i

MONETARY POLICY APPLICATION AND ITS PERFORMANCE ON

NIGERIAN ECONOMY

(1990 – 2014)

BY

YUSUF ABDULKABIR ABIODUN

U12BA1044

A PROJECT SUBMITTED TO THE DEPARTMENT OF BUSINESS

ADMINISTRATION, FACULTY OF ADMINISTRATION

AHMADU BELLO UNIVERSITY, ZARIA-NIGERIA

IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE

AWARD OF BACHELOR OF SCIENCE (B.Sc.) DEGREE IN BUSINESS

ADMINISTRATION

AUGUST, 2016

ii

DECLARATION

I Yusuf Abdulkabir Abiodun hereby declare that this project work is the product of my own

independent research effort, undertaken under the supervision of Mohammad B. Hussaini in

partial fulfilment of B.Sc. Degree in Business Administration (Banking and Finance option)

and submitted to the Department of Business Administration, Ahmadu Bello University Zaria.

The information derived from the literature has been duly acknowledged in the text and list of

references provided. To the best of my knowledge, this project was not previously presented

for another Degree or Diploma.

YUSUF ABDULKABIR ABIODUN -------------------------------

RESEARCHER SIGNATURE AND DATE

iii

CERTIFICATION

This is to certify that this project work was originally carried out by Yusuf Abdulkabir

Abiodun, a student in the department of Business Administration (Banking and Finance option)

with Registration number U12BA1044, Ahmadu Bello University Zaria, Nigeria.

MUHAMMAD B. HUSSAINI ------------------------------

MY PROJECT SUPERVISOR SIGNATURE & DATE

MAL. YAZEED MOHAMMAD --------------------------------

PROJECT CORDINATOR SIGNATURE & DATE

PROF. BELLO SABO ---------------------------------

HEAD OF DEPARTMENT SIGNATURE & DATE

iv

DEDICATION

This project is dedicated to the best mother in the world ‘‘Amisu Ismat Amope’’ (Iya ni

wura) and to my entire family.

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AKNOWLEDGEMENT

My utmost gratitude to the Almighty, for His Grace and Mercy on me in leading me through

in this part of journey of life.

And to my Sweet Mother, you have really proven to me your worthiness; with your kindness,

love, care, prayers and financial support in my life. No wonder why the Yoruba say “Mother

is Gold’’. You are indeed a blessing to me.

To my supervisor Muhammad B Hussaini, despite other commitment, you still created time for

me in reading through, correcting and guiding me in this project work. I appreciate your effort.

To all my lecturers, I thank you all for you contribution and the knowledge you impacted in

me in various courses.

My blood brother Mr. Yusuf Afeez Oladapo (Big Bro), your contribution to this project work

is not small at all. Thanks for your words of encouragement and academic advice. I also thank

my friends; Mr. Afolabi Abdulmajid (Afodapsy), Mr. Aliyu Yusuf (Ojeje one), Mr. Sodeeq

Abdul Muttalib (MD), Mr. Aliyu Haliyu and others. They have really contributed to my stay

in school.

I’m forever grateful to a brother Mr. Yusuf Oyedeko, for taking his time and effort in advising,

guiding, correcting and his words of encouragement regarding my study and this project work.

Lastly, to my friends, loved ones and all my family members who have in one way or the other

contributed to the success of my program, I express my gratitude to you all.

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TABLE OF CONTENTS

Title page i

Certification ii

Dedication iii

Acknowledgement iv

Table of contents v

Abstract viii

CHAPTER ONE: INTRODUCTION

1.1 Background of the study ---------- ---------------------------------------------------------- 1

1.2 Statement of the problem --------- ---------------------------------------------------------- 3

1.3 Research questions ------- ------------------------------------------------------------------- 4

1.4 Objective of the study ---- ------------------ ------------------------------------------------- 5

1.5 Research hypotheses ----- ------------------------------------------------------------------- 5

1.6 Significance of the study --------- ---------------------------------------------------------- 5

1.7 Scope and limitation of the study ---------------------------------------------------------- 5

1.8 Definition of related terms ---------------- ------------------------------------------------- 6

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction ------ ---------------------------------------------------------------------------- 8

2.2 Conceptualization of Monetary Policy -- ------------------------------------------------- 8

2.2.1 Instruments of Monetary Policy -------- ------------------------------------------------- 9

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2. 3 Theoretical Framework - ------------------------------------------------------------------- 12

2.3.1 Monetary Policy Framework and Implementation in Nigeria - ---------------------- 14

2.4 Review of Empirical Studies ----- ---------------------------------------------------------- 19

2.4.1 An appraisal of the performance of monetary policy in Nigeria ------- ------------- 26

2.4.2 Strategies of Monetary Policy in Nigeria ------ ---------------------------------------- 30

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Introduction ------ ----------------------------------------------------------------------------- 33

3.2 Research Design ---------------------------- -------------------------------------------------- 33

3.3 Method of Data collection ------------------------------------------------------------------- 33

3.4 Method of Data Analysis -------------------------------------------------------------------- 33

3.5 Model specification -------------------------------------------------------------------------- 34

3.6 Measurement of Variables ------- ---------------------------------------------------------- 35

3.7 Method of evaluation ------------------------------------------------------------------------ 35

CHAPTER FOUR: DATA PRESENTATION, ANALYSIS AND INTERPRETATION

4.1 Introduction ------ ---------------------------------------------------------------------------- 39

4.2 Data Presentation ---------------------------------------------------------------------------- 39

4.3 Result Presentation ---------------- ---------------------------------------------------------- 41

4.4 Test of Hypothesis -------- ------------------------------------------------------------------- 50

4.5 Discussion of Findings --- ------------------------------------------------------------------- 50

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CHAPTER FIVE: SUMMARY, CONCLUSION, AND RECOMMENDATIONS

5.1 Summary of Findings ------------------------------------------------------------------------52

5.2 Recommendation ---------------------------------------------------------------------------- 53

5.3 Conclusion ------------------------------------------------------------------------------------ 53

References ---------------------------------------------------------------------------------------- 55

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Abstract

This study examine the performance of monetary policy on the economic growth of Nigeria

from 1990 to 2014. Knowing that CBN used many instruments of monetary policy to regulate

Nigerian economy, this study only focused on three instruments (money supply, monetary

policy rate and exchange rate) in relation with gross domestic product (GDP). Relevant data

were collected from the CBN and these data were subjected to various statistical and

econometric test using Ordinary Least Square method (OLS) and E-view statistical package.

The result showed that money supply (MS) was positively related and statistically significant

to GDP. Monetary policy rate (MPR) was found to be positively related but highly statistically

insignificant. Exchange rate result on the other hand, showed that exchange rate was

negatively related and statistically insignificant to GDP.

The result of the overall significance (F-statistic test) showed that monetary policy had a

positive impact on Nigerian economic growth. In conclusion, the study shows that monetary

policy exerts significant impact on the level of economic growth in Nigeria. It is recommended

that the monetary authorities should exercise influence that would affect the behaviour of

monetary aggregates, inflation, monetary policy rate, bank credit, among others, in the overall

liquidity of the economy.

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CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Achieving pro-poor and long term sustainable economic growth and development has

long been emphasized as a major macroeconomic objective of every nation of the world.

The course of attaining this goal however depends, among other things, on the

establishment and the responsibility of the financial sector regulator of each country. The

Central Bank of Nigeria (CBN) since its establishment in 1959, 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 (Ajayi, 1999). This role is anchored on the

use of monetary policy that is usually targeted towards the achievement of full-

employment equilibrium, rapid economic growth, price stability, and external balance

(Fasanya et al, 2013; Adesoye et al, 2012).

This action of the monetary authority is usually carried out by changing the volume of

money in circulation and the interest rate. It is not an exaggeration that the importance of

money in economic life has made policy makers and other relevant stakeholders to accord

special recognition to the conduct of monetary policy. This policy application could

either be expansionary or contractionary at any given time depending on the monetary

authorities.

Monetary policy as a technique of economic management to bring about sustainable

economic growth and development has been the pursuit of nations and formal articulation

of how money affects economic aggregates dates back to the time of Adams Smith and

later championed by the monetary economists. Since the expositions of the role of

monetary policy in influencing macroeconomic objectives like economic growth, price

stability, equilibrium in balance of payments and host of other objectives, monetary

authorities are saddled with the responsibility of using monetary policy to grow their

economies.

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

11

source of balancing liquidity in the economy. 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. Monetary and fiscal policies are the two most

important macroeconomic tools to achieve high employment rates, price stability and

overall economic growth. An important issue that has exercised the minds of

macroeconomists is the understanding of how the dependence, independence and

interdependencies between monetary and fiscal policies could lead the economy closer

or further away from set goals and targets. In a poorly co-coordinated macroeconomic

environment, fiscal policies might affect the chances of success of monetary policies in

various ways, such as: its eroding impact on the general confidence and efficacy of

monetary policy, through its short-run effects on aggregate demand, and by modifying

the long-term conditions for economic growth and low inflation. On the other hand,

monetary policies may be accommodative or counteractive to fiscal policies, depending

on the prevailing political and economic paradigms.

Monetary policy is one of the macroeconomic instruments with which monetary

authority in a country employs in the management of their economy to attain desired

objectives. It entails those actions initiated by the Central Bank which aim at influencing

the cost and availability of credits (Nwankwo, 1991 and Wrightsman 1976). For most

economies, the fundamental objectives of monetary policy include price stability,

maintenance of balance of payments equilibrium, and promotion of employment, output

growth and sustainable development. These objectives are necessary for the attainment

of internal and external balance of value of money and promotion of long run economic

growth. Ajisafe and Folorunso (2002) noted that the objectives of monetary policy

include increase in Gross Domestic Product growth rate, reduction in the rates of inflation

and unemployment, improvement in the balance of payments, accumulation of financial

savings and external reserves as well as stability in Naira exchange rate, the policy as

well as instruments applied to attain these objectives, however, have until recently been

far from adequate. Economic development is one of the major objectives of many

countries in the world and economic growth is fundamental to economic development.

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 decline in

manufacturing output which is the main engine of growth according to Kaldor’s first law

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and the growing poverty among the populace. Monetary policy is one of the

macroeconomic instruments with which nations (including Nigeria) do manage their

economies (Ajie and Nenbe, 2010). According to Ubi, Lionel and Eyo (2012), monetary

policy is an aspect of macroeconomics which deals with the use of monetary instruments

designed to regulate the value, supply and cost of money in an economy, in line with the

expected level of economic activity. It covers gamut of measures or combination of

packages intended to influence or regulate the volume, prices as well as direction of

money in the economy per unit of time. Specifically, it permeates all the debonair efforts

by the monetary authorites to control the money supply and credits conditions for the

purpose of achieving diverse macroeconomic objectives. Actually, monetary policy

attempts to achieve a set of objectives that are expressed in terms of macroeconomic

variables, such as inflation, real output and unemployment.

