THE EFFECTIVENESS OF MONETARY POLICY IN CONTROLLING INFLATION IN NIGERIA

ABSTRACT

 

This paper investigated the effectiveness of monetary policy in controlling inflation in Nigeria using secondary annual data spanning from 1981 to 2019. Money Supply, Treasury bills rate, monetary policy rate and exchange rate were the variables used in the study to check inflation. The paper employed cointegration method to check for the long run relationship between the variables, Augmented Dickey Fuller unit root test to check if the variables are stationary or nonstationary, Granger causality test to know if the variables are uni-directional, bi-directional or have no causal relationship and Ordinary Least Square (OLS) was adopted because of its property of Best Linear Unbiased Estimator. The study commenced with the analysis of testing the variables of interest using Augmented Dickey Fuller (ADF) unit root test and the result indicates that the variables were non-stationary at level but was stationary at first differences. The Johansen cointegration test revealed the existence of long-run relationship between the variables. While the empirical result of the OLS  test showed that monetary policy rate, money supply and treasury bill rates exert positive influence on inflation in Nigeria. While exchange rate depreciation leads to inflationary growth. This result is consistent with the prediction of economic theory. The study therefore concluded that money supply, treasury bills rate, monetary policy and exchange rate had influence on inflation within the period under consideration and recommends that  since open market operation using annual Treasury bill rate as proxy has not been effective in managing inflation; therefore, schemes to make it more effective should be adopted perhaps by offering competitive rates and the monetary authority should re-assess the effectiveness of monetary policy rate given its ineffectiveness as a tool to manage inflation in Nigeria during the period.

CHAPTER ONE

INTRODUCTION

 

1.1 BACKGROUND TO THE STUDY

Monetary policy is the action taken by the monetary authority (Central Bank) to control the supply of money in the country, with the objective of promoting price stability and economic growth.

The connection between money in circulation and inflationary rate are the main indicator for the measurement of an economy’s prosperity, performance and growth abilities. The regulation of the volume of money in circulation and maintaining price stability has been one of the main objectives of emerging nations such as Nigeria. Monetarist economist has maintained that there is an indicating relationship between inflation and money supply and uncontrollable increase in the volume of money may have adverse effect on economic condition (Chaudhry, Ismail, Farooq & Murtaza, 2015).

The key target of Nigerian policy architects is to ensure price stability and maintain inflation rate at single digit. They try to achieve this through the manipulation of monetary policy instruments so as to ensure a stable and strong financial system and enhance economic growth. In regards to this, Fabian and Charles (2014) opined that monetary policy is one of the major tools hired by Central Bank of Nigeria (CBN) to regulate financial activities through the control of monetary policy rate (MPR), introduced towards the end of 2006 to influence the level of economic activities in the money market.

Irrespective of the policy thrust of policy makers in controlling inflation, just a little have been achieved in curbing the threat of inflation in Nigerian economy as inflation is the leading cause of economic impedance and social and political unrest in developing countries like Nigeria (Philip, Christoper and Pius, 2014). Furthermore, the paraphernalia of general price increase include continuous fall of the purchasing power of money, inequality in distribution of income, loss of social welfare due to price increases and fall in reserves and investments (Philip et al. 2014). “Inflation causes excessive relative price variability and misallocation of resources”.

Inflation is the general rise in the price of goods and services. The delinquent of inflation has always been a problem as a result of its effect on economic activities. Rise in general amount of goods and services leads to the decrease in the value of money, this leads to fall in unit a currency can buy. Inflation can as well result to rise in the cost of production, and excess demand over supply.

One of the fundamental objectives of Central Bank of Nigeria is to sustain price stability in the economy through monetary policy. This is achieved by ensuring the rate of inflation is sustained within a certain limit to enable a sustainable economic activity in all facets of the economy.

