The aim of this study was to investigate the effect of monetary policy variables that were consistently adopted by the Central Bank of Nigeria (CBN), on the inflation rate in Nigeria for the period 2009-2014. Two key issues where addressed; one, whether there was a significant relationship between the policy variables adopted and inflation. Two, whether the combined impact of all these variables adopted, was significant on the inflation rate. Data was sourced from the CBN’s statistical bulletin 2014, from the website of the CBN and the National Bureau of Statistics (NBS). The Ordinary Least Squares (OLS) method was adopted because of its best linear unbiased estimation (BLUE) property. The Augmented Dickey-Fuller test for stationarity, showed that the variables were all stationary at order one (1). Cointegration test also revealed that a long run relationship exists among the variables. The results show that apart from the MPR, all other policy variables were significant at the 5% level of significance (the monetary policy horizon) and this addressed the first key issue highlighted. For the second key issue, the estimation model displayed that all the explanatory variables adopted by the CBN (as used in this research) accounted for 61% of the variation in the inflation rate as regards its rise or drop. Hence, the combined effect of all the variables adopted by the CBN did reduce the inflation rate, as the monetary policy shocks did get traction on the economy in arriving at the policy trajectory of an inflation band of 6-9%. The CBN should constantly examine its policy environment to determine the instrument mix optimization that best serves its prime purpose of macroeconomic stability, especially when its inflation target is achieved.
TABLE OF CONTENTS
ACKNOWLEDGEMENTS
TABLE OF CONTENTS
ABSTRACT
CHAPTER I
INTRODUCTION
1.1 Background to the Study
1.2 Statement of the Problem
1.3 Objectives of the Study
1.4 Research Questions
1.5 Research Hypotheses
1.6 Significance of the Study
1.7 Scope of Study
CHAPTER II
REVIEW OF RELATED LITERATURE
2.1 Conceptual Framework
2.1.1 The Concept of Inflation and Inflationary Pressures.
2.1.2 The Concept of Monetary Policy and Monetary Policy Tools
2.2 Theoretical Framework
2.2.1 Demand Oriented Theories of Inflation
2.2.2 Supply Oriented Theories of Inflation
2.2.3 The Structuralist's View of Inflation
2.2.4 The Monetarists' Theory of Inflation
2.3 Monetary Policy and Macroeconomic Stability
2.4 Strategies of Monetary Policy to Achieve Macroeconomic Stability
2.4.1 Monetary Targeting
2.4.2 Price Level Targeting
2.4.3 Inflation Targeting
2.5 Tools of Monetary Policy
2.5.1 Direct tools of Monetary Policy
2.5.2 Indirect Instruments of Monetary Policy
2.6 Empirical Literature Review
2.6.1 Empirical Research Gap
CHAPTER III
METHODOLOGY
3.1 Research Design
3.2 Nature and Sources of Data collection
3.3 Model Specification
3.4 Description of variables
3.4.1 Inflation
3.4.2 Bank Reserve Requirement (REQ)
3.4.3 Money Supply
3.4.4 Exchange Rate (EXR)
3.4.5 Monetary Policy Rate (MPR)
3.4.6 Treasury Bills Rate (TBR)
3.5 Econometric tests
3.5.1 The Unit Root Model
3.5.2 Co-integration Test
3.5.3 Error Correction Model
3.6 Hypotheses Testing:
3.6.1 t-test- (significance test)
3.6.2 F-test:
3.6.3 Goodness of fit test (R2):
3.7 Model to Test Hypotheses
3.7.1. Broad money supply has no major impact on the rate of inflation
3.7.2. The Exchange rate movement has no significant effect in checking a spike in the inflation rate for the period under study
3.7.3. The Monetary policy rate has no significant effect on the rate of inflation
3.7.4. The treasury bills rate movement does not have an effect on the rate of inflation?
CHAPTER IV
DATA PRESENTATION, ANALYSIS OF RESULT AND DISCUSSION
4.1 Data Presentation and Analysis
4.2. Ordinary Least Square Regression Result
4.3 Unit Root Test
4.4 Johansen Cointegration Test
4.5 Error Correction Mechanism
4.6 Hypotheses testing
4.6.1 Broad Money supply has no major impact on the rate of inflation
4.6.2 The Exchange rate movement has no significant effect in checking a spike in the inflation rate for the period under study.