Today, monetary and fiscal policies are both commonly accorded prominent roles in the

pursuit of macroeconomic stabilization in developing countries, but the relative

importance of these policies has been a serious debate between the Keynesians and the

monetarists. The monetarists believe that monetary policy exert greater impact on

economic activity while the Keynesian believe that fiscal policy rather than the monetary

policy exert greater influence on economic activity. Despite their demonstrated efficacy

in other economies as policies that exert influence on economic activities, both policies

have not been sufficiently or adequately used in Nigeria (Ajisafe and Folorunsho, 2002).

The objective of this paper is to review the practice of monetary policy in Nigeria. In

spite of many, and frequently changing, monetary and other macro-economic policies,

Nigeria has not been able to harness her economic potentials for rapid economic

development (Ogbole, 2010). These policies span through two broad periods, which can

be classified as “regulation” and “deregulation”. Our main focus is the differential in

monetary policy effectiveness in promoting economic growth in Nigeria.

1.2 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 stability, 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

13

enhancement and development of policy variable designed to ensure optimal

performance of the banking industry and ultimately to achieve 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. Vast researches have been conducted

on the monetary policy measures and its impact on the Nigerian economy. Vast

researches have been done on the nature of monetary policy and the economic growth

for years, most of the studies considered monetary policy impact on the development of

economy in both the developed and developing countries using various methodology and

variables to capture monetary policy instruments with variation in the duration of periods.

However, recent literatures have justified the need to jointly take into consideration

monetary policy and economic growth in an economic model and economic techniques

for unbiased result. Based on these divergent findings the researcher considers this area

of interest and re-examine the dynamic impact of monetary policy application on the

Nigerian economic growth using multiple regression and time series data from 1990 to

2014.

1.3 RESEARCH QUESTIONS

To examine the relationship between monetary policy instruments and the Nigerian

economic growth, the following research questions would be useful to aid the study:

(i) What impact does money supply has on the Nigerian economic growth?

(ii) What impact does monetary policy rate has on the Nigerian economic growth?

(iii) Is there any relationship between the exchange rate and Nigerian GDP?

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1.4 OBJECTIVES OF THE STUDY

The overall objective of this study is to analyse the impact of monetary policy instruments

on Nigerian economic growth. However the specific objectives of the study are:

(i) To examine the impact of money supply on the Nigerian economic growth.

(ii) To assess the impact of monetary policy rate on the Nigerian economic growth.

(iii) To ascertain the effect of exchange rate on Nigerian GDP.

1.5 RESEARCH HYPOTHESES

H01: Money supply has no significant impact on the Nigerian economic growth

H02: Monetary policy rate has no significant impact on the Nigerian economic growth.

H03: Exchange rate has no significant impact on the growth of Nigeria economy.

1.6 SIGNIFICANCE OF THE STUDY

From the empirical point of view, the importance of this study is to examine the

performance of monetary policy on the Nigeria economy. This study will be of immense

benefits and veritable tool for the government of the country, business man, company’s

holders, students, academic independent researchers and others who are interested in the

policies related issues. The study will serve as a criterion for determining the extent to

which the policy implementation is good for the economic growth of Nigeria. It would

also contribute to the existing literature on the subject matter by investigating empirically

the causation of monetary policy and economic growth in Nigeria. This study will also

enable Nigerians to know the impacts of monetary policy instruments on the Nigeria

economy whether is positives impact or negatives on the economic growth of the country.

1.7 SCOPE AND LIMITATION OF THE STUDY

The scope of this study shall be restricted only to the relationship between monetary policy

instruments proxy (money supply, monetary policy rate and exchange rate) and the

economic growth proxy (GDP). The study is limited to 25 years annual observations

ranging from 1990 to 2014. The monetary policy instruments are limited to these variables

because the accessibility of data on tax revenue generated by federal government is a bit

challenging. Data would be sourced from the CBN statistical bulletin and data used would

be only secondary data.

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1.8 DEFINITION OF KEY TERMS

Monetary Policy: It is a government policy which regulates the supply of money and

the cost and availability of credit in the economy.

Fiscal policy: It is government policy that is designed to achieve the objective of price

stability, growth, balance of payments equilibrium, full employment, mobilization of

resources and investment.

Economic Growth: Economic growth represents the expansion of a country’s potential

GDP or output.

Minimum Rediscount Rate (MRR): This was the former anchor policy interest rate of

the CBN. It reflected long-term interest rate and was indicative of the direction of policy

on interest rates structure.

Monetary Policy Rate (MPR): When interest rates were insensitive to changes in MRR,

the MPR which is a short term anchor rate replaced the MRR in December, 2006. It is

designed to influence short term money market rate and promote policy efficiency.

Policy: Guidelines or set of decisions for achieving some objectives or solving problems.

Economic Growth: Increase in a country’s productive capacity, as measured by

comparing gross national product (GNP) in a year with GNP of the previous year.

Gross National Product: GDP of a country to which income from abroad remittance of

nationals living outside and income from foreign subsidiaries of local firms has been

added.

Gross Domestic Product (GDP): This is the total output of goods and services in a

country measured through market prices. It is therefore the summation of the production

of goods and services of all residents in a country within a year.

Money Supply: Population’s spending power represented by the quantity of liquid assets

(usually cash) in an economy that can be exchanged for goods and services.

Liquidity Ratio: The ratio of liquid assets (usually cash) that banks are to remain in their

vault to be able to meet the needs and demands of cash by the depositors.

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Exchange Rate: The rate or the price for which the currency of a country can be

exchanged for another currency.

Interest Rate: the rate at which the central bank is ready to give loan to the commercial

banks when they are in need of liquid cash.

Inflation: A sustained, rapid increase in price of goods and services in an economy as a

result of too much of money circulating in the economy chasing few goods.

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CHAPTER TWO

LITERATURE REVIEW

2.1 INTRODUCTION

This chapter of the study focus of the conceptualization of monetary policy, the

theoretical framework, the review of some empirical studies and the appraisal of the

performance of monetary policy in Nigeria.

2.2 CONCEPTUALISATION OF MONETARY POLICY

Monetary policy is concerned with discretionary control of money supply by the

monetary authorities (Central Bank with Central Government) in order to achieve stated

or desired economic goals. Governments try to control the money supply because most

governments believe that its rate of growth has an effect on the rate of inflation. Hence

monetary policy comprises those government actions designed to influence the behaviour

of the monetary sector. Nigeria’s monetary policy is anchored on the monetary targeting

framework and price stability which represents the overriding objectives of monetary

policies.

Monetary policy is therefore defined as a policy employed by the central bank in

controlling the money supply as an instrument for achieving the objectives of

macroeconomic policy. It is therefore a combination of the measure designed to regulate

the value, supply and cost of money in the economy in consonance with the expected level

of economic activities (Central Bank of Nigeria, 1995).

Monetary Policy is the deliberate use of monetary instruments (direct and indirect) at the

disposal of monetary authorities such as central bank in order to achieve macroeconomic

stability. Monetary policy is essentially a programme of action undertaken by the monetary

authorities, generally the central bank, to control and regulate the supply of money with

the public and the flow of credit with a view to achieving predetermined macroeconomic

goals (Dwivedi, 2005).

Monetary policy consists of a Government’s formal efforts to manage the money in its

economy in order to realize specific economic goals. Three basic kinds of monetary policy

decisions can be made about:

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a) The amount of money in circulation;

b) The level of interest rate

c) The functions of credit markets and the banking system (Ogunjimi, 1997).

The combination of these measures is designed to regulate the value, supply and cost of

money in an economy, in line with the level of economic activity. Excess supply of money

will result in an excess demand for goods and services, prices will rise and balance of

payments will deteriorate.

The challenges of monetary policy management rest wholly on monetary authorities which

have over the years been committed to its effective control. The performance of monetary

policy has improved greatly in recent times- inflation has remained at moderate levels

accompanied by high growth of domestic output (Bolarinwa, Kehinde and Abata, 2012).

To sustain the efforts, there is need for appropriate collaboration with the fiscal authorities

as well as the development of confidence in inter-bank market and the necessary financial

market infrastructure is still relevant.

Monetary policy requires the establishment of a relationship between monetary

instruments, which the authority controls the key target of the policy objectives. Money

supply is therefore the centerpiece of monetary tools and intermediate target of monetary

policy.

Okwu, et al, (2011) stress as well that monetary policy is undoubtedly a veritable tool to

be employed in macroeconomic management and for achieving stability of the financial

system. It implies therefore that in Nigeria like any economies of the world, the primary

objective of monetary policy should be on how to realize a stable and non-inflationary

growth rate of the economy.

2.2.1 INSTRUMENTS OF MONETARY POLICY

To conduct monetary policy effectively, the central bank adjusts the monetary

aggregates, the policy rate or the exchange rate in order to affect the variables which it

does not control directly. The instruments of monetary policy used by the central bank

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depend on the level of development of the economy, especially the financial sector. These

instruments could be direct or indirect.

A. Direct Instruments of Monetary Policy

Direct Instruments of monetary policy are directives given by the central bank to control

the quantity and prices of financial assets/liabilities of deposit money banks (DMBs) and

discount houses.

The central bank can direct Deposit Money Banks on the maximum percentage or amount

of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid

asset ratio and issue credit guarantee to preferred loans. In this way the available savings is

allocated and investment directed in particular directions as desired by the authorities.

B. Indirect Instruments of Monetary Policy

Indirect Instruments of monetary policy involve controlling the price or quantity of base

money. These instruments are discussed below;

i. Reserve Requirements

This instrument is used by the central bank to influence the level of bank reserves and

hence, their ability to grant loans. Reserve requirements are lowered in order to free

reserves for banks to grant loans and thereby increase money supply in the economy. On

the other hand, they are raised in order to reduce the capacity of banks to provide loans

thereby reducing money supply in the economy.

ii. Open Market Operations (OMO)

The most important and flexible tool of monetary policy is open market operations. It is the

buying and selling of government securities in the open market (primary or secondary) in

order to expand or contract the amount of money in the banking system. By purchasing

securities, the central bank injects money into the banking system and stimulates growth

whereas by selling securities it absorbs excess money. Thus, if there is excess liquidity in

the system, the central bank will in a bid to reduce the money supply sell the government

securities such as Treasury Bills. On the other hand, in periods of liquidity shortages, the

central bank buys government securities so as to increase money supply. Instruments

20

commonly used for this purpose include treasury bills, central bank bills, or prime

commercial paper.

OMO enables the central bank to influence the cost and availability of reserves and bring

about desired changes in bank credit and money supply. This important instrument of

monetary policy has a number of advantages because it is flexible and precise, it is

implemented quickly and easily reversed and the central bank has complete control. The

effectiveness of OMO, however, depends on the existence of well-developed financial

markets that are sensitive to interest rate movements.

iii. Discount Window Operations

This instrument is a facility provided by the central bank which enables the DMBs to

borrow reserves against collaterals in form of government or other acceptable securities.

