INFLATION TARGETING IN EMERGING MARKET ECONOMY: THE NIGERIAN EXPERIENCE (2005-2016)

INFLATION TARGETING IN EMERGING MARKET ECONOMY: THE NIGERIAN EXPERIENCE (2005-2016)

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ABSTRACT

This work examined inflation targeting in emerging economies: evidence from Nigeria. This was motivated by the need to understand the adoption of inflation targeting as a framework for the control of inflation in Nigeria and how it has influenced productivity in Nigeria. Ex-post facto research design was adopted which enabled the researcher to gather secondary data from CBN statistical bulletin 2016 from 2005 to 2016. The data collected was analysed using multiple regression results and this was done in order to achieve the following research objectives earlier raised in the study: to examine the relationship between growth rate of money supply and inflation rate in Nigeria; to determine the relationship between cash reserve ratio and inflation rate in Nigeria; to access the relationship between monetary policy rate and inflation rate in Nigeria; to examine the relationship between interest rate and inflation rate in Nigeria; to determine the relationship between treasury bills rate and inflation rate in Nigeria and to examine the relationship between productivity and inflation targeting in Nigeria. From the analysis, the findings made include that growth of money supply has a positive and significant relationship with inflation; interest rate has a positive and significant relationship with inflation rate; cash reserve ratio has a negative and significant relationship with inflation rate and that both money supply growth and interest rate affects real GDP in Nigeria. It was concluded that inflation targeting has no significant effect on inflation rate but that the control of such aggregates such as money supply and interest rate can help bring down inflation and that inflation targeting impacts on productivity. Recommendations made include the widening of the scope of inflation targeting, the effective control of both money supply and interest rates in order to reduce inflation and to enhance productivity.

 

 

 

 

 

 

 

 

 

CHAPTER ONE

                                                           INTRODUCTION

1.1             Background to the Study

In most countries of the world and particularly in Nigeria, the economic policy makers such as Central Banks amongst others have come to the realization of the need of pursuing price stability as their primary objective. Price stability is generally assumed to mean having a low level of price fluctuations and the achievement of stable inflation rate in an economy. This situation has become necessary because of the inherent negative effects of high inflation in an economy. To a developing economy like the Nigerian economy, high inflationary trends would be considered disastrous if not properly checked. These effects may manifest in the form economic downturn and negative influence on the standard of living of the citizens.

In line with this opinion, the Central Bank of Nigeria (2009) observed that the period covering from 1990 to 2000, the average inflation rate had been above the double digit level (26%-51%) which rendered most deposit rates negative in real terms. According to them, this also eroded domestic savings and investments as well as real income.  Suggestions by the monetary authorities in Nigeria state that high rate of inflation in Nigeria before and in the early 21st century was as a direct result of policies that focused on stimulating faster rate of economic growth and development. The inflationary trend since independence shows that inflation in Nigeria has attained higher levels more than 40% especially in the early 1980s and 1990s and during this period the economy witnessed several economic distortions.

Similarly, the control of inflation in Nigerian shows that from one political administration to another, the Central Bank of Nigeria (CBN) has tried to initiate various monetary and other policies in an attempt to control inflation. However, in spite of all these efforts and policies, inflation rate still remains high and unyielding with pronounced implications on economic growth and development. High inflation rate has helped to force up interest rate, thus decimating investments and reducing the real values of aggregate consumer wealth (as government debt and money), and hence inhibits and distorts consumer spending. It also has raised domestic prices relative to foreign trade, inhibits exports and stimulates imports thus depleting the nation’s scarce foreign reserves and worsening the balance of payments. High rates of inflation also distort savings and that investors tend to divert scarce resources from productive uses.

Furthermore, the stress on price stability or low inflation as the main objective of monetary policy may not be that other goals of macroeconomic policy, such as maintaining a high level of employment, achieving sustainable economic growth and attaining favourable balance of payments are of less essence but that it could only be comprehended that price stability can later promote economic growth and attainment of full employment level. Consequently, there is therefore, an emerging unanimity that Central Banks can consistently promote sustainable economic growth objective by pursuing sustainable price stability through inflation targeting as a policy technique.

 Inflation targeting in this case refers to policy measure to direct inflation rate towards an expected level using monetary tools such as interest rate to achieve it. The actions of the Central Bank in this regard is expected to be very transparent as this will enable investors to factor in possible interest rate changes in their investment portfolios leading to a better economic stability or fluctuations in price. It could then be established that inflation targeting helps in stabilizing the financial system thus enabling reasonable level of inflation rate in the economy. Inflation targeting since its adoption first in New Zealand in 1990 have become promising that some Central Banks of the industrialized and developing economies have declared that maintaining price stability of the lowest possible rate of inflation is their only mandate(Riti and Kama, 2015).

From early 1990s, many developed countries especially in Europe and the Americas have moved towards implementing inflation targeting (IT) as a framework for monetary policy while developing counties in Nigeria especially Nigeria were not ready for it. In Africa, South Africa and Ghana were the first to implement inflation targeting in 2005. The move to use this framework by countries around the world has been attributed to several factors but prominent amongst these factors is the strong determination to bring down inflation rate to a minimal level to encourage domestic savings and moderation in prices such that aggregate demand and income levels can be improved.  Nigeria had indicated its intention to transit into inflation targeting as a framework for monetary policy since 2005 based on the positive results to which the framework have had on the development path of the countries that had adopted it. The country had a smooth take-off of inflation targeting as the Central Bank of Nigeria (CBN) had successively transited from its monetary targeting framework into that of inflation targeting. This study attempts to provide an examination of the impact of IT on economic performance in Nigeria and assess its relationship with other macroeconomic variables to cross check their level of performance in the country.