4.6.3 Monetary policy rate has no significant effect in checking a spike in the
inflation rate.
4.6.4 The Treasury bills rate does not have a significant effect in restraining an increase in the inflation rate.
4.7 Discussion of Findings
4.7.1 Money Supply (MS)
4.7.2 Exchange Rate (EXR)
4.7.3 Monetary Policy Rate (MPR)
4.7.4 Treasury bill Rate (TBR)
CHAPTER V
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary of findings
5.2 Conclusion
5.3 Contribution to knowledge
5.4 Recommendations
5.4.1 For further studies
5.5 Limitations of the Study
References
APPENDIX I
SUMMARY OF DESCRIPTIVE STATISTICS/ NORMALITY TEST
APPENDIX II
MONTHLY DATA ON MONETARY POLICY VARIABLES AND INFLATION
APPENDIX III
GRAPHICAL REPRESENTATION OF MACCROECONOMIC VARIABLE USE IN THE STUDY
ABSTRACT
The aim of this study was to investigate the effect of monetary policy variables that were consistently adopted by the Central Bank of Nigeria (CBN), on the inflation rate in Nigeria for the period 2009-2014. Two key issues where addressed; one, whether there was a significant relationship between the policy variables adopted and inflation. Two, whether the combined impact of all these variables adopted, was significant on the inflation rate. Data was sourced from the CBN’s statistical bulletin 2014, from the website of the CBN and the National Bureau of Statistics (NBS). The Ordinary Least Squares (OLS) method was adopted because of its best linear unbiased estimation (BLUE) property. The Augmented Dickey-Fuller test for stationarity, showed that the variables were all stationary at order one (1). Cointegration test also revealed that a long run relationship exists among the variables. The results show that apart from the MPR, all other policy variables were significant at the 5% level of significance (the monetary policy horizon) and this addressed the first key issue highlighted. For the second key issue, the estimation model displayed that all the explanatory variables adopted by the CBN (as used in this research) accounted for 61% of the variation in the inflation rate as regards its rise or drop. Hence, the combined effect of all the variables adopted by the CBN did reduce the inflation rate, as the monetary policy shocks did get traction on the economy in arriving at the policy trajectory of an inflation band of 6-9%. The CBN should constantly examine its policy environment to determine the instrument mix optimization that best serves its prime purpose of macroeconomic stability, especially when its inflation target is achieved.
ACKNOWLEDGEMENTS
I am greatly indebted to some person’s based on their various contributions in one way or the other to the success of this research work. My gratitude and special appreciation goes first of all to my first Supervisor, Dr. I.D. Poloamina for his incisive instructions and questions that guided this work to a logical conclusion. Gratitude is also extended to the Head of Department/Supervisor Dr. Tonye Ogiriki for his immeasurable assistance throughout the course of our academic programme, Prof. Christopher Orubu whose seminar topic led to an opportunity for research on this area of research is also highly acknowledged.
Appreciation is also given to all our pioneer lecturers for their sacrifice without which we would not have been able to reach our goals. Prof. Samuel Edoumiekumo was of an immense assistance, his contribution is highly appreciated. The contributions of our pioneer and present faculty Postgraduate programme coordinators, Dr. Peter Ayunku and Dr. Chris Akpotu is highly appreciated as well as our Dean Dr. Stanley Ogoun. I also appreciate the singular contributions of Mr. Ebi Akarara and Mr. Ebi Lubo for their useful inputs in analyzing the work, Mr. Isaac Kime whose skills in typing produced a decent work is not left out. The entire pioneer Masters students of the department are not left out for the determination and the encouragement they extended to one another.