The central bank operates this facility in accordance with its role as lender of last resort and

transactions are conducted in form of short term (usually overnight) loans. The central bank

lends to financially sound DMBs at the policy rate. This rate sets the floor for the interest

rate regime in the money market (the nominal anchor rate) and thereby affects the supply

of credit, the supply of savings (which affects the supply of reserves and monetary

aggregate) and the supply of investment (which affects employment and GDP).

C. Other Instruments

iv. Exchange Rate

The balance of payments can be in deficit or in surplus and this can affect the monetary

base, hence the money supply, in one direction or the other. By selling or buying foreign

exchange, the central bank ensures that the exchange rate is at an optimal level. The real

exchange rate when misaligned affects the current account balance because of its impact

on external competitiveness.

v. Prudential Guidelines

The central bank may require DMBs to exercise particular care in their credit operations in

order to achieve specified outcomes. Key elements of prudential guidelines remove some

discretion from bank management and replace them with rules.

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vi. Moral Suasion

The central bank issues licenses to DMBs and regulates the operation of the banking

system. Thus, it can persuade banks to follow certain policies such as credit restraint or

expansion, increase savings mobilization and promote exports through financial support,

which otherwise they may not do, on the basis of their risk/return assessment.

2.3. THEORETICAL LITERATURE

Monetary theory has undergone a vast and complex evolution since the study of the

economic phenomenon first came into limelight. It has drawn the attention of many

researchers with different views on the role and dimensions of money in attaining macro-

economic objectives.

Consequently, there are quite a number of studies aimed at establishing relationship

between monetary policy and other economic aggregates such as inflation and output.

In this chapter we will take a look at the different schools of thought, their views of

money in attaining policy objectives alongside are view the necessary literature relating

to this study.

I. THE CLASSICAL MONETARY THEORY

The classical school evolved through concerted efforts and contribution of economists

like Jean Baptist Say, Adam Smith, David Ricardo, Pigou and others who shared the

same beliefs. The classical model attempts to explain the determination, savings and

investment with respect to money. The classical model on say’s law markets which states

that “supply creates its own demand”. Thus classical economists believe that the

economy automatically tends towards full employment level by laying emphasis on price

level and on how best to eliminate inflation .The classical economists decided upon the

quantity theory of money as the determinant of the general price level. Theory shows

how money affects the economy. It may be considered in terms of the equation of

Exchange.

MV= PY

Two very similar quantity theory formulations were used to explain the level of price viz;

the transactions formulation or the Cambridge equation.

In the transaction version – associated with Fisher and Newcomb, some assumptions

were made: that the quantity of money (m) is determined independently of other variable,

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velocity of circulation (V) is taken as constant, the volume of transactions (T) is also

considered constant.

Thus of price (p) and the assumption of full employment of the economy, the equation

of exchange is given as;

MV = PT, which can readily establish the production that – the level of price is a function

of the supply of money. That is, p= F (m) which implies that, any change in price changes

money supply. In cash balances version – associated with Walras, Marshell, Wicksell

and pigou, the neoclassical school (Cambridge school), changed the focus of the quantity

theory of without changing its underlying assumptions. This version focuses on the

fraction (K) of income, held as money balances. The Cambridge version can be expressed

as:

M= kpy

Where K= Fraction of income, M =Quantity of money, P= price level, Y=value of goods

and services. The K in the Cambridge equation is merely inversion of V, the income

Velocity of money balances, in the original formulation of quantity theory. This version

directs attention to the determinants of demand for money, rather than the effects of

changes in the supply money (Anyanwu, 1993).

II. KEYNESIAN THEORY

The Keynesian model assumes a close economy and a perfect competitive market with

fairly price- interest aggregate supply function. The economy is also assumed not to exist

at employment equilibrium and also that it works only in the short run because as Keynes

aptly puts it ‘’ In the long run, we also will be dead’’. The Keynesian theory is rooted on

one notion of price rigidity and possibility of an economy setting at a less than full

employment level of output, income and employment. The Keynesian macro economy

brought into focus the issue of output rather than prices as being responsible for changing

economic conditions. In other records, they were not interested in the quantity theory per

say.

From the Keynesian in the mechanism, monetary policy works by influencing interest

rate which influences investment decisions and consequently, output and income via the

multiplies process. Thus, the Keynesian theory is a rejection of Say's Law and the notion

that the economy is self-regulating.

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III. THE MONETARIST THEORY

The monetarist essentially adopted Fisher’s equation of exchange to illustrate their theory

as a theory of demand for money and not a theory of output price and money income by

making a functional relationship between the quantities of real balances demanded and a

limited number of variables.

Monetarists like Friedman emphasized money supply as the key factor affecting the

wellbeing of the economy. Thus, in order to promote steady growth rate, the money

supply should grow at a fixed rate, instead of being regulated and altered by the monetary

authorities.

Friedman equally argued that since money supply is substitutive not just for bonds but

also for many goods and services, changes in money supply will therefore have both

direct and indirect effects on spending and investment respectively such that demand for

money will depend upon the relative rates of return available or different competing

assets in which wealth can be.

2.3.1 MONETARY POLICY FRAMEWORK AND IMPLEMENTATION IN NIGERIA

Prior to the banking sector consolidation exercise that was concluded in December 2005,

the framework for monetary policy in Nigeria had witnessed some transformation. This

included the shift from the use of direct monetary policy control to indirect (market-based)

monetary management, and the switch from short-term framework to a two-year medium-

term framework in the conduct of monetary policy. Although the objectives of monetary

policy remained basically the same and monetary aggregates remained the intermediate

target for achieving the ultimate objective of inflation during this period, there were some

fundamental changes in the strategies and instruments employed in the conduct of monetary

policy in order to cope with the evolving financial environment. These changes are phased

as shown below (CBN 2011).

i. Era of Direct Control (Pre-SAP Period)

Prior to the introduction of the Structural Adjustment Programme (SAP) in the mid-1980s,

the monetary policy framework placed emphasis on direct monetary controls. This was

essentially due to the relatively underdeveloped nature of money and capital markets in the

24

country then. The framework relied heavily on sectoral credit allocation; credit ceilings and

cash reserve requirements; administrative fixing of interest and exchange rates; as well as

imposition of special deposits. During this period the set monetary targets were hardly

realized. Instead, the strategy created a lot of distortions and bottlenecks in resource

allocation, resulting in wide spread inefficiencies in resource allocation and utilization.

ii. Period of Indirect or Market Approach (Post-SAP Era)

In line economic deregulation embodied by SAP, there was a paradigm shift from the

hitherto repressive direct monetary control method to an indirect approach anchored on the

use of market instruments in monetary management. This was borne out of the desire to

eliminate the distortions and inefficiencies in the financial system caused by the prolonged

use of administrative controls and the need to engender competition among banks and other

operators in the financial system. Two major policy regimes of short- and medium-term

frameworks can be identified.

iii. Regime of Short-Term Monetary Policy Framework (1986 – 2001)

Consistent with the broad objectives of monetary policy, a number of monetary targets and

instruments were adopted during the short-term (one-year) monetary policy framework

(1986 – 2001). OMO, conducted wholly using the Nigerian Treasury Bills (NTBs),

continued to be the primary instrument of monetary policy. This was complemented by the

cash reserve requirement (CRR) and the liquidity ratio (LR). Other policy instruments

employed included the discount window operations, mandatory sales of special NTBs to

banks and a requirement of 200 per cent treasury instrument to cover for banks’ foreign

exchange demand at the Autonomous Foreign Exchange Market (AFEM). Interest rate

policy was deregulated through the proactive adjustment of minimum rediscount rate

(MRR) to signal policy direction consistent with liquidity conditions. Surveillance

activities of the CBN focused mainly on ensuring sound management and maintenance of

a healthy balance sheet position on the part of deposit money banks (DMBs). On the

external front, the official and inter-bank exchange rates were unified in 1999.

In spite of the reforms in the articulation and execution of monetary policy during this

period, most of the monetary and financial targets were substantially missed. As can be

observed from Table 1, the actual growth rates in broad measure of money supply (M2) and

aggregate bank credit for the years, 1999 – 2001, were higher than the targets by wide

25

margins. Although, inflation performed better in two of the three years, aggregate output

was sluggish during the period. The major problem could be attributed to the expansionary

fiscal policies of the three tiers of government and the resultant liquidity overhang, as well

as lack of coordination of monetary and fiscal policy implementation.

iv. Regime of Medium-Term Monetary Policy Framework (2002 – 2005)

In 2002, the CBN commenced a two-year medium-term monetary policy framework, aimed

at freeing monetary policy from the problem of time inconsistency and minimizing over-

reaction due to temporary shocks. The new monetary policy framework, still in operation,

is based on the evidence that monetary policy actions affect the ultimate objectives with a

substantial lag. Under the new framework, monetary policy guidelines are open to half-

yearly review in the light of developments in monetary and financial market conditions in

order to achieve medium- to long-term goals.

The major objectives of monetary policy since the 2002/2003 period have been to subdue

inflation to a single-digit level and maintain a stable exchange rate of the naira. Attention

has also been focused on the need for a more competitive financial sector geared towards

improving the payments system. The OMO has continued to be the primary tool of

monetary policy, and is complemented by reserve requirements, discount window

operations, foreign exchange market intervention and movement of public sector deposits

in and out of the DMBs. The CBN has also continued to ensure banking soundness and

financial sector stability, not only to ensure the effective transmission of monetary policy

to the real sector but also to enhance the efficiency of the payments system.

The measures taken to strengthen the banking sector and consolidate the gains of monetary

policy included the introduction of a 13-point reform agenda in the banking sector in July

2004 (the key point of which was the N25 billion minimum capital base for DMBs). The

2004/2005 monetary policy and credit guidelines were fine-tuned in 2005 in the light of

changing environment. New policy measures introduced included maintenance of a tight

exchange rate band of plus/minus 3 per cent, two-week maintenance period of cash reserve

requirement and the injection/withdrawal of public sector deposits from the DMBs. The

various measures put in place, complemented by improved fiscal discipline at the federal

government level, impacted positively on the monetary aggregates in 2004 and 2005,

resulting in achievement of set targets during the period. The CBN was able to achieve the

26

targets by being pro-active in the implementation of sound monetary policies, including

zero tolerance on government borrowing from the CBN.

v. Monetary Policy, Post-Banking Consolidation (2006-2007)

Two key features have defined the monetary policy landscape in the post consolidation

period, 2006/07: persistence of excess liquidity despite reversal of historic conditions, for

example, ways and means and emergence of a new but very important source of excess

liquidity -increased private inflows. The objectives of monetary policy during this period

have however remained unchanged. Current monetary policy strategy involves (amongst

others):

a) Zero tolerance on ways and means advances

b) Gradual run-down of CBN holding of TBs

c) Aggressive liquidity mop-up operations-frequent OMO sales supported by discount

window operations

d) Unremunerated reserve requirements

e) Increased coordination between the Bank and the fiscal authorities

f) Restructuring of debt instruments into longer tenor debts

g) Increased deregulation of forex market, and

h) Occasional forex swap

The strategy is complimented by on-going reforms of monetary policy in particular and the

financial system in general.

