35
might involve. Serious consequences for the banking system and the
economy as a whole.
Moral suasion as an instrument of monetary control is one of the
widely used instrument of monetary control in Nigeria. Before 1964 there
was no central bank control of commercial bank loans and advances in
Nigeria. In October 1964, the bank embarked on selective credit control
measures based on moral suasion. The situation was further tightened in
1966.
2.1.9 MONETARY POLICY FORMULATION
In formulating monetary policy, the CBN relies on the techniques of
financial programming whose starting point is a comprehensive review of
recent economic performance as the current and anticipated economic
problems. Projections are usually made on money supply, GDP growth,
inflation rate and balance of payment position.
On the basis of optimum money supply economy’s absorptive capacity
for domestic credit is derived so as to permit growth target to be
36
determined for the key policy variables of money supply and aggregate
domestic credit.
Meanwhile, the permissible aggregate domestic credit is then allocated
between the public and private sectors. Then the size allocated to the public
sector is been determined by the size of the fiscal deficit to be financed by
the banking system. While the residual is allocated to the private sector.
2.1.10
EFFICIENCY OF MONETARY POLICY DURING INFLATION
The efficiency of monetary policy is severely limited in checking
inflation. This especially with the inflation that occurs as a result of the
upward shift in aggregate demand, that is demand- pull inflation. In such a
situation, inflation arises due to a rapid expansion of aggregate demand. To
time the demand – pull through open market operations. For instance, we
may find that the public might succeed in increasing the money supply in the
economy by increasing the velocity of the money available. Thus, to the
extent that the cost and supply of money to the extent that the CBN is help
less in checking inflation such a way might include:
37
a) The commercial bank can adjust their portfolio of asset by selling
government bond and using the proceed to lend to their customers
which defeat the intention of CBN to restrict credit through selling of
securities of business loans in their portfolio of assets affects the
ability of the CBN to control inflation.
b) The emergency of non financial institutions that hold government
securities and other asset as well as making loan available to
customers also affect the CBN control of inflation. Although they do
not have credit creating capacity of the commercial bank, never-less,
the fact that use funds obtained from the public saving to lend to the
borrowers in the economy and can adjust their portfolio of asset in the
same way as the commercial banks, limit the efficiency of the
monetary policy whether expansionary or contractionary depends on
a number of factors including the state of the economy, the
consistency and direction of other polices, income policy and other
domestic policies.
38
2.1.11
EFFICIENCY OF MONETARY POLICY DURING DEPRESSION
Monetary policy does not achieve its stated objectives during periods
of severe depression. Thus, during severe depression aggregate output and
income are falling and at very low ebb when there is a high level of
unemployment coupled with severe Bop problem and low aggregate
demand. In such situation although the CBN can pursue an expansionary
monetary policy to pump more money into the system and expand
aggregate bank lending to all classes of borrowers.
An economy that is facing bleak future investors would not be induced
to borrow to finance additions to capital since they ae already having excess
capital. And like wise consumers with falling income and unemployment will
not be induced to borrow to finance additional spending. This expansionary
monetary policy during recession is likely to help the economy out. On the
other hand, a contraction monetary policy at this point in time will only
aggregate the down turn and worsen the state of the economy.
39
2.1.12
OPERATION OF MONETARY POLICY
Monetary policy provides a complement approach to fiscal policy as
means of safeguarding the economy’s property and stability. When the
economy is weakening and unemployment is rising, the federal reserve
Authorities seek to expand money and credit, the resources and then the
federal reserve will seek to the growth of money and credit and thereby
contract aggregate demand.
Increase in money supply affect total spending in the economy directly
by putting more fund in the hands of consumers, business and government
agent and indirectly by reducing interest rate, thereby making it cheaper
and more attractive for the economic agent to borrow and then boost their
spending on available goods and services. On the opposite side, reduction
on the money supply will cause a drop in total spending both directly by
making fewer funds available and indirectly by raising interest rates, which
invariably makes money costly and deter customer’s businesses and
government from borrowing and spending.
40
If there is idle capacity in the economy, increase in total spending can
increase out put and employment without putting much upward pressure
on the price level but if the economy is at full capacity and there are no
many employed resources around, an increase in total demand will tend to
bid up prices. Under some conditions, a cut in total spending is called for,
and we would want to reduce the rate of growth of money supply on the
hopes that restraints upon spending would prevent prices from rising
further, without changing the level of out put and employment.