My gratitude also goes to my wife Mrs. Rose Okotori and my daughter Shalom for their patience and understanding during the entire course. Finally my unlimited gratitude goes to my Lord and Saviour Jesus Christ, who alone has brought me through all my academic huddles and has kept me alive.
CHAPTER I
INTRODUCTION
1.1 Background to the Study
The world is considered to be a global village due to advances in science and technology. This has led to a greater measure of economic integration amongst the various countries in the world. It is thus a fact, that "...no country is immune to external economic shocks which cause fluctuations of macroeconomic variables like output and inflation" (Gajic, 2012). The financial crises in the first decade of this millennium affected various countries in diverse ways, while some of these countries experienced a slowdown in economic activity that led to a recession; other countries experienced an increased level of inflation and the attendant inflationary pressures. In essence, the world is on a two-speed train as regards economic experiences, revealed in what advanced economies experienced on one hand and emerging economies on the other hand. Inflation which is a sustained rise in general price levels in itself cannot be said to be adverse, but its rates have to be within certain levels or predetermined thresholds that are country specific.
Bawa and Abdullahi (2012) were able to determine a "threshold level of inflation for Nigeria using a threshold regression model developed by Khan and Senhadji (2001)” arriving at a threshold inflation level of 13 percent for Nigeria. But Doguwa (2012) adopting the threshold model of Sarel (1996), Khan and Senhadji (2001) and (Drukker, Gomez-Porqueras, & Henandez-Veme, 2005) arrived at a threshold range of 10.5 to 12% for Nigeria."Thus below the threshold level, inflation had a mild effect on economic activities, while above it, the magnitude of the negative impact of inflation on growth is high". Macroeconomic policy is the main tool for curbing the effects of a recession or inflation as well as inflationary pressures on an economy. Inflationary pressures in Nigeria have been seen "...through increases in prices of commodities in the country and these increases have been causes for concern for those in charge of the economy" (Orubu, 2009).
Macroeconomic policy has also been the "main tool for achieving output stabilization in the short-run and a diversified self-sustaining economic growth in the long run" (Ajie, Akekere & Ewubare , 2007). Dolamore (2015) was of the opinion that the aim of macroeconomic policy is to provide a stable economic environment conducive to fostering strong and sustainable growth. The approach of macroeconomic policy has twin foci, these are; (i) Fiscal policy and (ii) Monetary policy. Fiscal policy can be referred to as "that part of government policy concerning the raising of revenue through taxation and other means and deciding on the level and pattern of expenditure for the purpose of influencing economic activities" (Anyanwu, 1993). Monetary policy, on the other hand is the management of variables such as money supply or interest rates to achieve macroeconomic goals.
Buiter (2014) observed that “…an unwillingness or inability of governments to use countercyclical fiscal policy has made monetary policy the only tool in town”. The Central Bank of Nigeria adopts monetary policy measures to stabilize the economy and curb inflation to fall within acceptable as well as predetermined thresholds that will enhance the achievement of stated goals. But the absence of Central Banks’ "reaction will leave inflation to provoke currency devaluation, opening a vicious circle of negative economic reactions/outcomes" (Piana, 2001).
The process of successfully conducting monetary policy requires "policy makers not only to specify a set of objectives for the performance of the economy, but also to understand the effects of policies designed to attain these goals" (Altavilla & Ciccarelli, 2009). When there is "a change in monetary policy stance, the effect of which is an exogenous shock in main policy variables, and that ultimately affects the economy with changes in inflation, output," (Munyengwa, 2012). It has been observed that ''monetary policy has an advantage of acting relatively uniformly on spending decisions throughout the economy, allowing policymakers to stabilize inflationary pressures without creating undue allocative distortions across sectors of the economy'' (Woodford, 2002). Pennings, Ramayani and Tang, (2011) in referring to the deductions of Krugman(2008) and Mishkin(2009) saw it as a two part process from monetary policy instruments shocks impacting on financial markets and financial markets impacting on real activity(final goal).