The reform of the financial system, a key component of which was bank consolidation, was

intended to minimize macroeconomic instability arising from banking systemic distress;

motivate intermediation through the deepening of the capital market; finance productive

sector growth in the private sector, particularly non-oil growth; minimize the counterfactual

shocks of creating distortions in the money markets and the financial system; encourage

investment inflows through effective participation of the industry in the global financial

system, among others. As a direct consequence of the exercise the capital base of Nigerian

banks (combined) increased from about US$2.5 billion in June 2004 to about US$5.8

billion at end-December 2005. This has been accompanied by rising inflow of foreign

investment in the sector till date. Virtually all the banks have been listed in the Nigerian

Stock Exchange (NSE) with the capital market becoming more liquid and more capitalized.

27

The banks now have the potential to finance big investment transactions as their single

obligor limits have increased, while regulation and supervision have become more effective

given that ownership has been diluted with more regulators having the legal authority to

oversee them. The CBN now focuses on a fewer number of banks. This has raised

efficiency of supervision resulting in zero tolerance towards infractions and improved

corporate governance. Greater transparency is being enforced and the deployment of IT

infrastructure (eFASS and RTGS) has significantly helped the process.

28

2.4.0 REVIEW OF EMPIRICAL STUDIES

Studies have been carried out by many researchers, financial analysts and practitioners

on the topic related to monetary policy application and its performance on Nigeria

economy. This aspect of the study has discussed some such previous research works and

their empirical conclusions that are related to the study.

I. Monetary Rather than Fiscal Policy Exerts a Greater Impact an Economic Activity

in Nigeria

Ajisafe and Folorunso (2002), examined the relative effectiveness of monetary and fiscal

policy on economic activity in Nigeria using co-integration and error correction

modelling techniques and annual series for the period 1970 to 1998. The study revealed

that monetary rather than fiscal policy exerts a greater impact on economic activity in

Nigeria and concluded that emphasis on fiscal action by the government has led to greater

distortion in the Nigerian economy.

II. Effects of Monetary Policy Shocks on Output and Prices in Nigeria

Chuku A (2009), In his paper, he carried out a controlled experiment using a structural

vector autoregression (SVAR) model to trace the effects of monetary policy shocks on

output and prices in Nigeria. We make the assumption that the Central Bank cannot

observe unexpected changes in output and prices within the same period. This places a

recursive restriction on the disturbances of the SVAR. We conduct the experiment using

three alternative policy instruments i.e. broad money (M2), Minimum Rediscount Rate

(MRR) and the real effective exchange rate (REER). Overall, we find evidence that

monetary policy innovations carried out on the quantity-based nominal anchor (M2) has

modest effects on output and prices with a very fast speed of adjustment. While,

innovations on the price-based nominal anchors (MRR and REER) have neutral and

fleeting effects on output. We conclude that the manipulation of the quantity of money

(M2) in the economy is the most influential instrument for monetary policy

implementation. Hence, we recommend that central bankers should place more emphasis

on the use of the quantity-based nominal anchor rather than the price-based nominal

anchors.

29

III. The Impact of Monetary and Fiscal Policies on Non-Oil Exports in Nigeria

Chukuigwe (2008), analyzed the impact of monetary and fiscal policies on non-oil

exports in Nigeria from 1974 to 2003. Using Ordinary Least Squares estimation, the

study revealed that both interest rate and exchange rate, being proxies for monetary

policy, negatively affect non-oil exports. Budget deficits – proxy for fiscal policy also

had a negative effect on non-oil exports. Based on the findings, the study recommended

that there is need to formulate a new strategy to address the identified challenges. This

would be anchored on macroeconomic stability, export promotion, rationalization of the

role of government, fortification of infrastructural facilities and stimulation of demand

for goods and services since it would create an enabling investment climate.

IV. The Relationship between Monetary Policy and Stock Prices in the Nigerian Stock

Exchange Market (NSE)

Ajie and Nenbee (2010), investigated empirically the relationship between monetary

policy and stock prices in the Nigerian stock exchange market (NSE). We employed time

series data on money supply (MSU), interest (RA) and stock prices (SPR) spanning

(1986-2008). This period was considered due to the liberalization of the financial sector.

Using the method of co-integration and Error correction modeling (ECM), the study

revealed that both MSU and IRA were rightly signed with SPR. Again, the error

correction coefficient was relatively high, rightly signed and significant at 5% level. It is

suggested that the SEC should be given enabling environment to monitor the activities

of the market operators to bread efficiency. Above all, the monetary authorizes should

formulate policies that will reduce the rising pace of inflation to encourage availability

of investible funds for investors.

V. Impact of Monetary and Fiscal Policies on Economic Growth

Karimi and Khosravi (2010), investigated the impact of monetary and fiscal policies on

economic growth in Iran using autoregressive distributed approach to co-integration

between 1960 and 2006. The empirical results indicated existence of long-run

relationship between economic growth, monetary policy and fiscal policy. The results

further showed exchange rate and inflation as proxies for monetary policy have inverse

impact on economic growth.

30

VI. Impact of Monetary Policy Instruments on the Economic Development of Nigeria

Akujuobi (2010), investigated the impact of monetary policy instruments on the

economic development of Nigeria, using multiple regression technique. It was found that

cash reserve ratio was significant in impacting on the economic development of Nigeria

at both 1% and 5% levels of significance, Treasury bill at 5.6%, minimum rediscount rate

at 7.4% and liquidity rate at 7.7%, while interest rate was not significant at all. It is

recommended that the country pursues vigorously the development of the money and

capital markets so that the monetary policy instruments would be allowed to play more

positive impact in addition to combining them with fiscal policies.

VII. Effect of Monetary Policy on Macroeconomic Variables in Nigeria

Ditimi, Nwosa and Olaiya (2011), appraised monetary policy development in Nigeria

and also examined the effect of monetary policy on macroeconomic variables in Nigeria

for the period 1986 to 2009. The study adopted a simplified Ordinary Least Squared

technique and also conducted the unit root and co-integration tests. The study showed

that monetary policy have witnessed the implementation of various policy initiatives and

has therefore experienced sustained expansion over the years. The results also shows that

monetary policy had a significant effect on exchange rate and money supply while

monetary policy was observed to have an insignificant influence on price instability.

They noted that the implication of this finding is that monetary policy has had a

significant influence in maintaining price stability within the Nigeria economy. The study

concluded that for monetary policy to achieve its other macroeconomic objective such as

output performance; there is the need to reduce the excessive expenditure of the

government and align fiscal policy along with monetary policy measure.

VIII. Impact of Monetary Policy on the Nigerian Economy

In a study conducted by Charles (2012), he examined the impact of monetary policy on

the Nigerian economy. The study uses Ordinary Least Squares Method (OLS) to analyse

data between 1981 and 2008. The result of the analysis shows that monetary policy

presented by money supply exerts a positive impact on GDP growth and Balance of

Payment but negative impact on rate of inflation. The recommendations are that

monetary policy should facilitate a favourable investment climate through appropriate

31

interest rates, exchange rate and liquidity management mechanism and the money market

should provide more financial instruments that satisfy the requirement of the ever-

growing sophistication of operators. However, the study did not run the diagnostic test

to check the fitness of the model.

IX. How Fiscal and Monetary Policies Influence Economic Growth and Development

in Nigeria

Adeolu et al (2012), assessed how fiscal and monetary policies influence economic

growth and development in Nigeria. The paper argues that curbing the fiscal indiscipline

of Government will take much more than enshrining fiscal policy rules in our statute

books. This is because the statute books are replete with dormant rules and regulation. It

notes that there exist a mild longrun equilibrium relationship between economic growth

and fiscal policy variables in Nigeria. The paper suggest that for any meaningful progress

towards fiscal prudence on the part of Government to occur, some powerful pro-stability

stakeholders strong enough to challenge government fiscal policy.

X. Transmission Channels of Monetary Policy Impulses on Sectoral Output Growth

Nwosa and Saibu (2012) investigated the transmission channels of monetary policy

impulses on sectoral output growth for the period 1986 to 2009 using secondary quarterly

data. Granger causality and Vector Auto-regressive methods of analysis were employed.

They showed that interest rate channel was most effective in transmitting monetary

policy to Agriculture and Manufacturing sectors while exchange rate channel was most

effective for transmitting monetary policy to Building/Construction, Mining, Service and

Wholesale/Retail sectors, indicating that interest rate and exchange rate policies were the

most effective monetary policy measures in stimulating sectoral output growth in

Nigeria.

XI. How The Decisions of Monetary Authorities Influence the Macro Variables like

GDP, Money Supply, Interest Rates, Exchange Rates and Inflation

Hameed, Khaid, and Sabit (2012), the paper presented a review on how the decisions of

monetary authorities influence the macro variables like GDP, money supply, interest

rates, exchange rates and inflation. The foremost objective of monetary policy is to

enhance the level of welfare of the masses. It is instrumental to price stability, economic

32

growth, checking BOP deficits and lowering unemployment? Since monetary policy

blends political and economic realities, study of monetary policy is catching more

attention of the policy makers. The method of least square OLS explains the relationship

between the variables under study. Tight monetary policy with balanced adjustments in

independent variables shows a positive relationship with dependent variable. . The study

recommended that central bank can best contribute to a nation’s Economic health by

eliminating the price uncertainties associated with inflation.

XII. Impact of Monetary Policy on Nigerian Economic Growth

Okoro (2013), examined the impact of monetary policy on Nigerian economic growth

from 1970 - 2010. Using a time series data the study employed Augmented Dickey-Fuller

(ADF) test, Philips-Perron Unit Test, Co-integration test and error correction model

(ECM) techniques in the analysis of the data collected. The study result shows that there

exists a long-run equilibrium relationship between monetary policy instruments and

economic growth in Nigeria. From our result interest rate and inflation rate were

negatively correlated with gross domestic product (GDP), while Exchange rate, money

supply and Credit to the Economy were positively related to GDP, based on the long-run

test. Theoretically, the study infer that monetary policy instruments have contributed

significantly to the positive economic growth of Nigeria. Therefore, the suggestion was

that there is need for a suitable monetary supply policy through inflation targeting. In

addition, the Central Bank of Nigeria should employ direct regulation of interest rates

since the existence of high interest rate acts as an obstacle to the growth of both private

and public investment in Nigeria.