Monetary policy can be illustrated through the equation of exchange
MV = PQ
Where M = Money Supply
V = Velocity of Money
P = the General Price Level
Q = the Quantity Goods and Services
41
Money supply is a stock at a particular point of time though it conveys the
idea of a flow over time; money supply is defined as currency with the public
and demand deposits with commercial banks.
Money supply is the stock of currency and chequeing accounts. While
total economic activity is a flow of goods and services which is a measure of
Gross National Product. Changes in the stock of money affects economic
activity by its impact on either total demand of total spending.
PQ is the product of goods and services produced and the price level.
This is another way of defining Gross National Product (GNP), which are the
current market value of fiscal goods and services. The above equation can
be rewritten thus, MV = GNP. M, which is the money, seems to embrace all
the number of time at any given period that money turns over. The velocity
of money .
2.1.13
INFLATION IN NIGERIA, DEFINATION OF INFLATION
There has been a proliferation of definition of inflation. Some of these
definitions however express the descriptions of the processes by which the
underlie causes of inflation reveal themselves. Consequently, an
42
understanding of what the phenomenon is really pointing to is obscured.
According to public understanding by inflation is meant to condition which
produces a using trend in the general price level in the economy.
In attempt to define inflation, most economics succeeded only in
pointing to specific aspects of the phenomenon thereby giving the
impression that the term is not amendable to only one definition. some
people have coined the following expression “an increase in the amount of
currency, too much money chasing too few goods’’ when referring to
inflation. Many of these definitions at their best would not help us in using
the term for purpose of further investigations.
According to Griffiths (1976), ‘’ if inflation is defined s too much
money chasing too few goods’’, then the dice is based in favour of
monetary theory of inflation, implying that it can be controlled through
monetary policy’’ (Yubwen 1996) however define inflation in
‘’ An economy is commonly regarded as suffering from inflation when
it is undergoing period of continuously rising price’’
43
This definition point to the fact that, for a price rise to be described as
inflation, it must be sustaining over a long period. In agreeing with Garwens
definition of the sustenance of the price rise, went a step further than
Garwen’s and Griffith defining inflation as ‘’a sustained rise in the general
price level” what is meant by ‘’general’’ here is that all prices may not be
rising at the same commodities may
even be experiencing downward
trends in their prices. The main advantage of this definition as claimed by
Griffith (1996) is that, it is neutral with respect to the cause of inflation and
the most appropriate policy for bringing it under control. Another definition
worth nothing is that given by Odeh (1968). According to him, inflation is a
‘’significant price increase for number of years’’ he argues that significant
here means that level of price rise that may be regard as inflation for
different countries may not be the same, and that this will depend on their
past experience of the trend of prices in the economy in question. A
definition that seems to be more embracing is the one given by, Garder
Ackely (1972)
44
‘’According to him, inflation is persistent and appreciable rise in the
general level or average of prices’’. In addition to all the above views about
inflation Hagger (1977) maintained further, that inflation really come to the
surface due to constitutional controls.
Some economist in their own strength have defined inflation
quantitatively, in this wise, Parkin and Swoboda (1977) defined inflation as ‘’
the first different of logarithm of some price index’’ elaborating on this,
Pakin and Swiboda however stated, that the breath of the index and the
length of the time over which the change is considered as matters in which
the choice also depend of course, on the problem at hand hence consumer
price index or wholesale price index can be used.
What is significant about these definition is that inflation is a
disequilibrium state. Hence, it must be analyzed dynamically rather than
with the tools of states.
2.1.14
MONEY SUPPLY IN THE ECONOMY
What constitute the money stock of my country are those mediums
that facilitate the exchange mechanism and command general acceptability
45
( I. B. Eziri; 1995:45) these include currency (C) and chequable demand
deposits (DD). In Nigeria this is defines and as M1. Thus M1 = C + DD.
Some economist (the Chicago school) argue that total money stock
must not be restricted to M1, but must include any other asset that
command liquidity or near to currency these other assets have been
described as ‘’quasi’’ or ‘’near money’’ above. In Nigeria, the context of M2
is defined by the central bank of Nigeria (CBN) as
M2 = M1 +TD +SD +TDL
1. Currency outside bank is defined as currency in circulation less cash in
commercial and merchant banks.
2. Money supply (M1) is defined as currency outside banks plus privately
held demand deposits with the commercial and central banks.
3. Quasi – money (QM) is defined as savings and time deposit with the
commercial bank plus total deposit liabilities of merchant banks.
