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This study examined the effectiveness  of monetary policy on the growth of Nigeria economy between the period of 1981 and 2012 with the objective of finding out the impact of various monetary policy instruments (money supply, interest rate, exchange rate and liquidity ratio) in enhancing economic growth of the country within the period considered. To identify the stationarity characteristics of the data employed in the empirical investigation, various advanced econometric techniques like Augmented Dickey Fuller Unit Root Test, Johansen Co-integration Test and Vector Error Correction Mechanism (VECM) were employed and the following information surfaced: None of the variables was stationary at level meaning they all have unit roots. But all the variables became stationary after first difference with the exclusion of money supply. However, all the variables became stationary after second difference. Hence they were integrated of order two. The co-integration result indicated that there is long run relationship among the variable with two co-integrating vectors. The result of the vector error correction mechanism (VECM) test indicates that only exchange rate exerted significant impact on economic growth in Nigeria while other variables did not. Equally, only money supply though statistically insignificant possessed the expected sign while others contradicted expectation. The study concluded that monetary policy did not impact significantly on economic growth of Nigeria within the period under review and that the inability of monetary policies to effectively maximize its policy objective most times is as a result of the shortcomings of the policy instruments used in Nigeria as such limits its contribution to growth. The study recommended among others that Commercial banks and other financial intermediaries must be forced to ensure compliance with the stipulated prudential guidelines.



1.0     Background to the Study

Since its establishment in 1959, the Central Bank of Nigeria (CBN) has continued to play the traditional role expected of a central bank, which is the regulation of the stock of money in such a way as to promote the social welfare. This role is anchored on the use of monetary policy thatis usually targeted towards the achievement of full-employment equilibrium, rapid economic growth, price stability, and external balance (Fasanya et al, 2013). These objectives are necessary for the attainment of internal and external balance, and the promotion of long-run economic growth. Evidence in the Nigerian economy has shown that since the 1980’s some relationship exist between the stock of money and economic growth or economic activity. Over the years, Nigeria has been controlling her economy through variation in her stock of money. Hence monetary policy comprises those government actions designed to influence the behaviour of the monetary sector.

Over the years, the major goals of monetary policy have often been the two later objectives. Thus, inflation targeting and exchange rate policy have dominated CBN’s monetary policy focus based on assumption that these are essential tools of achieving macroeconomic stability (Ajayi, 1999). In Nigeria, monetary policy has been in use since the Central bank of Nigeria was saddled the responsibility of formulating and implementing monetary policy by Central bank Act of 1958. This role has facilitated the emergence of active money market where treasury bills, a financial instrument used for open market operations and raising debt for government has grown in volume and value becoming a prominent earning asset for investors and source of balancing liquidity in the market. Monetary policy has two fundamental goals to promote maximum sustainable output and employment and to maintain sustainable price level in the economy. The job of stabilizing output in the short run and promoting price stability in the long run involves several steps first, the central bank tries to estimate how the economy is doing now and how it is likely to do in the medium term, then, it compares this estimates to its goals for the output and the price level, if there is a gap between the estimates and the goals, the CBN have to decide on how forcefully and swiftly to act to close the gap. Estimate of the current economic conditions are not as even as the most up-to-date data on key variables like employment, growth, productivity etc, largely reflect condition in the past. So to get a reasonable estimate of the current and medium term economic conditions, the central bank tries to find out what the most relevant economic developments are such as government spending, economic conditions abroad, financial conditions at home and abroad and the use of new technologies that boost productivity. These developments are the incorporated in an economic model to see how the economy is likely to evolve over time. In doing this, the central bank is confronted with some unexpected development such as the Niger- Delta crisis that disturbed the oil production and slowed down the revenue generation by the government they therefore, have to build uncertainties into their model. Uncertainty seems to be problem at every part of the monetary policy process and there is yet no set of policy and procedures that policy makers can use to deal with all situations that may arise (Chimezie, 2012). Indeed, the central bank spends a great deal of time and effort in researching into the various ways to deal with different kinds of situation.

The economy of Nigeria is faced with unemployment, low investment and high inflation rate and these factors militate against the growth of the economy. Thus, adopting monetary policy in manipulating the fluctuations experienced so far in the economy, CBN undertakes both contractionary and expansionary measures in tackling the problems observed above.