XIII. The Responsiveness of Real Sector Output to Monetary Policy Shocks in Nigeria

Samuel, Tamarauntari and Michael (2013), examined the responsiveness of real sector

output to monetary policy shocks in Nigeria. Applying a VAR model and covering the

period 1970 to 2011 the study revealed that credit to the private sector and investment

had direct instantaneous impacts on real sector development (GDP). Real GDP

responded more to shocks in MPR, CPS and own innovations in the log-run. Although

monetary policy rate and interest rate had no instantaneous and direct impact on real

sector development they indirectly do so through the credit and investment channels. To

this end monetary policy rate and bank lending rates are the most important monetary

policy tools that can make or mare the Nigerian real sector. It was concluded that a sound

33

monetary policy in Nigeria is one that encourages credit to the private sector and capital

accumulation.

XIV. The Performance of Monetary Policy on Manufacturing Sector in Nigeria

Nneka (2013) examined the performance of monetary policy on manufacturing sector in

Nigeria for time frame 1986 to 2009. She noted that the main focus of monetary policy

in relation to the manufacturing sector has always been the stimulation of output,

employment and the promotion of domestic and external stability, while that of fiscal

policy has been the generation of revenue for the government and the protection of

domestic infant industries against unfair competition from import and dumping. Vector

Error Correction (VEC) and Ordinary Least Square (OLS) estimation were used to study

the models for significance, magnitude, direction and relationship. The study revealed

that money supply positively affect manufacturing output index while company lending

rate, Company income tax rate, Inflation rate, Exchange rate has a negative impact to the

performance of the manufacturing sector over the years. They recommended that

expansionary policies are vital for the growth of the manufacturing sector in Nigeria

which in turn would lead to economic growth.

XV. The impact of monetary policy on selected macroeconomics variables such as gross

domestic product, inflation, and balance of payment in Nigeria

Michael and Ebibai (2014), empirically examined the impact of monetary policy on

selected macroeconomics variables such as gross domestic product, inflation, and balance

of payment in Nigeria from 1980 to 2011. Data were extracted from the Central Bank

Statistical Bulletin. Monetary policies played an indispensable role in Nigeria’s economy

by regulating and stabilizing the volume of money in circulation in order to create an

enabling environment for investment, which will foster economic development. Today,

the impact of monetary policy has wider implication and this arises partly because of

proactive measures put in place by CBN to ensure macroeconomic stability in the country.

The study is designed in such a way that it is an econometric investigation of the impact

of monetary policy on economic growth in Nigeria using such econometric tools like the

ordinary least square (OLS) regression analysis. The error correction method was used to

ascertain if there is a static long run equilibrium relationship among the explanatory

variables and subsequently derive an adequate dynamic model of the short run

34

relationship. The study showed that the provision of investment friendly environment in

the Nigerian economy will increase the growth rate of GDP.

In summary, the overall findings of the works reviewed so far indicate that there is somehow

a general consensus that there is a direct relationship between monetary policy and economic

growth. However, while the robustness of most of the works reviewed could be widely

acclaimed, it will be noteworthy that there are some flaws inherent in some others which

could somehow hinder the robustness of their results and which this work is intended to

correct.

35

2.4.1 AN APPRAISAL OF THE PERFORMANCE OF MONETARY POLICY IN

NIGERIA

Over the years, the objectives of monetary policy have remained the attainment of

internal and external balance of payments. However, emphasis on techniques/instruments

to achieve those objectives have changed 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 direct monetary controls, while the second relies on market

mechanisms. (CBN 2015)

i. Monetary Policy Performance in 2008 - 2011

The conduct of monetary policy by the Central Bank of Nigeria since 2008 has been

designed to: influence the growth of money supply consistent with the required aggregate

Gross Domestic Product (GDP) growth rate, ensure financial stability, maintain a stable

and competitive exchange rate of the naira, and achieve positive real interest rates.

The conduct of monetary policy in the review period was largely influenced by the global

financial crisis which started in 2007 in the U.S. and spread to other regions and emerging

markets including Nigeria. The crisis created liquidity crisis in the banking system, large

quantum of non-performing credits, large capital outflows and pressure on the exchange

rate, decline in oil prices and falling external reserves, sharp drop in government revenue,

huge fiscal injections and collapse of the capital market.

Consequently in the wake of the global financial crisis, the Bank largely adopted the

policy of monetary easing to address the problem of liquidity shortages in the banking

system from September 2008 to September 2010. The monetary policy easing measures

taken during the period included:

a) Stoppage of aggressive liquidity mop-up since September 18, 2008.

b) Progressive reduction of monetary policy rate (MPR) from 10.25 to 6.0 per cent.

c) Reduction of cash reserve requirement (CRR) from 4.0 to 2.0 and 1.0 per cent

d) Reduction of liquidity ratio (LR) from 40.0 to 30.0, and 25.0 per cent.

36

e) Introduction of Expanded Discount Window (EDW) to increase DMB's access to

facilities from the CBN, and by July 2009 was replaced with CBN Guarantee of

interbank transactions.

f) Reduction of Net Open Position (NOP) limit of deposit money banks from 20.00 to

10.00, 5.00 and 1.00 per cent

g) Injection of N620 billion as tier 2 capital in 8 troubled banks

Following the restoration of stability and re-emergence of liquidity surfeit in the

banking system, the Bank adopted a tightening stance from September 2010 to

December 2011.

The monetary policy easing measures coupled with huge fiscal expansion put much

pressure on inflation, exchange rate and external reserves. To curtail these threats the

stance of monetary policy changed from monetary easing to tightening, from September

2010 to December 2011 and the following monetary policy actions were taken during

the period:

h) The Resumption of active Open Market Operations for the purpose of targeted liquidity

management.

i) Progressive increase in the monetary policy rate (MPR) from 6.00 to 12.00 per cent

j) Increase in the Cash Reserve Requirement (CRR) from 1.00 to 2.00, 4.00 and 8.00 per

cent

k) Increase in liquidity ratio (LR) from 25.00 to 30 per cent

l) Introduction of reserve averaging method of computing Cash Reserve Requirement

(CRR), which was later stopped

m) Increase of Net Foreign Exchange Open Position (NOP) of banks from 1.00 to 5.00 per

cent; but later reduced to 3.00 per cent

n) Shift in the mid-point of the foreign exchange band from N150/US$1 +/-3 per cent to

N155/US$1 +/-3 per cent

ii. Monetary Policy Performance (2012)

The monetary policy environment in 2012 was characterized by continuing threat of

inflationary pressures against the backdrop of declining trend in output growth. Other

37

key concerns included sustaining a stable exchange rate for the naira, creating a buffer

for the external reserves, sustaining stability in money market rates, narrowing the spread

between the lending and deposit rates and mitigating the impact of the continued

slowdown in global economic activities on the domestic economy. In view of these multi-

dimensional challenges, monetary policy during the period focused on deploying the mix

of appropriate instruments to deliver price stability.

The Monetary Policy Committee (MPC) held six regular meetings in the review period,

during which it maintained the MPR at 12.0 per cent with a symmetric corridor of +/-

200 basis points. To further sustain the tightening stance, CRR was raised from 8.0 to

12.0 per cent and NOP limit reduced from 3.0 to 1.0 per cent at the July 2012 meeting.

The LR was retained at 30.0 per cent with the mid-point of exchange rate maintained at

N155/US$ within a band of +/-3.0 per cent.

iii. Monetary Policy Performance (2013)

Monetary policy in 2013 aimed primarily at sustaining the already moderated rate of

inflation which was achieved in the first half of 2013. The benign headline inflation rate

of 8.0 per cent at end-December 2013, from 8.4 per cent at end-June 2013, is evidence

of the effectiveness of the policy. Besides, monetary policy also aimed at limiting

pressure on the exchange rate, boosting the external reserves position, sustaining stability

in the money market and reducing the spread between lending and deposit rates. These

goals were largely achieved through a mixed-grill of a number of instruments, which

helped to strengthen investor confidence in the economy.

The Monetary Policy Rate (MPR) was the principal instrument used to control the

direction of interest rates and anchor inflation expectations in the economy. The other

intervention instruments included Open Market Operations (OMO), Discount Window

Operations, Cash Reserve Ratio (CRR) and foreign exchange Net Open Position (NOP).

Open Market Operations (OMO) was the other major tool for liquidity management in

2013; achieved through the issuance of CBN bills. The sale of CBN bills declined by

52.8 per cent in the second half compared with the first half. In the second half, the

volume of transactions of the standing lending facility window rose by 30.66 per cent,

38

while that of standing deposit facility window rose by 53.6 per cent, compared with the

first half.

The Monetary Policy Committee (MPC) held six regular meetings during the review

period, and the MPR was successively maintained at 12.0 per cent with a symmetric

corridor of +/- 200 basis points. The MPC introduced a higher Cash Reserve Ratio (CRR)

for public sector deposits with the Deposit Money Banks (DMBs), in order to further

tighten money supply.

Beside the change in the CRR on public sector deposits, other existing policies were

retained, and complemented with administrative measures. The Net Open Position

(NOP) limit was sustained at 1.0 per cent, Liquidity Ratio (LR) at 30.0 per cent and the

mid-point of the exchange rate at N155/US$ +/-3.0 per cent. The decision of the MPC to

retain most of the existing measures was to assure the market of the continuity of the

tight monetary policy regime.

Monetary policy continued to contribute significantly to the robust performance of the

economy after the shock of the global financial crisis in 2008 (on the one hand and the

domestic banking crisis of 2009 on the other). In spite of these developments, output

remained relatively high while inflation decelerated in 2013.

Most measures of inflation moderated throughout the period in response to the policy

measures implemented by the Bank.

Year-on-year headline inflation decreased to 8.0 per cent in December 2013, from 8.4

per cent in June 2013 and 12.0 per cent in December 2012. Food inflation also declined

marginally to 9.3 per cent from 9.6 per cent over the same period. However, core inflation

rose from 5.5 per cent to 7.9 per cent between June and December 2013.

iv. Monetary Policy Performance (2014)

In 2014, monetary policy was focused on achieving the objective of price and rate

stability. Accordingly, the Bank sustained its tight policy stance with a view to ensuring

that electioneering spending did not result in uptick in inflation. Headline Inflation

remained within single digits, and fluctuated between 7.7 and 8.5 per cent, in the review

period due to the combined effect of the declines in the prices of clothing and footwear;

39

and transport components as well as the relative stability in the price of education in

response to the tight liquidity measures taken at the MPC meetings during the year.

The financial market was generally stable for 2014, although, significant fluctuations

were noticed towards the end of the year. A number of policy instruments were deployed

to achieve price and financial system stability, with a view to boosting investor

confidence and reduce concerns about declining foreign exchange reserves.

The policy instruments used to achieve price and financial system stability objectives

were the Monetary Policy Rate (MPR), and other intervention instruments such as Open

Market Operations (OMO), Discount Window Operations, Cash Reserve Ratio (CRR)

and Foreign Exchange Net Open Position (NOP) limit. During the period, the MPC raised

MPR by 100 basis points from 12.0 to 13.0 per cent while maintaining the symmetric

corridor of +/- 200 basis points around the MPR.