46
1.2.15
CAUSES OF INFLATION
Most economists agree that inflation arises, when aggregate demand
exceed the aggregate supply of goods and services. We analyse the
factors which lead to increase in demand and the shortage of supply.
Factors affecting aggregate demand
This is a considerable aggregate among scholars that inflation is
caused by increase in aggregate demand. They point to some of the
following.
Factors are causative ingredients.
1. The increase in the supply of money which lead to increase in
aggregate demand. The higher the growth rate of norminal money
supply, the higher the inflation rate.
2. Increase in public expenditure stimulate aggregate demand for goods
and service and result in price increase
3. The repayment of internal debt by the government tend to increase
the money supply and consequently price.
47
4. Cheap monetary policy or policy of credit expansion also lead to
increase in the money supply which raise the demand for goods and
services in the economy. When credit expands it raises the money
income of the borrowers which in turn, raises aggregate demand
relative to supply, thereby leading to inflation.
5. Finally, where there is exogenous factor of increase demand abroad
for domestically produced commodities. This foreign demand
increases the income and reverse of the industries concerned and
ultimately the result is increased demand at home which create
inflationary pressure.
FACTORS AFFECTING AGGREGATE SUPPLY
The following operate on the supply side and tend to reduce
aggregate supply of goods and services.
1. Shortage of such factors as raw material spare parts, machinery,
capital etc. These shortages result in excess capital and reduction in
industrial production.
48
2. Drought, floods and such natural disaster are very potent factors that
affect supply their occurrence create shortage on supply which create
inflationary pressure.
3. Inexistence of widespread technologies and know how which lead to
absence of management efficiencies and inadvertently shortages in
industrial output of supply.
4. The activities of hoarders, middlemen, and speculators who indulge in
black marketing. Thus they are instrumental in reducing supplies of
goods and raising their prices.
5. Finally, when the country produces more goods for export than
domestic consumption, this create shortages of goods in domestic
market. This lead to inflation in the economy. The above factors lead
to the erosion of the purchasing power money and consequently
inflation.
49
2.1.16
TYPE OF INFLATION
By ‘’type’’ of inflation, we mean the rapidity of price change. That is
whether price change slowly, rapidly or very rapidly. Economist used the
term, creeping, mild or galloping/runaway or hyper inflation. There is no
agreement on numerical estimations on the type’s mentioned above. It
all depends on how one views the situation
A slowly rising price level is often described as a creeping inflation,
while an extremely fast rate of price is described as hyper inflation. In
between this is galloping inflation. (Akakpan; 1989:71
Three main type of inflation can be mentioned here.
1. Creeping inflation
One that proceed for a long time at a moderate and fairly steady rate.
2. Galloping inflation
One that proceed at an exceptionally high rate, perhaps only for a
relatively belief period, but generally characterized by accelerating
rate of inflation so that the rate is higher one month that it was the
proceeding month.
50
3. Hyper inflation
This is a situation when the rate of inflation becomes immeasurable
and absolutely uncontrollable. Price rise many times every day. Such a
situation brings a total collapse of the monetary system because of the
continues fall in the purchasing power of money.
2.1.17
INFLATION RATE IN NIGERIA
YEAR
INFLATION RATE
1984
39.6
1985
5.5
1986
5.4
1987
10.2
1988
38.3
1989
40.9
1990
7.5
1991
13.0
1992
44.5
1993
57.2
51
1994
57.0
1995
72.8
1996
29.3
1997
8.5
1998
10.0
1999
6.6
2000
6.9
2001
18.9
2002
12.9
2003
14.0
2004
15.0
2005
17.9
2006
8.2
The table above show data indicating inflation rate in Nigeria for the
period 1984 to 2006. In the year of our study (1984), inflation rate of the
economy stood at an almost 40% (39.6% precisely). This was as a result of
52
ban in importation of food and other agricultural product by the authorities,
motivated by several balance of payment pressures.
The following year, the rate of inflation was 5.5%, this showed a fall.
The measure adopted by government then was the result. The inflation rate
mildly raised double digit to 10.2% again in 1987. This was due to structural
adjustment programme (SAP) measure taken in the economy. In the peak of
the economic crises, capital inflow had not but dried up, which the economy
or country’s foreign exchange earnings were far from adequate to support
the already expressed level of economic activities.
The situation continued further with higher level of idle industrial
capacity, plant closures, labour retr emachment
and
alike.
Shortages
generally through the proceeding years to an all times high of 40.9% in 1989.