The objective of monetary policy, in essence, addresses the inherent problems in any economy that monetary policy was intended to effectively curtail. These objectives include: promotion of the full-employment, exchange rate stability, domestic price stability, maintenance of balance of payment equilibrium, etc. The approach of monetary policy is not a recent development, Uchendu (2009) did see the "conduct of monetary policy as having evolved over time and that this has mainly been influenced by developments in the science of economics and knowledge of the workings of the economies and the interrelationships among macroeconomic objectives and variables, gained from experience as well as research". Job(2011) observed that the Central Bank of Nigeria commenced the implementation of inflation targeting(IT) regime as one of its core monetary policy strategies by using the monetary policy rate(MPR) as the main tool of stabilization in 2009.
Recent policy indications from the Central Bank of Nigeria (CBN) show that the bank may have soft-pedaled on its implementation of full-fledged inflation targeting for the country (Bassey & Essien, 2014). According to the Central Bank of Nigeria (CBN), while reviewing the policy environment and macroeconomic developments in 2013, "that open market operations (OMO), remained the main instrument of monetary policy, complemented by reserve requirement and discount window operations as well as the monetary policy rate (MPR)" (Central Bank of Nigeria [CBN], 2014a). The CBN had earlier stated that the monetary policy strategy in 2014/2015 will continue to be monetary targeting and that there was to be a close monitoring of the growth in money supply (MS) (Central Bank of Nigeria [CBN], 2014b). Thus, the main issue(s) of concern in this study was the effectiveness of monetary policy tools in achieving macroeconomic policy objectives by curbing inflation and restraining inflationary pressures on the economy.
1.2 Statement of the Problem
The Nigerian economy has experienced inflationary pressures over the years. Inflation has been an elusive factor that has characterized our very existence as an independent nation. Monetary policy tools have been geared towards attaining macroeconomic stability of the economy. "In Nigeria, the formulation and implementation of monetary policy by the Central Bank of Nigeria (CBN) was aimed at maintaining price stability, which is consistent with the achievement of sustainable economic growth” (Bawa & Abdullahi, 2012). The problem that monetary policy takes care of is in essence price stability (Onayemi, 2013), because central Banks have reoriented their monetary policy objectives, setting price stability as their main goal (Banco de Mexico [BDM], 2015). Domestic price instability can have a vicious effect on the economy and this is a major problem in Nigeria.
The unemployment rate in Nigeria has not dropped over the years, but it is still rising. Wen (2011) observed that "permanent increases in the monetary base foreshadow eventual increases in inflation that can increase rather than reduce unemployment". This was corroborated by Berentsen, Menzio and Wright, (2011) when they documented a similar positive relationship between longer-term inflation and the unemployment rate. The unemployment rate is rising as the economy has not been able to create enough jobs for the teeming population of school leavers and graduates. Farmers are also leaving their farms and fishing nets to the nearest cities and towns for elusive job openings.
Nigeria’s transactions’ with the rest of the world that as recorded in the balance of payments statements (BOP’s) will be negatively impacted upon when domestic price increases are high. When the rate of inflation is high in the country, domestic export goods will become unattractive to foreigners’ and this will lead to a reduction in the country’s exports’. We also see a situation where Nigerians will prefer to buy foreign goods which result in increased imports as an increased exchange rate ( depreciation of the naira) will lead to higher raw material cost as well as higher prices when compared to imported commodities. This will lead to balance of payments disequilibrium.
The exchange rate of the domestic currency can be negatively affected by a high inflation rate .A relatively higher inflation rate of a country compared to other countries will tend to reduce the value of the domestic currency (Pettinger, 2012). A weak naira has been a serious concern in Nigeria as it impacts on the real value of our exports, being a mono commodity economy. The instability and incessant depreciation in the foreign exchange value of the naira have several implications such as the decline in people’s standard of living as well as increased cost of imports (Obadan, 2012). A steep upward or downward trend in the price of crude oil will be of a concern as regards its macroeconomic implications, especially the exchange rate and the rate of economic growth given that the Nigerian economy is highly vulnerable to oil price fluctuations (Akpan, 2009). Inflation thus distorts purchasing power over time for recipients and payers of fixed interest rates (Oner, 2015).