The CRR on private sector deposits was raised by 500 basis points from 15.0 to 20.0 per

cent, while CRR on public sector deposits was raised from 50.0 per cent to 75.0 per cent.

The MPC also retained the Liquidity Ratio at 30.0 per cent, in order to address liquidity

surfeit in the banking system.

OMO was principally used to mop up or inject liquidity into the system as a strategy for

monetary management by the Bank.

The Bank's monetary policy decisions strengthened financial system stability and

supported the growth of the Nigerian economy.

2.4.2 STRATEGIES OF MONETARY POLICY IN NIGERIA

The strategy of monetary policy involves modifying the amount of base money (M1) in

circulation. This process of changing base money through the sale and purchase of

government securities is called open market operations. Continuous market transactions

by the monetary authorities modify the supply of money which affects other market

variables such as short term interest and exchange rates.

The distinction between the various strategies of monetary policy lies primarily with the

set of instruments, targets and variables that are used by the monetary authorities to

40

achieve the desired goals (Table 2.4). The strategies of monetary policy could be

classified as; monetary targeting, price level targeting, inflation targeting and exchange

rate targeting.

Table 2.4

i. Monetary Targeting

Under this approach, the target variable is the growth in money supply designed to

achieve the long-term objective of price stability. This is currently used by CBN. Under

this framework, the central bank watches very closely growth in the monetary aggregates

in order to predict the future size of money supply. If the monetary aggregates were

growing too quickly, it could trigger inflationary pressures (more money chasing after

the same amount of goods and services leads to rising prices) and cause the central bank

to raise interest rates or otherwise halt growth in money-supply. While other monetary

policy strategies focus on a price signal of one form or another, this approach is focused

on monetary quantities.

ii. Price Level Targeting

Price level targeting is similar to inflation targeting in that both establish targets for a

price index like the CPI. However, where inflation targeting only looks forward (i.e., a

Monetary Policy Strategy Target Variable Long Term Objective

Monetary Targeting Growth in money supply A given rate of change in CPI

Price Level Targeting

Interest rate on overnight

debt

A specific CPI

Inflation Targeting Interest rate on overnight

debt

A given rate/band of

inflation

Fixed Exchange Rate

Spot price of the currency A given rate of change in CPI

41

2% inflation target per year), price level targeting actually takes past years into account

when conducting open market operations. So, if the price level rose by 2% in the previous

year (from a theoretical base of 100 to 102), the price level would have to drop the next

year in order to bring the price level back down to the 100 target level. This could mean

more forceful action needs to be taken than would be required if inflation targeting were

used.

Price level targeting is generally considered a risky policy stance, and one not used by

many central banks. It is believed to bring more variability in inflation and employment

in the short run compared to inflation targeting. Most economies feel that a small amount

of annual inflation is (up to about 2% per year) actually good for the economy.

iii. Inflation Targeting

Inflation targeting is a monetary policy framework, in which a central bank estimates

makes public a projected, or "target", inflation rate and then attempts to steer actual

inflation towards the target through the use of interest rate changes and other monetary

tools. The likely actions of the central bank to raise or reduce the policy rate become

more transparent under inflation targeting. If inflation is above the target, the central

bank is likely to raise the policy rate. This usually (but not always) has the effect over

time of cooling the economy and bringing down inflation. If inflation is below the target,

the central bank is likely to lower the policy rate. This usually (again, not always) has an

effect over time of accelerating the growth rate of the economy and raising inflation.

Under the framework, investors know the target inflation rate and therefore can more

easily anticipate interest rate changes and factor these into their investment decisions.

This is regarded by proponents of inflation targeting as leading to increased economic

stability.

iv. Exchange Rate Targeting

Under exchange rate targeting, the value of a currency is fixed in relation to another

currency or a basket of currencies. This facilitates trade and investment between the two

countries, and is especially useful for small economies where external trade forms a large

part of their GDP. It can also be used as a means to control inflation. However, as the

reference value rises and falls, so does the currency pegged to it.

42

43

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 INTRODUCTION

This chapter presents the general design of this study. It deals with the means by which

data are collected and analysis for the research conducted on the relationship between

monetary policy instruments and the economic growth in Nigeria. It explains the method

and instrument used in the study. This study will employ the techniques of ordinary least

square (OLS) to examine the impact of monetary policy instruments on the Nigeria

economy.

3.2 RESEARCH DESIGN

The research is designed to establish the statistical and econometric relationship between

the monetary policy instruments and economic growth in Nigeria. It is a survey research

design which ensures that the procedure to be employed in the study is carefully planned

so as to obtain correct and reliable information about the research work. Data relating to

monetary policy instruments (money supply, monetary policy rate and exchange rate)

and economic growth (GDP) were obtained from secondary sources.

3.3 METHOD OF DATA COLLECTION

Data for the study are obtained from secondary sources (time series data). These sources

include the statistical bulletin of the Central Bank of Nigeria (CBN) for various editions

and the Central Bank of Nigeria (CBN) annual publication. This study uses annual data

with a sample period from 1990 to 2014.

3.4 METHOD OF DATA ANALYSIS

The study employs the use of the multiple regression technique which offers explanation

on the relationship between a dependent variable and two or more explanatory variables.

The ordinary least square (OLS) method was used based on its BLUE (best, linear,

unbiased, estimator) properties which distinguish it from other techniques of estimation

of models. A system based program known as E-Views (Econometrics views) has been

adopted for the econometric and statistical analysis of the data.

44

3.5 MODEL SPECIFICATION

Model specification is a mathematical expression used to measure the economic

relationship that exists between the dependent and independent variable(s). Model

specification is based on the available literature and the theory as they help in the

specification of the relationship between the independent variable and the dependent

variable. This stage is one of the most difficult stage yet the most important because of

specification errors that occurs in the model. The model of this study is specified below:

GDP=β0 + β1MS + β2 MPR + β3EXR + μ

Where; MS is money supply, MPR represent monetary policy rate, EXR represent

exchange rate, β0 is intercept or constant term of the relationship, β1 ----β3 (Betas) are

the regression coefficients or the slope parameters for the various regressors (explanatory

variables stated above), and μ is random disturbance/error term. The error term takes care

of the measurement errors that would have resulted in the collection and processing of

the data. This specification was in line with the one applied by Adeoye (2006).

3.5.1 A priori Expectation

Here we highlight the theoretical relationship between independent variables and the

dependent variables. It is expected that based on a priori functional relationship between

dependent and independent variables, the model will adopt; β1> 0 because it is positively

related to GDP, β2 < 0 because it is negatively related to the Nigerian GDP and β3< 0

because it is negatively related to the GDP. The functional relationship between

dependent and independent variables are presumed to exist based on the assumptions

mentioned above.

3.6 MEASUREMENT OF VARIABLE

a. Money supply (MS): is the aggregate stock of money in circulation in the economy

for a given period of time, usually a year. It is a strong determinant of the level of

economic growth. Hence the study adopts broad money as a measure of money supply

(M2).

b. Monetary Policy Rate (MPR): is an instrument used by the CBN to control the

direction of interest rates and anchor inflation expectation in the economy. MPR,

45

which is a short term anchor replaced the MRR in December, 2006. It is designed to

influence short term money market rate and promote policy efficiency. Due to the fact

that MPR was introduced in 2006, to replaced MRR, the data of MRR from the period

of 1990 to 2005 will be used in place of MPR.

c. Exchange Rate (EXR): the price of a nation’s currency in terms of another currency.

An exchange rate thus has two components, the domestic currency and the foreign

currency, and can be quoted either directly or indirectly. In a direct quotation, the price

of a unit of foreign currency is expressed in terms of the domestic currency. In an

indirect quotation, the price of a unit of domestic currency is expressed in terms of

foreign currency. The exchange rate to be compared in this study is the rate of Naira

per US dollar.

3.7 METHOD OF EVALUATION

The study adopted regression analysis to examine the impact between the variables in the

model.

Model evaluation is concerned with the reliability of the result of the estimation from

multiple regressions. The evaluation will consist of deciding whether the estimates of the

parameters are theoretically meaningful and statistically satisfactory and significant. The

following criteria will be useful:

3.7.1 Economic criteria

Economic a priori criteria are derived from the economic theory from which the model

is being specified. The criterion is in regards to the sign of the economic relationship

between the monetary policy instruments and the economic growth in Nigeria. This

criteria has to do with the coefficient of the regressors, they are used to measure by how

much a change in the independent variable would affect the dependent variable. Here we

highlight the theoretical relationship between the independent and dependent variables.

3.7.2 Statistical Criteria

This criterion is often referred to as first order test. It is used to measure the extent of

reliability of the parameter of the variables in the model. The statistical criteria appear to

be superior to the graphical, however all these criteria should be used together in making

46

decision about the model. There are different test used in testing the statistical reliability

of the parameters which includes the following;

i. Coefficient of determinant (R2)

The overall fitness is measured using R2. It shows the percentage of the total variation in

the economic growth that can be explained by the independent variable; invariably it

helps to measure the fitness of the model. The value of R2 ranges from 0-1. The closer

the value to 1, the higher the R2 which denotes a strong relationship between explained

and the explanatory variables and the better the model is considered to be.

ii. T –Test

The student T-table will be used to measure the statistical significance of the coefficients

of the explanatory variables in the specified models. This will be at 5% level of

significance.

If T calculated < T tabulated do not reject H0

If T calculated > T tabulated reject H0

iii. Test of Significance

This is used to verify the truthfulness or otherwise of a null hypothesis. It determines the

basis for accepting or rejecting the null hypothesis. The null hypothesis will not be

rejected if the t-calculated is less than the t tabulated, otherwise it will be rejected.

iv. Test of overall significance (F-Test)

F-Test measures the overall significance of the coefficients of the explanatory variables

in the specified model. It is used to test the joint significance and to form the basis of

either not rejecting the null hypothesis (H0) or the alternative hypothesis (H1)

Decision rule:

If F calculated < F tabulated Accept H0

If F calculated > F tabulated do not accept H0

47

3.7.3 Econometric Criteria

i. The Durbin Watson Test (dw)

The Durbin – Watson statistics (dw) is used to test for the presence of auto-correlation in

the disturbance term which implies that the error term of successive periods relates to

one another. It is used to test whether or not one of the ordinary least squares has been

violated i.e. the assumption of serial independence or non-autocorrelation of the

disturbance (error) term. Auto correlation is a special case of correlation. It refers to the

relationship that occurs, not between two (or more) different variables but between the

successive values of the same variable.

ii. Diagnostic Test Statistics

This study further performed various diagnostic tests to ensure that the data series was

consistent with all the OLS assumptions. These includes the White’s test which is used

to test for heteroscedasticity problems, the Breusch-Godfrey Lagrange Multiplier (LM)

test is used to test for autocorrelation and the probability distribution will also be tested.

iii. Unit root test

Based on Ordinary least square (OLS) regression techniques, the data were subjected to

unit root test to figure out whether the data is stationary or not. According to Sajjad, Syed,

Shafi, Haroon, Jan, Sddat, Madina, and Ur (2012) economic time series tend to have a

strong trend, which causes these series to depict rising or falling patterns. The study will

apply unit root tests represented by the Augmented Dickey Fuller (ADF).