The financial and economic condition of any nation or state is mainly centered on the monetary policy being instigated by the monetary authority or Central Bank of the state or nation. It has been generally agreed that monetary policy contributes to sustainable growth by maintaining the stability of prices. Christiano and Fitzgerald (2003) identifies that when inflation rate is adequately low, individuals do not have to take account when taking daily choices. A government controls its economy through combined actions of monetary and fiscal policies. The fiscal policy is geared towards government expenditures, both investments and recurrent, the government regulates its spending in order to control and positively impact the state’s economy.

Monetary policy as one of the main tools of economic planning, contributes to the fulfilment of the aims of economic policy.

Monetary policy according to (Fisher, 1911) influences “all prices in the economy, and a price indicator of the general price level covers prices of everything acquired or purchasable”. How fast monetary policy induce the price level, that is, “the swiftness of the process depends on how rapidly prices absorb shocks”. Consumer prices are among the stickiest in the economy and absorb shocks slowly, while asset prices are among the most flexible and absorb shocks quickly. Central Banks commonly estimate the rate of inflation using a consumer price index, but because consumer prices are sticky, this may cause the policy maker to misjudge the underlying monetary inflationary pressure in the short run and pursue the wrong monetary policy. This is one of the reasons why Alchian and Klein (1973), Goodhart (2001) and Bryan et al. (2002) argue that flexible asset prices should be included in the Central Bank’s price index.

Monetary policy resolutions are based on diverse pointers that provide “key information on impending inflation and output growth”. In monetary policy, the output gap can be used as one of the indicators of inflation. Therefore, the important task for policymakers is to study the link between output gap and inflation and thereby ensure the required changes in policy rates.

Monetary policy is one of the macroeconomic instruments in which countries (like Nigeria) manage their economies. It involves those measures and activities triggered by the Central Bank which focus at inducing the availability and cost of credit. It entails measures planned to impact or control the volume, prices and direction of money in the economy to attain vital target of price stability, balance of payment equilibrium and provision of employment. Directing the supply or price of money may apply a powerful impact over the economy. The attainment of the fundamental targets and objectives is crucial in determining the value of the currency both internally and externally.

Typically, macroeconomic strategies in emerging economies and nations are intended to stabilize the economy, increase growth and decrease poverty.

Ajie and Nenbee (2010) and Masha et al., (2004) identifies that “the achievements of these objective are grounded on the posture of fiscal and monetary policies. Monetary policy invention is based on the both money supply and credit obtainability in the economy.  In ensuring monetary stability, the Apex Bank through the commercial banks gears policies that pledge the orderly growth of the economy through suitable changes in the level of money supply.  The reserves of the banks are determined by the Central Bank through various tools of monetary policy. These tools include the cash reserve requirement, liquidity ratio, open market operations and primary operations to influence the movement of reserves”.

Inflation remains one of the main economic variables that disrupt economic activities in both developed and developing economies which affects investment and growth of any economy. It has received various attention as a result of its sensitivity to economic issues. Inflation rates have been on the rise since late 1970s, and has caused major economic disruptions in the Nigerian economy.

Nigeria, regrettably has reached the point where it threatens the entire system. Producers are faced with high cost of production and low utilization of capacity which has decreased level of production and has affected unit cost. Consumers bear burden of high prices which decreases their disposable income.

A typical instance of Central Bank of Nigeria price stability was practically introduced during the pandemic of coronavirus which has affected most nations in the world.

 

 

1.2 STATEMENT OF THE PROBLEM

Many years ago, the Nigerian economy has been faced with inflationary pressure which has retarded her growth process. Gbadebo and Muhammed (2015) stated that this could be traced to 1970s when inflation increased to a double digit. The trends of inflation in the economy indicated that inflation rate rose in 1990s from 63.6% to 72.8%. However, the economy experienced stability in 2003 through economic reforms programs which was later followed by inflationary pressure with rises in inflation rate at 12.9%, and 14% in 2000 and 2001 respectively. Headline inflation rate remained at double digits between 2002 and 2005 as it recorded of 15%, and 17.9% respectively. However, it decreased dramatically to 8.24% and 5.38% in 2006 and 2007 before increasing immensely to 11.60% and 12.00% in 2008 and 2009 respectively in that order, although dropped slightly to 11.8% and 12.3% in 2010 and 2013 respectively (Gbadebo & Muhammed, 2015). There is drop in the rate to 8.1% in 2014 but rises to 9.1% in 2015 with a sharp rise in 2016 to 15.7%.