Monetary policy (MP) decision making starts with the identification of global and domestic challenges where issues relating to global growth, commodity prices, capital flows, inflation rate and purchase managers index are examined in relation to the Nigerian economy. This is followed by an analysis of the domestic environment taking into consideration the level of output growth, direction of prices such as inflation, interest and exchange rates and liquidity in the economy. In addition, the financial sector’s soundness is assessed by comparing the outcome of the fitness tests conducted by the Banking and Supervision Department of the Central Bank of Nigeria (CBN) on indicators such as Capital Adequacy Ratio (CAR); Non Performing Loans (NPLs); Liquidity Ratio (LR); Return On Equity (ROE); Return On Assets (ROA); Interest Margin to Gross Income and Total Operating Cost to Gross Income; etc. against the prudential requirements.

It should be noted that suggestions on the application of appropriate monetary policy, tools or instruments depend not only on the results of the fitness test but also on the effectiveness of previous policy measures implemented by the Monetary PolicyImplementation Committee (MPIC). Views or opinions on the final measures to be adopted are open to vote by the Monetary Policy Committee (MPC) members. However, there are personal statements and/or opinions that individual are free to communicate which may vary from that of the majority. However, opinions contrary to that of the majority are expressed in the individual member’s personal statement.

The MPC regularly formulates policies and strategies aimed at ensuring optimal performance of the banking industry and by extension, achieve other macroeconomic objectives. But in the course of implementing these policies, certain conflicting issues and challenges are experienced that has to do with compliance with the rules and regulations set by the CBN on Open Market Operation (OMO), Cash Reserve Ratio (CRR), interest rate, and Liquidity Ratio (LR) which are instruments of Monetary Policy manipulated to achieve growth, price stability, Balance Of Payment (BOP) equilibrium and full-employment.

In the light of this, the major objective of this paper was to review the framework for monetary policy decisions and the effectiveness of monetary policy implementation in the Nigerian economy by analyzing the impact of the policy on inflation, exchange rate and growth. The paper also identified the challenges of monetary policy in Nigeria and tried to proffer answers to the four fundamental questions that most governments and policymakers, at global and domestic levels, are always faced with which are:

i. How can inflation be kept under control?

ii. How can exchange rate be stabilized?

iii. How can unemployment be reduced? and

iv. How can the rate of economic growth be increased and sustained?

It is hoped that this paper will shade more light on how effective monetary policy has been used in managing the Nigerian economy particularly since the adoption of the IMF/WORLD BANK sponsored Structural Adjustment Programme (SAP) in 1986 when financial liberalization and indirect monetary policies were implemented.

1.1     Statement of the problem

“Monetary policy is known to be a vital instrument that a country can deploy for the maintenance of domestic price and exchange rate viability, as a critical condition for the achievement of a sustainable economic growth and external viability”(Amasomma et al, 2011). On a yearly basis,the monetary authority formulate guidelines geared towards the enhancement and development of policy variable designed to ensure optimal performance of the banking industry and ultimately to advise the macroeconomic goals or objectives but in the implementation of such policy variable certain conflicting issues are to be addressed ranging from the ability to comply with various monetary policy guidelines as well as satisfying depositors and shareholders (Chimezie, 2012). Central bank of Nigeria uses various instruments to achieve its stated objective and these include: open market operation (OMO), required reserve ratio (RRR), bank rate, liquidity ratio, selective credit control and moral suasion. There have been various regimes of monetary policy in Nigeria. Sometimes, monetary policy is tight and at other times it is loose, mostly used to stabilize prices. The economy has also witnessed times of expansion and contraction but evidently, the reported growth has not been a sustainable one as there is evidence of growing poverty among the populace. The controversy bothering on whether or not monetary policy measures actually impact on the Nigerian economy is a problem this study sets to solve. Therefore, the main thrust of this study is to evaluate the effectiveness of the CBN’s monetary policy over the years. This would go a long way in assessing the extent to which the monetary policies have impacted on the growth process of Nigeria using the major objectives of monetary policy as yardstick.