48

CHAPTER FOUR

DATA PRESENTATION, ANALYSIS AND INTERPRETATION

4.1 INTRODUCTION

This chapter of the study focus on the analysis and the interpretation of the result. Data

are collected from the CBN statistical bulletin and are subjected to various test as

specified in the chapter three, by running the data on the E-view software package. The

result of the data tested are interpreted with appropriate conclusions related to the result.

The hypothesis are also compared with the result to know whether or not to reject the

hypothesis stated. The last chapter of the study emphasise on the discussion of the

findings in the study.

4.2 PRESENTATION OF DATA

Based on this research study, time series data of Gross Domestic Product (GDP),

money supply (MS), monetary policy rate (MPR) and Exchange rate (EXR) of naira

to US dollar from 1990 to 2014 (25 years) were collected from the Central Bank of

Nigeria Statistical bulletin. The data collected from the secondary source are

presented in the table below:

Table 4.1: Data presentation

YEAR

GROSS

DOMESTIC

PRODUCT (GDP)

(N‘000,000,000)

MONEY

SUPPLY (MS)

(N’000,000,000)

MONETARY

POLICY

RATE (MPR)

(%)

EXCHANGE

RATE

(EXR)

(N)

1990 472.65 52.86 18.50 8.0378

1991 545.67 75.4 14.50 9.9095

1992 875.34 111.11 17.50 17.2984

1993 1,089.68 165.34 26.00 22.0511

49

1994 1,399.70 230.29 13.50 21.8861

1995 2,907.36 289.09 13.50 21.8861

1996 4,032.30 345.85 13.50 21.8861

1997 4,189.25 413.28 13.50 21.8861

1998 3,989.45 488.15 14.31 21.8861

1999 4,679.21 628.95 18.00 92.6934

2000 6,713.57 878.46 13.50 102.1052

2001 6,895.20 1,269.32 14.31 111.9433

2002 7,795.76 1,505.96 19.00 120.9702

2003 9,913.52 1,952.92 15.75 129.3565

2004 11,411.07 2,131.82 15.00 133.5004

2005 14,610.88 2,637.91 13.00 132.147

2006 18,564.59 3,797.91 12.25 128.6516

2007 20,657.32 5,127.40 8.75 125.8331

2008 24,296.33 8,008.20 9.81 118.5669

2009 24,794.24 9,411.11 7.44 148.8802

2010 54,612.26 11,034.94 6.13 150.298

2011 62,980.40 12,172.49 9.19 153.8616

2012 71,713.94 13,895.39 12.00 157.4994

2013 80,092.56 15,160.29 12.00 157.3112

2014 89,043.62 17,680.52 12.25 158.5526

Source: Extracted from 2014 Central Bank of Nigeria Statistical Bulletin

50

4.3 RESULT PRESENTATION

In trying to find the performance of monetary policy application on Nigerian economy,

data such as; Gross Domestic Product, Money Supply, Monetary policy rate and

Exchange rate obtained from the CBN statistical bulletin were computed on the E-view

software and the result of the analysis are presented below.

Table 4.2: Modeling GDP by OLS

Variable Coefficient Std. Error t-Statistic Prob.

Constant 2.770137 0.487259 5.685144 0.0000

LOG(MS) 0.926232 0.091563 10.11579 0.0000

MPR 0.004428 0.018478 0.239650 0.8129

LOG(EXR) -0.122638 0.137411 -0.892490 0.3822

R2 = 0.976983

F (3, 21) = 297.1244 [0.0000]

Durbin-Watson stat (DW) = 0.807375

From table 4.2 above, the estimated model is stated as:

GDP = 2.770137+ 0.926232MS + 0.004428MPR – 0.122638EXR + μ

Interpretations:

From the result above, when all the independent variables are equal to zero, the intercept

for GDP becomes 2.770137.

MONEY SUPPLY: A unit increase in the money supply will increase the GDP by

0.926232.

MONETARY POLICY RATE: A unit increase in monetary policy rate will increase

GDP by 0.004428.

51

EXCHANGE RATE: A unit increase in exchange rate will decrease the GDP by

0.122638.

From the result presented above, the coefficient of money supply shows that money

supply possess a positive relationship and highly significant impact on the Nigerian GDP,

monetary policy rate coefficient shows a positive relationship and highly insignificant

impact of the GDP. On the side of exchange rate, the coefficient shows that exchange

rate has a negative relationship and insignificant impact on Nigerian GDP.

4.3.1 EVALUATION BASED ON ECONOMIC CRITERIA

This criteria shows if the a priori expectations conform to the empirical findings. The

result is presented in the table below;

Table 4.2: Economic a priori expectation

Variable Expected sign Estimate Remark

MS + + Conform

MPR - + Does not conform

EXR - - Conform

From the table above, money supply and exchange rate conform to the a priori

expectation of the study. Only monetary policy rate (MPR) does not conform to the

expectation. The sign of the MS and MPR is an indication that an increase in money

supply and monetary policy rate increase the economic growth, the sign of the exchange

rate on the other hand, indicates that an increase in the exchange rate decreases the

economic growth.

4.3.2 EVALUATION BASED ON STATISTICAL CRITERIA

52

These test includes;

i. Coefficient of determinant (R2)

R2 shows the percentage of the total variation in the economic growth that can be

explained by the independent variable. From thee result obtained in the regression, R2 is

0.976983 showing a goodness of fit of 97.6%, the fitness in the model shows that the

explanatory variables (money supply, monetary policy rate and exchange rate) pointedly

accounted for 97.6% of the variations in the explained variable (GDP).

ii. T –Test

The student T-table will be used to measure the statistical significance of the coefficients

of the explanatory variables in the specified models. This will be at 5% level of

significance.

If T calculated < T tabulated do not reject H0

If T calculated > T tabulated reject H0

The summary of the student t-test is presented in the table below:

Table 4.3: T-statistic test

Variables t-Statistic 5% critical value Decision

Constant 5.685144 2.080 Significant

MS 10.11579 2.080 Significant

MPR 0.239650 2.080 Not significant

EXR -0.892490 2.080 Not significant

The result above shows that monetary policy rate and exchange rate are not statistically

significant, only money supply is found to be statistically significant in the model. Thus,

for this model, we cannot reject the null hypothesis for the variable of monetary policy

rate and exchange rate but we can reject the null hypothesis of no significant relationship

in the model and accept the alternate hypothesis in the case of money supply.

53

iii. Test of Significance

Here we test the significant of the independent variables in the model using the

probability value of the t-statistic. By comparing the p-value with the critical value of

5%, we will be able to know if the independent variables has a significant impact in our

model.

The table below shows the summary of the result:

Table 4.4: Test of significance

Variables P-value Significant

level

Decision Conclusion

MS 0.0000 0.05 Significant Reject H0

MPR 0.8129 0.05 Not significant Accept H0

EXR 0.3822 0.05 Not significant Accept H0

From the result presented in the table above, it shows that MS has a high significant

relationship with GDP because it present a probability of 0.0000 which is less than the

critical value of 0.05. MPR and EXR on the other hand, shows that they have no

significant relationship with GDP because they present the probability of 0.8129 and

0.3822 respectively, which is greater than the significant level of 5% (0.05).

iv. Test of overall significance (F-Test)

F-statistic is conducted to see if the regression model is well specified. It is used to test

the joint significance and to form the basis of either not rejecting the null hypothesis (H0)

or the alternative hypothesis (H1)

Decision Rule:

Reject H0 if f-cal > f-tab otherwise accept H0.

54

To check for F-test on the critical value table, the degree of freedom is given as:

V1 = K-1 = 4-1 = 3 (numerator)

V2 = n-k = 25-4 = 21 (denominator)

Table 4.5: F-statistic test

Comparing the F-cal with the F-tab, the result shows that F-cal > F-tab (i.e 297.1244 >

3.07) hence, we reject the null hypothesis (H0) and accept the alternate hypothesis (H1),

concluding that at 5% level of significant, the model is well specified and the overall

regression is statistically significant.

4.3.3 EVALUATION BASED ON ECONOMETRIC CRITERIA

i. The Durbin Watson Test (dw)

The Durbin – Watson statistics (dw) is used to test for the presence of auto-correlation in

the disturbance term which implies that the error term of successive periods relates to

one another. It is used to test whether or not one of the ordinary least squares has been

violated i.e. the assumption of serial independence or non-autocorrelation of the

disturbance (error) term.

The decision rule is given below:

Table 4.5: Durbin Watson test

NULL HYPOTHESIS DECISION If

No positive autocorrelation Reject 0 < d* < du

No positive autocorrelation No decision dL ≤ d* ≤ du

No negative autocorrelation Reject 4 – dL < d* ≤ 4

F-statistic Critical value (0.05) Decision

297.1244 3.07 Reject H0

55

No negative autocorrelation No decision 4 – du ≤ d* ≤ 4-dL

No autocorrelation (positive or

negative)

Do not reject du < d* < 4 ≤ dL

Where: dL = lower unit = 1.04

du = upper unit = 1.77

d* = durbin Watson calculated = 0.807375

At 0.05 significant level

The decision falls under 0 < d* < du (i.e 0 < 0.807375 < 1.77)

Thus we can reject the null hypothesis and conclude that there is no positive

autocorrelation in the residuals.

ii. Diagnostic Test Statistics

This study further performed various diagnostic tests to ensure that the data series was

consistent with all the OLS assumptions. These includes:

a) The White’s test which is used to test for heteroscedasticity problems,

b) The Breusch-Godfrey Lagrange Multiplier (LM) test is used to test for

autocorrelation and

c) The probability distribution (normality test) will also be tested.

a) Heteroscedasticity test

This test is carried out to test if the error term have a constant variance. The test follows

chi-square distribution with degrees of freedom equal to the number of regression in

the auxiliary heteroskedasticity regression, excluding the error term. The table below

shows the result of the heteroskedasticity test:

Table 4.6: Heteroskedasticity Test: White

F-statistic 0.696420 Prob. F(9,15) 0.7032

Obs*R-squared 7.367696 Prob. Chi-Square(9) 0.5989

56

Source: Author’s computation on E-view

Test Hypothesis

H0: Homoscedasticity (The variance is constant)

H1: Heteroscedasticity (the variance is not constant)

Decision rule

Reject H0 if X2 cal > X2 tab otherwise accept Ho.

