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This research work evaluates the responses of inflation, interest and exchange rate to shocks in Monetary Policy (captured by MPR) as well as the impacts of MPR on these Macroeconomic Variables. The study used monthly data spanning from December, 2006 (when the MPR was introduced) through February, 2012. Following Joao and Andrea (2006), the research used Structural VAR to estimate the model. The result shows that inflation responds to shocks in MPR only in a fairly unstable manner (a pattern that is almost unpredictable); in the first four periods, positive shocks in MPR could not bring down inflation but thereafter, any further increase in MPR produced gradually declining but positive rate of interest. On the other hand, exchange rate responds to shocks in MPR in a relatively downward fashion and quickly assumes upward trend from the second period lasting throughout the period, while interest rate, responds quickly and positively to shocks in MPR from the first thorough the lastperiod.
Therefore, interest and exchange rates are more responsive to shocks in MPRthan inflation and above all sometimes changes in MPR cannot guarantee the expected changes in Inflation (because of large informal sector as well as policy divergence between the monetary and fiscal authorities among other reasons). Hence, of all the three variables, inflation is the most difficult to deal with and stability of which is a necessary condition for the achievement of stability in the other two variables (interest & exchange rates). More so, interest and exchange rates as well as MPC meetings are better predictors of MPR (because of their high sensitivity to it) than the rate of inflation. The result also uncovered that as the most difficult enemy of the economy, inflation cannot be effectively and efficiently conquered with the variation in MPR alone, other instruments particularly Cash Reserve Requirement (CRR) and especially Open Market Operations (OMO) should be prudently used to compliment the efficacy of MPR. Consequently, the paper further recommends the current monetary tightening stance of CBN but should be used with caution, improvement and expansion of the cash-lite policy and non-interest banking of the CBN, infrastructural development, harmonization of fiscal and monetary policy as well as the reduction in the number of MPC meetings to at most quarterly unless in case ofemergency.
1.1 Background to the Study
Macroeconomic policy consists of the actions aimed at inducing appropriate changes in macroeconomic aggregates such as output, employment and the price level. The major components of macroeconomic policy include fiscal, monetary, debt management, exchange rate and prices and incomes policies. The objectives of macroeconomic policy include economic growth, balance of payments equilibrium, a satisfactory rate of growth and a high level of employment of the labour force. Monetary policy being one of the available tools of macroeconomic policy assists in the pursuit of these macroeconomic objectives.
Monetary policy refers to the actions undertaken by a central bank to influence the availability and cost of money and credit as a means of helping to promote national economic goals. The policy which aims at controlling the growth of the monetary aggregates is expected to assist the other policy tools in achieving the pre-stated macroeconomic objectives as well as economic growth. Monetary policy is very important because it can go further than some of the tools in helping to attain the overall policy goals but it must be supported by these other tools. The Central Bank of any country makes use of monetary policy instruments to influence the level of money supply in the economy.
The monetary policy instruments are the direct means available to the monetary authorities for influencing the intermediate variables to achieve the ultimate goals of policy. Monetary policy instruments are of two types: first, quantitative, general, indirect or market-based instruments; and second, qualitative, selective or direct control instruments. The direct control instruments are discretionally manipulated to achieve some set targets while the market-based instruments are employed in a well-developed financial system to influence market participants in such a way that the desirable targets are achieved. The indirect instruments include bank rate variations, open market operations and changing reserve requirements and they regulate the overall level of credit in the economy through commercial banks. The direct instruments on the other hand are aimed at controlling specific types of credit and they include changing margin requirements and regulation of consumer credit. While the indirect instruments have been used very extensively in the more developed market economies, the direct instruments predominate in less developed economies such as ours. Both techniques aim at influencing the cost and availability of banking systems credit. The direct technique involves fixing of credit ceilings and interest rates by the monetary authorities for compliance by banks, while the indirect technique achieves the same objective through the financial markets. The most potent instrument of the indirect or market based technique is Open Market Operations (OMO).
In the Nigerian case, the design and implementation of monetary policy between 1970 and 1985 had the primary objectives of maintaining relative economic growth, a healthy balance of payments position and stimulation of output and employment. Throughout this period, monetary policy depended on the use of direct monetary instruments such as the prescription of aggregate credit ceilings, use of selective controls, imposition of special deposits, among others. The most popular instrument used at this time was the issuance of credit rationing guidelines to the commercial banks. A number of reserve requirement guidelines were also in use. The prolonged used of these direct controls generated considerable problems and became counter-productive. Some of these negative effects of direct controls include reduced competition in the financial system, leading to inefficiency and misallocation of resources in the banking sector. Credit ceilings generated arbitrary and high lending rates, lack of transparency in transactions and the employment of various ploys to circumvent the controls by window-dressing, the use of off- balance sheet items and the channeling of transactions through uncontrolled institutions, especially finance houses which mushroomed. This led to monetary policy under a liberalized economy.
In the specific environment of financial and economic liberalization, monetary policy objectives remained the same – promotion of economic growth, maintenance of external equilibrium and stimulation of output and employment. Monetary policy was also to stabilize the economy in the short-run and to induce the emergence of a market-oriented financial sector for effective mobilization of financial savings and efficient allocation of resources. The monetary control framework remained essentially the same at the initial stage of the programme, but several dynamic reforms were introduced ad the implementation of the programme progressed. Here, there was a shift in the policy instruments used from the direct instruments to the indirect instruments. As a result of the problems posed by the direct monetary control, the Central bank embarked on the selective removal of all credit ceilings of banks that met some criteria under the prescribed prudential guidelines and the indirect approach to monetary policy was initiated.