It then clopped sharply to 7.5 in 1990 and 13.0 in 1991, it ascended to 44.5
in 1993, 57.2 in 1993, 57.0 in 1994, 72.8 in 1995, 29.3 in 1996, in other to
improve price stability, efforts were directed toward management of excess
liquidity; thus a number a measure were introduced to reduce liquity in the
system, this is done by increasing the commercial banks reverse
53
requirement in 1999 which reduced the inflation rate to 6.6%, in 2000 it was
6.9% and later increased to 18.9% in 2001, with the reintroduction of the
Dutch Auction System (DAS) of foreign exchange management in 2002
engendered inflation rate to 12.9%. in the year 2003 the inflation rate
increased to 14.0 %, the following year it increased to 15.0% and 17.9 in
2005.
In 2006, the new monetary policy framework for monetary policy
implementation was introduced, which aimed at achieving price stability
and non inflationary growth, as enunciated in the national economic
empowerment and development strategy (NEEDS). The target for single
inflation was however, achieved in 2006, the inflation stood at 8.2%.
2.1.18
MONETARY POLICY AS A CONTROL MEASURE ON
INFLATION IN NIGERIA
There is the traditional indication that knowing the cause of a problem
is bold step toward rectifying it. Thus having known that money supply
influence inflation at least from the literature review and the appraisal of
monetary theories, it should be reasonable also to suggest just like the
54
monetarist and the quantity theorists. That a proper adjustment or
manipulation of the money supply by the authorities concerned will help in
controlling inflation.
This measure has thus been adapted by the Nigeria government and
its mentalities (i.e CBN and the ministry of finance) to control inflation. The
CBN carries out this function via it monetary policy measure.
Essentially, monetary policy is the deliberate action on the part of the
monetary authorities to control the money supply and general credit
availability as the level of its cost, that is the rate of interest, the policy
makers exercise this control in either way that is they can use to stimulate
the economy by reducing the money supply. Thus in a period of inflation,
the policy makers contract the level of money supply by setting all these
instrument in motion. Operationally, the reserve requirements ratio are
raised, government sells it securities in the open market operation (OMO)
interest rate are raised etc, theoretically, however, this is simple, but it has
not be easy to manipulate these instrument due to; policy inconsistency,
55
2.1.19
EFFECT OF INFLATION
Inflation affects different people differently. This is because of the fall in the
value of money, when price rises or the value of money falls, some group of
the society gains and some lose and some stands in between. Broadly
speaking, there are two economic groups in every society, the fixed income
group and the flexible income group. people belonging to the first group
lose and those belonging to the second group gains. The reason is that the
price movement in the case of different goods, services, asset, etc are not
uniform. When there is inflation, most price are rising, but the rate of
increase of individual price differs much. Prices of some goods and services
rise faster, and others slowly and still other remain unchanged. The effect
are discussed below.
1. Salaried persons. Salaried power such as clerks, teachers and other
white collar persons lose when there is inflation. The reason is that
their salaries are slow to adjust when prices are rising.
2. Debtors and creditors: debtors gain and creditors lose when price rise
the value of money falls though debtor return the same amount of
56
money, but they pay less in term of goods and services. This is because
the value of money is less than when they borrowed the money on the
other hand creditors lose although they get back the same amount of
money which they lent, they receive less of the real terms because of
the value of money falls.
3. Government: the government as a debtor gains at the expense of
household who are its principal creditors. This is because interest rate
on government bond are fixed and raised to offset expected rise in
prices. The government in turn, levies less tax to service and retire its
debt. With inflation even the real value of taxes is reduced. Thus
redistribution of wealth in favour of the government accrues as a
benefit to the tax payers.
4. Reduction in production. Inflation adversely affect the volume of
production because the expectation of rising price along with rising
cost of inputs brings uncertainty. This reduces production.
5. Balance of payment: inflation involves sacrificing of the advantage of
international specialization and division of labour. When price rise
more rapidly in the home country than in foreign counties, domestic
57
product becomes costlier compared to foreign products. This tend to
increase import and reduce export, thereby making the balance of
payment of a country unfavorable.
6. Collapse of the monetary system: if hyper inflation persist and the
value of money continue to fall many times in a year, it ultimately lead
to the collapse of the monetary system.
2.0 EMPERICAL LITERATRE
According to Soludo (2001) the pursuit of sound monetary policy and
strong moderating influence on the exogenous factors that have militate
against it development.