The problem of inflation has always been a problem as a result of its effect on economic activities. Rise in general price of goods and services which leads to the drop in the value of money, this leads to fall in unit a currency can buy. Inflation can as well result to rise in the cost of production, excess demand over supply.

Inflation has been an economic problem in Nigeria due to continuous spike in prices of goods and services in the country which results to panic and uncertainty in the economy resulting to citizens not willing to spend too much for a little in return or invest so as to not make losses when prices

fall.

Inflation decreases the standard of living of the citizens in an economy. This has imposed the need for this study due to the unceasing increase in the prices of goods and services in the nation due to the outbreak of COVID-19 (Coronavirus).

 

 

1.3 RESEARCH QUESTIONS

The study has answered the following questions:

1. What is the relationship between monetary policy on inflation in Nigeria? ii. What is the nature of relationship between monetary policy on inflation in Nigeria?

 

1.4 OBJECTIVES OF THE STUDY

The broad objective of this paper is to examine the effectiveness of monetary policy on inflation in Nigeria.

To achieve that, the following specific objectives were pursued:

1. To examine the relationship between monetary policy on inflation in Nigeria ii. To examine the nature of relationship between monetary policy on inflation in Nigeria.

 

1.5 RESEARCH HYPOTHESIS

 

H₀: There is no significant relationship between monetary policy on inflation in Nigeria H₀: There is no causal relationship between monetary policy on inflation in Nigeria.

 

1.6SIGNIFICANCE OF THE STUDY

 

The central monetary authority has implemented several policies over the years to reduce inflation in Nigeria but has not been too effective. This justified the detailed study to analyze the effectiveness of monetary policy in controlling inflation in Nigeria.

 

The findings and recommendation of this study will be useful to monetary authority and economic policy planners who can adopt the recommendations in reducing and controlling inflation in the country.

 

This research will be a source of information base on future researchers (both academic and non-academic) on matters regarding the relationship between monetary policy and inflation.

 

The study of monetary policy on inflation is a timeless topic as it remains a paramount topic as long as inflation still exist. Therefore, it shall be of great benefit to students who intend to do more research in this area, while serving as a reference material in the near future to other researchers.

 

1.7  SCOPE AND LIMITATION OF THE STUDY

This study will focus on assessing the effectiveness of monetary policy in controlling inflation in Nigeria. The data covers the period from 1981 to 2019. It is therefore appropriate to establish the limitation of this research work. Thus, the main limitations are factors such as:

Time Constraints: This study is limited by time constraints as researcher needed time to study for the final year examinations while also ensuring that this study does not suffer from dateline.

Fund: The inabilities to access more material in order to make several consultations was poised by inadequate supply of money.

Availability of Data: The lockdown imposed by the Federal Government as a result of COVID-19 could not allow the researcher to visit ample relevant libraries and data sources.

 

1.8 ORGANIZATION OF THE CHAPTERS

This study is organized in five chapters.

The first chapter contains the introduction and background of the study, statement of research problem, research questions, objectives of the research, research hypothesis, significance of the study, scope and limitations.

Chapter two contains the review of associated literatures, conceptual and theoretical framework.

Chapter three comprising of the methodology which includes research design, data sources, specification of models and method of data analysis.

Chapter four presents the data analysis, test of hypothesis, and presentation of results.

Chapter five finally comprises the summary, conclusion and policy recommendation.

THE EFFECTIVENESS OF MONETARY POLICY IN CONTROLLING INFLATION IN NIGERIA

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