1.2       Statement of the Problem

The major challenge of the Nigerian economy has been the issue of price instability. It could be observed that price stability is not a major policy objective of the monetary authority in the country over the years hence incessant increases in price levels. This could be that the management of domestic policies in Nigeria seem not to have a fair or better understanding of stabilization policies as prices kept rising almost on daily basis to the detriment and impoverishment of the citizens. At the same time wages were not increased commensurately as frequently as the price levels were jumping. Again, this could it be that nothing was being done to ameliorate the persistent rise in the prices of goods and services within the domestic settings. During these periods it was expected that the interest rates pattern and other policy instruments need to be managed in ways that would not exacerbate high prices in the economy.

            Difficult socio-economic situation arises at high inflation rates. It becomes a device in deterring investments, causing high poverty incidence, reduction in the real values of aggregate consumer wealth. This distorts consumer spending by raising domestic prices above the reach of most citizens and in comparison to foreign prices. This also inhibits exports while stimulating imports to the detriment of the domestic economy as high import would deplete the nation’s scarce foreign reserves and worsen the balance of payments statement. It also discourages savings and investments since there may not be effective demand for the produced items causing huge inventory build-up. Inflation targeting could be seen to be the needed policy measure that is needed to curb the menace of incessant price hike and hence the study is to find out the impact of inflation targeting on the Nigerian economy and where possible proffer solution as to the linkages to abate the effect.

1.3       Objectives of Study

Broadly, the objective of this study is to examine inflation targeting in emerging market economy: the Nigerian experience from 2005-2016. The specific objectives are:

1.      To examine the relationship between growth rate of money supply and inflation rate in Nigeria.

2.      To determine the relationship between cash reserve ratio and inflation rate in Nigeria.

3.      To access the relationship between monetary policy rate and inflation rate in Nigeria.

4.      To examine the relationship between interest rate and inflation rate in Nigeria.

5.      To determine the relationship between treasury bills rate and inflation rate in Nigeria.

6.      To examine the relationship between productivity and inflation targeting in Nigeria.

1.4       Research Questions

            Based on the objectives of the study, the research questions can be generated thus:

Is there any relationship between growth rate of money supply and inflation rate in Nigeria ?

1.      To what extent does cash reserve ratio influence inflation rate in Nigeria?

2.      Does monetary policy rate affect inflation rate in Nigeria?

3.      Is there any relationship between interest rate and inflation in Nigeria?

4.      Does any relationship exist between treasury bills rate and inflation rate in Nigeria?

5.      Does inflation targeting have any impact on productivity in Nigeria?

 

1.5       Research Hypothesis

To guide the success of the study, the following research null hypotheses (H0) were formulated:

H01: There is no significant relationship between growth rates of money supply, cash reserve ratio, monetary policy rate, interest rate, treasury bills rate and inflation rate in Nigeria.

H02: There is no significant relationship between inflation targeting and real Gross Domestic Product (GDP) in Nigeria.

1.5       Significance of the Study

This study has both theoretical and practical significance. The findings of this study will help to add to the body of knowledge on the management of inflation in Nigeria using inflation targeting. This will help people understand what inflation targeting does in the Nigerian economy. The practical significance of this study stems from its value to some groups of people. These include the monetary policy officials of Central Bank of Nigeria (CBN), officials of the Federal Ministry of Finance, experts on economic and monetary matters, researchers and students.

To the officials of Central Bank of Nigeria (CBN) and Federal Ministry of Finance, the study will help them work towards the better implementation of inflation targeting policies in order to make it work better. To experts on economic and monetary matters, this study will enable them to map out further strategies through new resolutions to strengthen inflation targeting in Nigeria. Finally to researchers and students, this study will help them to become interested in this area and with that carry out further research in this area.

1.6       Scope of the Study

The study is on assessing inflation targeting in emerging market economy: the Nigerian experience from 2005 to 2016. The choice of the period for the study is based on the period that inflation targeting was introduced in Nigeria. Prior to this period, the Central Bank of Nigeria has adopted different policy regimes in the monetary policy implementation ranging from exchange rate peg, targeting various types of monetary aggregates and presently inflation targeting. The main focus is how inflation targeting has helped to reduce inflation rate and increase output levels in Nigeria within this period of study.

1.7       Definition of Terms

Inflation: This refers to a continuous or persistent rise in the price level.

Inflation Targeting: Inflation targeting as a framework of constrained discretion in which the constraint is the inflation target which may be a point or a range and the discretion is the scope and flexibility to take account of economic and other considerations.

Emerging Economies: This describes a nation's economy that is progressing toward becoming more advanced, usually by means of rapid growth and industrialization. These countries experience an expanding role both in the world economy and on the political frontier

Emerging Markets: An emerging market is one that is in the transitional phase from a developing country to a developed one.

Productivity: Refers to the level of economic activities or level of output produced within a given economy.


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