Central bank of Nigeria (1999) review monetary policy as a
combination of measured designed to regulate to value supply and cost of
money in an economic activity. Excess demand for goods and services will
cause inflation or balance of payment problem. On the other hand
appropriate to assume sustainable economic growth and maintain internal
and external stability.
58
Oyejide (2004) maintained that money supply is important in the
study of inflation due to its effect on aggregate demand. Availability of
money makes demand effective. It enables such demand to be translated to
reality. But if production level in an economy cannot sustains the level of
aggregate demand. The excess demand will bid up general price level
thereby bringing about inflation. Hence, the need to maintain sustainable
balance between this is done to provide for easy analysis.
Fried man (1963) went further to say that inflation is essentially a
monetary phenomenon. Assuming that economic agent are rational,
increase in money supply lead to appropriate price increase, leaving real
money balance and output unchanged. He argues that change
in the
quantity of money will work through to cause changes in nominal income.
Inflation everywhere is based on an increased demand for goods and
services ass people try to spend their cash balance since the demand for
money is fairly stable, this excess spending is the outcome of a rise in a
norminal quantity of money supplied to the economy. So inflation is always
a monetary phenomenon.
59
Moser (1995). Studied inflation under long run dynamic error
correction model, he found out that monetary effect was substantial as well
as real income and exchange rate at a one percent significance level.
However, the important of price stability drives effect of price vitality
which undermines the ability of policy maker to achieve other laudable
macroeconomic objectives. There is indeed general saying that domestic
price fluctuation undermines the role of money as a store of value and
frustrate investment and growth (Ajaji and Ojo 1981, fisher 1993)
Bermanke (2005) observed that inflation is driven by bottleneck in the
real economy. In developing country food supply is relatively inelastic,
occasionally excess demand arising for example after an increase in non
agricultural income cannot be absorbed quickly enough to avoid price
increase, like wise foreign exchange constraint often lead to inflation. If food
import are restricted, negative supply shock such as drought or locost
invasion will lead to food stage and price increase further more when wage
are indexed and monetary policy is accommodative and initial increase in
60
price will lead to wage adjustment to compensate for the lost real income
and reinforcing inflation in Nigeria.
Hagfer (1964:12) believes in the theory of total absence of money and
monetary influence in combating inflation. According to him once there is a
tendency toward capacity shortage in a country it will produce inflationary
effect which cannot be ignored if the problem of inflation is persistent what
they need are measures that will maintain investment despite the reduction
in the growth of income. The most direct way to accomplish the desired
result would be to reduce interest rate and government expenditure. This
combine policy would then provide a stimulus to investment combined with
a reduction to total demand. He argued that a general reduction of
government expenditure would offset the effect of this increase.
INFLATION AND ECONOMIC GROWTH
There is a widespread belief that inflation and economic are related.
Inflation may be associated with a rapid or slow economic growth.
61
H.G .Johnson (1986) in his studies argued there is no convincing
evidence of any clear association, positive or negative between the rate of
inflation and the rate of economic growth.
Tomori .S: (1982) says, there are some countries which have
developed with varying degrees of inflationary situation. That Britain, United
State of America and Japan for example grew without inflation; while india
and South American countries had varying rate of recorded inflation with
economic growth. Some others no inflation and no growth e.g Venezuela
and European countries between wars (first and second world wars)
In Nigeria, S. Tomori observed
“it is becoming increasingly evident that we cannot count on
maintaining the measurable level of economic development(growth) and
simultaneously achieving reasonable price stability.
Consider the table below. It is observed that inflation rate and growth rate
to the period have moved in almost the same direction. This is comfirming
the observation of Tomori above.
62
COMPOSITE TABLE OF GDP AND INFLATIONARY RATES (BILLION
Year
Annual
total Annual growth rate Inflation rate
GDP
of GDP (%)
1984
63.0
5.1
39.5
1985
68.9
9.4
5.5
1986
71.1
3.2
5.4
1987
70.7
0.6
10.2
1988
77.8
10.0
38.3
1989
83.5
7.3
40.9
1990
90.3
8.1
7.5
1991
94.3
4.7
13.0
1992
98.4
4.1
44.5
1993
100.84
2.5
57.2
Source: CBN statistical bulletin, it is observed from the table that annual
GDP in billion (N) has grown steadly over the years. Meanwhile, the annual
63
growth rate of GDP in percentage has been series of ups and downs from
the peak of 9.4% in 1985 to 6.0 in 1987 and declined steadily.