X2 –tab = 16.919

X2-cal = 7.367696

Conclusion:

Looking at the Chi-squared critical value table at 5% significant value and 9 degree of

freedom, our X2 –tab (16.919) exceed our X2-cal (Obs*R-squared) value = 7.367696,

even the p-value of the X2-cal = 0.5989 also confirm this, because it is greater than the

significant level of 0.05. From the result and the comparism of the X2-cal and the X2-

tab, we cannot reject the null hypothesis because the X2-cal < X2-tab. We conclude that

the variance of the error term is constant.

b) The Breusch-Godfrey Lagrange Multiplier (LM)

This is used to test if there is a serial correlation occur between the residuals, we will

arrive at our decision by comparing the p-value of the Obs*R-squared(X2) with level of

significant of 5% (0.05). The decision rule is:

H0 = there is no serial correlation

Accept the null hypothesis if Obs*-squared (R2) p-value > 0.05 significant level,

otherwise reject.

Scaled explained SS 4.764214 Prob. Chi-Square(9) 0.8544

57

Source: Author’s computation on E-view

Interpretation:

The result above shows that p-value (0.0036) < 0.05 significant level, we can reject the

null hypothesis of no serial correlation and conclude that there is serial correlation in

the model.

c) The probability distribution (normality test)

This test is carried out to test if the error term follows normal distribution. It is done

using the Jarque-Bera statistic which follows chi-square distribution with 2 degrees of

freedom at 5% level of significance.

The result is presented in the diagram below;

0

1

2

3

4

5

6

7

8

-0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0.0 0.1 0.2 0.3 0.4 0.5

Series: ResidualsSample 1990 2014Observations 25

Mean 5.51e-16Median 0.006659Maximum 0.435857Minimum -0.545839Std. Dev. 0.236593Skewness -0.440720Kurtosis 2.832867

Jarque-Bera 0.838408Probability 0.657570

Test Hypothesis

H0: ei = 0 (The error term is normally distributed)

H1: ei ≠ 0 (The error term is not normally distributed).

Table 4.7: Breusch-Godfrey Serial Correlation LM Test:

F-statistic 7.791285 Prob. F(2,19) 0.0034

Obs*R-squared 11.26476 Prob. Chi-Square(2) 0.0036

58

a = 5% (0.05 significant level)

Decision Rule:

Reject Ho if X2-cal > X2-tab otherwise accept Ho

From the result obtained from Jarque-Bera test of normality, (JB) = 0.838408

(0.657570).

That is X2 cal = 0.838408 (0.657570)

X2 tab = 5.991(0.05)

Conclusion:

From the result presented above, it shows that X2-cal < X2-tab i.e (0.838408 < 5.991).

Hence, we cannot reject H0, we conclude that the error term is normally distributed.

This can also be verified with the probability presented, our JB p-value is higher than

the 5% significant level which is the basis on which we cannot reject the null

hypothesis.

iii. Unit root test

The study will apply unit root tests represented by the Augmented Dickey Fuller (ADF)

to test for the stationary of the model variables.

Hypothesis testing

H0: The monetary policy variables have a unit root

H1: The monetary policy variables does not have a unit root

Decision rule:

Reject the null hypothesis of unit root if the ADF calculated value exceeds the critical

value in absolute term at a given level of significant.

The table below shows the result of the ADF test.

Table: 4.7: Unit root test

59

Variable ADF 1%

critical

level

5%

critical

level

10% critical

level

Order of

integration

D(MS) 5.964533 -3.737853 -2.991878 -2.635542 I(0)

D(MPR,2) -5.306357 -3.769597 -3.004861 -2.642242 I(1)

D(EXR,2) -4.654699 -3.752946 -2.998064 -2.638752 I(1)

D(GDP,2) -3.512131 -3.752946 -2.998064 -2.638752 I(1)

Source: Author’s computation on E-view

Conclusion

From the result in the table above, it shows that MS attained stationary status at level,

while MPR, EXR and GDP attained stationary status at 1st difference. The critical value

forming the basis of the decision is 5%. Thus, the null hypothesis of non-stationary of

monetary policy variables is rejected at respective critical level. We conclude that all

the variables except money supply are integrated of one order.

4.4 TEST OF HYPOTHESES

The hypothesis have earlier been stated has;

H01: Money supply has no significant impact on the Nigerian economic growth

H02: Monetary policy rate has no significant impact on the Nigerian economic growth.

H03: Exchange rate has no significant impact on the Nigerian GDP.

Conclusion

60

Money supply: Based on the result presented by the p-value of t-test statistic, we reject

H0 and conclude that money supply has a high significant impact on the Nigerian

economic growth.

Monetary policy rate: the result presented in the statistical test shows that p-value

exceed our level of significant of 0.05, which means we cannot reject the null hypothesis

for monetary policy rate. We thereby conclude that monetary policy rate has no

significant impact on the Nigerian economic growth.

Exchange rate: also comparing the result presented by t-test statistic which shows that

t-cal is less than the critical value, hence, we accept the null hypothesis and conclude that

exchange rate has no significant impact on the growth of Nigeria economy.

4.5 DISCUSSION OF FINDINGS

This study examined how monetary policy application by the CBN has performed on

Nigerian economy from 1990 to 2014. The result of the study shows that money supply

possess a positive relationship and highly significant impact on Nigerian economic

growth, this is because if the supply of money is increased, there will be more

availability of funds in the economy and this lead to more investment which will boost

the economy. The result of the monetary policy rate shows that MPR has a positive

relationship and highly insignificant impact on the GDP, this is so because a rise in the

MPR will lead to an increase in the bank rate, which will in turn reduce the demand of

credit by the customer of the bank because of the high rate and by this there will be

little money available in the economy to sustain the business that will boost the

economy. The exchange rate result on the other hand, proves that there exchange rate

has a negative relationship and insignificant impact on Nigerian GDP, an increase in

the exchange rate will cause the economic growth to shrink, because when the exchange

rate rise, the importers of raw materials and equipment to boost production will incur

more in order to purchase this input and this leads to less demand of these input which

indirectly reduce the Nigerian economic growth.

The overall significant of the study shows that monetary policy has a positive

performance on the Nigerian economy. However, previous studies have confirmed the

status of this research study. Nneka (2013), The study revealed that money supply

61

positively affect manufacturing output index while company lending rate, Company

income tax rate, Inflation rate, Exchange rate has a negative impact to the performance

of the manufacturing sector over the years. Also in the study of Okoro (2013), he

conclude that monetary policy instruments have contributed significantly to the positive

economic growth of Nigeria.

It is suggested that further research should be carried out in order to determine how the

CBN can manipulate the monetary policy rate and the exchange rate, so that the policy

objectives can be achieved effectively.

62

CHAPTER FIVE

SUMMARY, CONCLUSION AND RECCOMMENDATIONS

5.1 SUMMARY

The research study focussed on the monetary policy application and its performance on

Nigerian economy. The overall objective of the study is to analyse the impact of

monetary policy instruments on Nigerian economic growth. However, to achieve this,

various data on monetary policy and economic growth were collected and range from

1990-2014. Variables such as money supply (MS), monetary policy rate (MPR) and

exchange rate have been x-rayed to promote effective analysis for the study. These

variables were then subjected to multiple regression analysis, using Ordinary Least

Square method (OLS), with Gross Domestic Product (GDP) as its dependent variable.

The summary of the findings are given below;

i) Money supply was found to conform to the expectation, by having a positive sign.

Its significant test showed that money supply possess a positive relationship and

highly significant impact on Nigerian economic growth.

ii) Monetary policy rate does not conform to the a priori expectation, because it

showed a positive sign. The significant test also revealed that monetary policy has

a highly insignificant impact on the GDP.

iii) Exchange rate on the other hand, did not conform to the a priori expected sign.

When subjected to individual significance, it was found that exchange rate has an

insignificant impact on Nigerian economic growth.

iv) The goodness of fit test reveal that money supply, monetary policy rate and

exchange rate explain 97.6% of the dependent variable (Gross Domestic Product),

which shows a good sign.

v) Also the overall significance of the model, using F-statistic test showed that the

model is well specified and the overall regression is statistically significant.

63

5.2 CONCLUSION

In this research study, we examined the performance of monetary policy application on

Nigerian economic growth. The overall conclusion from this study is that monetary

policy exerts significant impact on the level of economic growth in Nigeria. This status

is confirmed by the result presented by the F-statistic test in our multiple regression

analysis. The study reveals that money supply and monetary policy rate have positive

influence on economic growth. Where money supply shows a strong influence,

monetary policy rate on its own shows a weak influence on the economic growth. The

study also reveals that exchange rate has negative relationship with the GDP.

In addition, monetary policy rate and exchange rate were found to have insignificant

impact on economic growth in Nigeria. Money supply on the other hand, has highly

significant impact on Nigeria economic growth. This shows that if the CBN increases

the money supply, more money will be available for people to invest and manage their

business which will in turn boost the economy.

5.3 RECOMMENDATIONS

Based on the findings made in the course of this study, particularly the results of the

regression models, it is clear that the growth of the Nigerian economy is highly

dependent on the provision of the right environment for investment. The following

recommendations are hereby made:

1. Monetary policies should be used to create a favourable investment climate by

facilitating the emergence of market based interest rates and exchange rate regimes

that attract both domestic and foreign investments, create jobs, promote non-oil

export and revive industries that are currently operating far below installed

capacity. In order to strengthen the financial sector, the Central Bank has to

encourage the introduction of more financial instruments that are flexible enough

to meet the risk preferences and sophistication of operators in the financial sector.

2. The government should also endeavour to make the financial sector less volatile

and more viable which will allow for smooth execution of the Central Bank

monetary policies. Laws relating to the operation of the financial institutions could

64

be made less stringent and more favourable for the operators to have room to

operate more freely.

3. The Central Bank should find a way of reducing the level of deficit financing,

improve funding of the informal sector and the SMEs and promote their integration

into the formal sector. Also government should improve the tax administration so

as to reduce tax evasion to barest minimum. It should also ensure proper balance

between capital and recurrent expenditures of government.

4. There is the need for the monetary authorities to exercise influence that would

affect the behaviour of monetary aggregates namely; money supply, inflation,

monetary policy rate, bank credit, among others, in the overall liquidity of the

economy.

5. The regulatory bodies should sustain the current economic reforms and maintain

sound fiscal and monetary policies so that inflation trends can be reduced to single

digit on a sustained basis.

6. However, in order to maintain and exploit the current investment climate, the

Central Bank should introduce more monetary instruments that are flexible enough

to meet the ever-growing financial sector. This will allow for the existence of

different measures that will deal with different situations.

7. The Central Bank should make more stringent punishment for non-compliance to

the monetary policies by financial institutions. This will help to curtail the nefarious

activities of some financial institution who undermine the Nigerian economy.

8. The government should also create awareness on the desire of Nigerians to invest

in short-term instruments.

9. Finally, the government of Nigerian should work together with the Central Bank

of Nigeria, in terms of the fiscal policy formulation in other to achieve the macro-

economic objectives. This joint effort will lead to the rapid growth of the Nigerian

economy.

65

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