Deregulation of interest rates was a major policy instrument early in the programme. Early in 1987, the interest rate structure was adjusted upward to improve efficiency in savings mobilization and resource allocation. The use of stabilization securities was reintroduced in 1990 to put a check on the incidence of excess liquidity. The minimum paid up capital for commercial and merchant banks was also raised to ensure the soundness of the banking sector for effective monetary management.
In September 1, 1992, there was a major change in monetary operating techniques, from the use of direct control to indirect control operating techniques. The CBN, lifted credit ceiling imposition on individual banks that met CBN requirements on selective basis in respect of minimum capital base, capital adequacy ratio, cash reserve and liquidity ratio requirement, prudential guidelines, sectoral credit allocation and sound management. On June 30, 1993, CBN commenced OMO in treasury securities with banks through discount houses on a weekly basis. With the introduction of indirect monetary control instrument, CBN now controls the stock of money (from banks and non-bank public) through manipulating the monetary base or reserve aggregates. This study is of great importance since it will provide an insight into the extent to which monetary policy can be relied upon for the attainment of macroeconomic objectives in the country.
1.2 Statement of the Problem
Nigeria as a country has been plagued by many macroeconomic problems, including low level of economic growth and instability. As a result, there has been a need for all stakeholders to contribute their quota in ensuring that the economy’s performance is at its peak. The government, as well as the Central Bank is instrumental in achieving this. The government carries out its obligations of ensuring a healthy macroeconomic environment by way of administering fiscal policies while the Central Bank carries out its own duty by means of monetary policies. The state of economic degradation brings about the need for appropriate and workable monetary policies to ensure that pre-determined macroeconomic objectives are achieved.
The adoption of monetary policies in Nigeria is not a recent development but is one that has been in use since the early 1970s. Since then, there have been a lot of problems in the conduct of monetary policy in the economy. This resulted in the shift from the use of direct monetary policy instruments to the indirect monetary policy instruments that are in use till date.
There has been a growing interest on economic growth as a major goal of monetary policy. This is as a result of recent developments in economic theory which tend to show that a reduction in the inflation rate impacts measurably and positively on economic growth (Uchendu, 2000).
1. How do interest rate, exchange rate and inflation respond to shocks in monetary policy rates(MPR)?
2. What is the impact of monetary policies on economic growth of Nigeria.
1.4 Objectives of theStudy
The General objective of the study is to find out the extent to which monetary policy (captured by MPR) could bring about Economic growth (stability in inflation, interest and exchangerates)inNigeria.Consequently,thefollowingisthespecificobjectiveofthestudy:
To investigate how interest rate, exchange rate and inflation respond to shocks in monetary policy rate (MPR).
(1) H0: Interest rate, exchange rate and inflation do not respond to shocks in monetary policy rate (MPR).
1.6 Scope of the Study
The study attempts to examine the relationship between monetary policy and economic growth in Nigeria in the period of 1971 to 2005. The choice of this period is necessitated by various factors. First, both positive and negative effects of monetary policy have been observed especially in the period before the Structural Adjustment Programme. During this period, direct control measures were used to regulate the money supply in the country. This therefore resulted in a lot of malfunctioning in the economy. Also, indirect controls were put in place by the Central Bank. Till date, both the direct and indirect controls are in use by the Central Bank to control the price level in the economy. The choice of the above period is also necessitated by the availability of data for the research work.
The study focuses mainly on the money supply because of the belief that the institution of various monetary policy instruments is meant to change the volume and value of money supply.
1.7 Limitations of theStudy
One of the major limitations of the study is the use of MPR as a proxy to capture monetary in Nigeria. In practice, CBN uses other instruments like OMO, Liquidity ratio and Cash reserve
Requirement to compliment variation in MPR in achieving Economic growth. The use of prime lending rate (excluding the maximum lending rate) for interest rate could also be a challenge toward producing the accurate and most reliable outcome. In a nutshell, there is likelihood that the research model has omitted some important explanatoryvariables.
Furthermore, the accuracy and the reliability of the data produced by NBS, CBN etc. used in this study cannot be guaranteed. Finally, the study might be seen as restrictive because any development (in the variables examined) before December, 2006 and after February, 2012 is considered to be beyond the scope of thisstudy.
1.8 organization of Study
The work is divided into chapters to ensure that there is a clear understanding of the issue of monetary policy and economic growth in Nigeria. The study is arranged as follows. Chapter 1 consists of the introduction, statement of the problem, objectives, research problem, justification of the study, scope of the study, and outline of the study. Chapter 2 contains the literature review and analytical framework. This is a simple and brief general review of issues surrounding the topic of study as well as an examination of past and relevant literatures done by others in relation to the topic of study. Chapter 3 comprises the research methodology and it seeks to find and explain an economic theory which can be associated with the study. Chapter 4 shows the empirical analysis which is simply the presentation of results and their analysis and interpretation. Chapter 5 consists of summary, conclusion, policy recommendation, and suggestions for further research.
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