The inflation rate however has tend to move in the direction of GDP
(growth rate). From 39.6% in 1986, and upwards two digits to 40% in 1989,
from there on it rose again to all high rate of 57.2%. Nigeria can be said to
be enjoying both an increasing growth rate and increasing inflation.
However, the success of monetary policy depend on the operating
economic environment, the institutional framework adopted in Nigeria, the
choice of mix of instrument used, the
monetary policy.
design and implementation of
64
CHAPTER THREE
3.0 RESEARCH METHODOLOGY
3.1 RESEARCH DESIGN
The original least square method of the classical linear regression
model is the econometric technique adopted in this study which covers a
period of (1984 – 2006) the preference of the use of this model is because of
certain assumption underlying the classical linear regression model.
ASSUMPTIONS:
1. The relationship between the regressor and the regress is linear
2. The expected mean value of ui is zero. That is ∑(ui/xi) = 0
3. Homosecdasticity or equal variance of ui given the value of x, the
value of ui is the same for all observation
4. The error term is normally distributed.
5. There is no perfect linear relationship among the explanatory
variables.
Base on the above assumption, the estimator BLUE
65
i
the estimate are symmetrically unbiased
ii
the estimate are consistent i.e as sample size increase the B
approaches it true value
iii
the estimators are efficient i.e among a group of unbiased consistent
estimate Bs have the smallest variance.
iv
the estimator are linearly and normally distributed.
On the above four basis assumption and properties lies the
justification for the procedure.
3.2 METHODOLOGY
This research work follows econometric research methodology with
measurement of parameters of economic relationship. The choice of this
method is necessary since we will analyze the efficiency of monetary policy
in controlling inflation in Nigeria. This is studied using these variables.
Economic growth, money supply, and interest rate.
66
3.3 MODEL SPECIFICATION
Specification of econometric model is based on economic theory and
on any valuable information relating to the phenomenon being studied.
In order word to test our working hypothesis, there is need to specify
the appropriate relationship between the dependent and independent
variables. This is because it is the relationship of economic theory which can
be measured with one or other econometric techniques as casual, that is
they are in relationship in which some variables are postulated to be causes
of the variables of the other variables thus, the relationship between
inflation and monetary variables can be presented as follows
INF = F (ms, int, GDP) …………………………………………………………………(1)
Where
INF = inflation
MS = money supply
INT = interest rate
67
GDP = Gross domestic product
The econometric model can be specified as shown below in equation two.
INF = BO + B1MS +B2INT + B3GDP +ui …………………………………………(2)
Where
B0 = Constant
B1, B2,B3 are constant of the parameter
Ui = error term.
3.4
METHOD OF EVALUATION
The evaluation of the research finding consist of deciding whether the
parameter estimates of the economic relationship or model are theoretically
meaningful and statistically satisfactory. According to Koutsoyiannis
(2001:25), the estimates or result are obtained from the estimation of an
econometric model are evaluated on basically three criteria include.
1. A priori criteria
68
This refers to the supposed relationship between and or among the
dependent or independent variables of the model as determined by the
postulations of economic theory. The result or parameter estimates of the
models will be interpreted on the basis of the supposed signs of the
parameters as established by economic theory put differently, the
parameter estimates of the model will be checked to find out whether they
conform to the postulations of economic theory.
The relationship between money supply and inflation are positive.
Because an increase in money supply will lead to an increase in inflation.
Vice visa.
Inflation and interest rate are positively related because an increase
inflation, increase the interest rate, while a decrease inflation will lead to a
decrease in interest rate.
1. Statistical criteria: First order test
The theories of statistic prescribe some test of finding out how
accurate the parameter estimates of a model are, these test help to suggest
69
whether or not the parameter estimates of the model. It will tell us whether
it’s a good fit or not
Such statistical criteria test are:
T tests: The co-efficient of the model will be tested for significance using the
t- test. The T testing procedure is based on the assumption that the error
term ui follows the normal distribution.
F test: The F test will be used to test the overall significance of the model
Durbin- Watson test: to test the validity of the assumptions of nonautocorrelated disturbances, an econometric technique known as the
Durbin – Watson will be computed.
2. Econometric criteria: second order test
These are set by the theory of econometrics and are aimed at investigating
whether the assumption of the econometric method employed are satisfied
or not. Thus, the assumptions of OLS will be investigated.
70
3.5
SOURCES AND DATA REQUIRED
In order to ensure an adequate and comprehensive research, I
collected secondary data of money supply, Gross domestic product, interest
rate and inflation from (1984 – 2006). The data used in this project are
sourced from the central bank of Nigeria statistical bulletin volume 17
December 2006.