One of the major objectives of monetary policy in Nigeria is price stability. But despite the various monetary regimes that have been adopted by the Central Bank of Nigeria over the years, inflation still remains a major threat to Nigeria’s economic growth. Greenspan (2003) observed succinctly that “Uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristic of that landscape” within the Nigerian monetary environment, “data robusity‟; data transmission mechanism and fiscal environment are notably found as her greatest challenge and uncertainty. This has become particularly interesting because according to Ibeabuchi (2007), the Nigerian external sector (balance of payment) via change in net foreign assets; government budget (net credit to government) influence monetary survey as much as the real growth of the economy and prices.

Okorie (2009) observed that monetary data that as a component of monetary policy proposals are often subject to frequent revision together with non-availability and quality concerns of non-monetary data such as real sector statistics. He further opined that transmission problem of monetary data is peculiar to most developing countries of which Nigeria is not an exception. One of the peculiar challenges of transmission channels is the „obsolesce‟ of the channel; relevant, and/or that the assumed magnitude of impact could be wrong by some significant Nigeria. This incidence is high, particularly for the fact that the structural relationship often subsisting amongst developing economies changes frequently, e.g. what constitute money has been expanded by the introduction of technology-backed proliferation of financial products which seemingly alter the empirical relationship between economic activity, inflation and the broad money (M2) in Nigeria, Okorie (2009).

Finally, fiscal surprises have been seen to undermine monetary policy substantially, for instance, in the event of fiscal tax surface, monetary policy is expected to immediately become reasonably investment to maintain both internal and external balance. From the foregoing, therefore, the study’s challenge is therefore how best to manage the uncertainties in such way as to continue to pursue the basic and primary function of monetary policy for efficient price stability and sustainable economic growth.

1.2     Objectives of the Study

The broad objective of the study is to examine the effectiveness of monetary policy application in Nigeria from 1981 - 2012. And the specific objectives include:

1.     To evaluate the impact of monetary policy instruments on economic growth in Nigeria

1.3     Research Questions

1.     To what extent does monetary policy impact on economic growth of Nigeria?

2.     Has monetary policy tools impacted on the growth of the Nigerian economy?

1.4     Research Hypotheses

Ho: Monetary policy instruments do not have significant impact on economic growth in Nigeria

H1: Monetary policy instruments have significant impact on economic growth in Nigeria

1.5     Significance of the Study

Most theories of economic stabilization revolve around monetary policies. This explains why several instruments have been experimented in Nigeria since 1986. Ogun and Adenikinju (1995) observed that money supply growth averaged about 33% in 1991 – 1980 and 13% in 1981 – 1989, inflation appears to have moved in line, with respective levels of 19% and 16% in the last two decades. Secondly, the explosive stage of Nigeria’s inflationary experience appears to be in the 1973 – 1975 period which coincides with the period of the first oil shock of the 1970s, between 1973 and 1974 alone; the country’s foreign exchange receipts grew at the unprecedented rate of about 113%. It was further noted that the monetary authority appears to have relied almost exclusively on commutation of foreign exchange receipts into domestic expenditures in the oil boom period but resolved to deficit financing in order to sustain theexpansionary monetary impulse in non-oil boom years; similarly, inflationary financing was experienced leading to negative real deposit interest rate, hence, decline in the velocity circulation of money supply as a result of fall in the efficiency of money in the production processes.

Mbutor (2009) argues that impulse response function indicated that an unexpected shock of the monetary policy rate does not have a contemporaneous effect on gross domestic product and consumer price index. He continued in his work that going by the result of the variance decomposition shows that change in the monetary policy rate contributes 22 percent to total variation in GDP, hence that monetary policy shock failed to impact on the Consumer Price Index (CPI) but by change in GDP and the lay of CPI. He therefore, posited that lending rate provides the strongest link or nexus for propagation of monetary policy impulse in Nigeria, thus study therefore would econometrically review those monetary factors as noted above via the use of ordinary least squares regression and Structural Vector Autoregressive Regression (SVAR). More so, findings that would precede this work, no doubt will be economically viable, particularly this time of financial reforms in the economy geared towards economic growth and development.

1.6     Scope of the Study

The effect of monetary policy is a very wide topic, however the project covers the period of 31years (1981-2012). This would go a long way in assessing the extent to which the monetary policy tools have impacted on the growth process of Nigeria using the major objectives of monetary policy as yardstick.

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