71
CHAPTER FOUR
PRESENTATION AND ANALYSIS OF RESULTS
4.O PRESENTATION OF RESULTS
The result of the original least square regression are presented below
as stipulated in the previous chapter, the OLS and the result of our model
was estimated using a computer software package E – view 6.0
The empirical result is presented in a table. The table shows the
estimated parameters, their t – statistics and other diagnostic test of
equation. The result obtained from the estimation techniques are presented
in the table below.
4.1
PRESENTATION OF REGRESSION RESULTS
Variable
Coefficient
Std error
T–statistic
prob
C
28.32041
21.82756
1.297461
0.2100
M2
162E.06
2.31E.06
0.700168
0.4923
INT
2.050578
1.208025
1.697463
0.1059
GDP
-9.62E.05
5.28E-05
- 1.821298
0.0843
72
This model has the following result
R2
= 0.210532
F
= (3, 19) = 1.688945
D*
= 1.035564
Where
R2
= coefficient of multiple determination
D*
= Durbin – Watson statistic
4.2
ANALYSIS OF RESULT
4.2.1 STATISTICAL CRITERIAL (1ST ORDER TEST)
We shall apply the student t test, R2 and F test to determine the
statistical reliability of the estimated parameter.
The value of R2 is 0.210532. this implies that 21% of the variation in
inflation is explained by independent variables which are interest rate,
73
money supply, and gross domestic product. This indicate that the goodness
of the model is not a good fit.
4..2.2 THE STUDENT T TEST
Evaluation is carried out to ascertain if the independent variables are
individually significant. If the calculated t is greater than the critical t at 0.05
level of significant then reject the null hypothesis Ho, otherwise accept the
alternative hypothesis H1.
From the statistical table, critical t 0.025 = 2.09. the result of the
evaluation is summarized in the table below.
Variable
T value
T – tab
Decision
Conclusion
M2
0.700168
2.09
Accept Ho
Insignificant
INT
1.697463
2.09
Accept Ho
Insignificant
GDP
-1.821298
2.09
Accept Ho
insignificant
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From the table above B1(MS), B2(INT) and B3(GDP) are not statistically
significant. We conclude that B1, B2 and B3 has no significant effect on
inflation rate in Nigeria in the period under review.
4.2.3 THE F – STATISTICS TEST
This evaluation is carried out to determine, if the independent
variables in the model are simultaneously significant of not. If F* if greater
than critical F at 0.05 level of significant, then reject the null hypothesis H0
and accept the alternative hypothesis.
DECISION RULE
Reject H0 if F- cal > F0.05 (V1/V2)
VI = K – 1 (numerator)
V2 = N – K (denominator)
From the result in the model, F cal = 1.688945. From the F table F0.05 (3/19)
=3.13.since
F – table of F0.05 (3.13)> F-cal (1.688945), we accept H0
and conclude that the independent variable in the model are not significant.
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4.3
ECONOMETRICS TEST OF SECOND ORDER TEST
This test will be based on whether the assumption of the classical
linear regression model are satisfied. The assumptions underlying the
statistic are:
1. The regression model include intercept term
2. The regressor or explanatory variables are nonstochastic of fixed in
repeated sample
3. The error term is assumed to be normally distributed
4. The regression model does not include the lagged value of the
dependent variable as one of the explanatory variables.
5. There are missing observation in the data.
When these assumption are not satisfied it is customary to respecify
The model, for instance, one may introduce new variable or omit some,
transform the original variable, so as to produce a new form that will satisfy
these assumption.
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4.3.1 AUTO CORRELATION TEST
We will adopt the Durbin Watson d – statistic to test the randomness
of the residuals. Based on this we state our hypothesis as thus
H0:
P = 0 (No positive first order autocorrelation)
H1:
P = 0 (positive first order autocorrelation)
DECISION RULE
Reject Ho if d* < du or d* > 4 -du
Accept Ho If d*> du or d* < 4 -du
Where:
d* = estimated Durbin – Watson
du = Upper Unit Durbin - Watson
from the Dw d table
du = 1.66 (n= 23, k = 3) at 5% level of significant. And d* = 1.035564
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since our d* = 1.035564 is less then du = 1.66,we conclude that there is no
evidence of positive autocorrelation in the regression result.
4.4
SUMMARY OF FINDING
1. The relationship between money supply and inflation is positive and
conformed with the a priori expectation but is statistically insignificant
2. The result indicate a positive relationship between interest rate and
inflation rate which conform with the apriori expectation but is
statistically insignificant
3. The relationship between GDP and inflation is negative which conform
with the apriori expectation but is statistically insignificant.
From the above study, it shows the performance of monetary policy as
an instrument to check inflation in nigeria. The null hypothesis of this
study posit that the use of monetary policy variable
in controlling
inflation in Nigeria is not effiecient. This is proves ture as monetary policy
variables (interest rate, money supply, and GDP) do not show statistical
significant relationship between them and inflation rate.
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CHAPTER FIVE
5.0 SUMMARY OF FINDING, RECOMMENDATION AND CONCLUSION
5.1 SUMMARY
In this study, we have tested for the relationship between inflation,
money supply, Interest rate and GDP, to find out if monetary policies are
efficient in controlling inflation. Using secondary data from 1984 to 2006.
It is discovered that all the monetary target variables exert an
insignificant impact on inflation control in Nigeria. The relationship which
exist between the monetary instrument and inflation shed more high on the
use of monetary policy for controlling inflation in Nigeria. A combination of
monetary variable such as money supply, interest rate and GDP, may not be
efficient for the purpose of controlling inflation.
5.2 CONCLUSION.
The monetary policy of a country is an important aspect of its overall
economy policy. Appropriate money supply instrument therefore contribute
to economic growth by adjusting money supply to need of growth by
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directing the flow of funds in the required channels and by providing
institutional faculties for credit in specific fields of economic activities. In this
way, a healthy growth of the economy could be masterminded.
Therefore, a proper monetary policy utilizing appropriate instrument
is not sufficient condition but a necessary condition in stimulating economic
growth.
In the final analysis, the operation of money policy instrument depend
on the intention of the regulating authorities and the degree of the
operation and response from banks. They should endeavour to respond
whole heartedly in carrying out the gigantic work of planned development.
Economic development is a joint venture between the government, the
various financial institutions. As it may be difficult to separate the spheres of
operation of the different component making up general economic policy,
there is a need for a continuous close co-ordination in the relationship
between the various monetary authorities. As monetary policy is an
important aspect of intervention in the economic process, it must there be
tuned to the larger economic objectives of the state. the choice of
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alternative policy instrument depend upon economic environment,
administrative ability and political situation.
From a broad economic viewpoint, monetary policy instrument can be
regarded as mere catalysts that accentuate the pace of economic
development. Their efficiency can largely depend on the economic will of
the people to implement genuine decisions of the government especially
concerning inflation control.
5.3 RECOMMENDATION
Firstly, the monetary authorities should use more important monetary
instruments than hitherto adopted. For example, the special deposit and
credit guidelines (selective credit control) should be impose on the
commercial banks whenever need arises.
Secondly, loans and advance should be given to production sectors of
the economy so as to increase productivity. Policy maker should adopt
monetary incentives or measures that would pave the way for an increase in
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the number of financial institutions in the country. Since the commercial
banks are inadequate and inefficient in their service to the public, most
people are discouraged from saving with the banks. If the whole economy
becomes adequately monetized through adequate banking system, the
incidence of outside money will be minimized.
Thirdly, Nigeria’s should be encouraged to have confidence in the
banks and the use of cheques in transacting business. If this is done, the
genuine effort of the central bank to control inflation through money supply
is easier in developed countries because the bulk of business transaction
are done with cheque which are controlled by their monetary authorities.
Fourthly, there is a need for a thorough reappraised of our tariff
structure a switch from our foreign dominated consumption pattern to
consumption of home goods should be encouraged. Importation of
machinery and production of capital equipment should be favored over
consumables or luxuries.
Moreover, there is need for price control board to critically examine
and monitor the cost structure and profit margin of producers and
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distributors. This involve fixing prices, to avoid excessive profit. If this is
done; there is no doubt that the prices of goods produced will be stable.
Furthermore, the most appropriate solution to inflation is supply
management, which entails increase in the domestic production of
consumer goods to meet the ever increasing consumer effective demand.
Hence, for a complete realization of this objective, there is need for a rapid
transformation of the economic system especially in the rural area. One of
such ways is to improve agricultural strategy, an effective adoption of
integrated rural development and the basis need approach application.
Finally, firm and industries located in the country should be persuaded
further to source a greater proportion of their raw material requirement
locally more than is being done. This will reduce the effect of imported
inflation in the economic activities, conserve foreign exchange and generate
employment.