Krueger (2005) posited that in "its own right inflation was damaging in that it distorts the calculus of profitability and encourages short-term investments to the detriment of long-term investments as well as diminishing the value of relative price signals". Investors hence should not hold and view equities as long-term investments providing with compensation for loss of purchasing power, rather they should hold them as good buys in the short to medium term. Constancio (2015) did expatiate further that "the main remit of monetary policy refers to the relevant variables of business and services and the level of real economic activity as monetary policy simultaneously affects all sectors of the economy".
There is an inverse relationship between higher inflation and lower share prices and this as observed by Feldsten (1978) was not due to chance, also Kimani and Mutuku (2012) discovered the negative relationship between inflation and stock market performance in Kenya. Thus, ''until the transmission linkages-from the instruments of monetary policy to financial markets, and financial markets to the rest of the economy-have been developed, monetary policy as it is perceived is unlikely to be very effective''( Crow,1990).
In driving at macroeconomic stability, "monetary policy pursues its objectives or goals such as ; (i) rapid economic growth, (ii) price stability, (iii)exchange rate stability, (iv)balance of payment equilibrium(BOP), (v) financial stability and (vi) full employment", (Mukunzi, 2004) . But Stiglitz (2011) did posit that “managing inflation is not an end in itself that the real end desired is a more stable economy and not just price stability and thus ensuring an economy that is growing faster in a sustainable way”. The adoption of monetary policy instruments had taken a more aggressive dimension in the period that is under review, with a far more independent Central Bank anchoring its policy decisions on sound international best practices in an attempt to tame Inflation to fall within predetermined thresholds.
Choi, Smith and Boyd (1996) observed a consensus amongst professionals in practice and the academia both in Finance and Economics that high rates of inflation cause "problems", not just for some individuals, but for aggregate economic performance. The CBN has adopted monetary targeting, with elements of inflation targeting to succeed at arriving at an inflation target that fall between 6-9%.Nigeria, like any other emerging market economies have two important features, (1) institutional weakness, (2) exposure to commodity prices changes in terms of trade shocks, Hove (2012). The monetary authority aimed at shaping the macroeconomic dynamics of monetary policy seen through responses of different monetary policy regimes to terms of trade shocks in emerging economies like Nigeria.
External economic shocks cause macroeconomic aggregates such as inflation to fluctuate. This calls for a macroeconomic policy (e.g. monetary policy) intervention. Thus, it is important to know if these shocks affect the domestic macroeconomic aggregate (e.g. inflation) as apriori expectation states and to investigate whether the theoretical predictions hold empirically. Containing inflation has a far reaching impact on various sectors of the economy. Hence the research problem can be encapsulated in the following questions ;( 1) did the monetary policy variables adopted by the Central Bank of Nigeria have any significant effect on the inflation rate? (2)Did the combined effect of these variables have the desired significant impact on inflation? In summary has the monetary shocks introduced by the monetary authority gotten traction in achieving the banks definition of price stability being an inflation band of 6-9% for Nigeria? These questions have not been specifically asked and addressed so far in all the empirical research on the subject matter as considered in this study.
The answer to these questions in the affirmative will confirm the position of the Central Bank of Nigeria (like any other monetary authority) as a strong player in public finance, acting as lender of last resort as well as having a strong influence on monetary and credit conditions in the economy. The key concern in the Finance discipline is focused on how monetary policy impulses are transmitted via the financial markets to businesses and households in the economy to achieve price stability and this is based on the effectiveness of the monetary policy instruments in controlling inflation. Meulendyke (1998) did observe aptly that the effect of monetary policy actions are not limited to depository institutions that in actual fact governments at various levels, quasi-government agencies, private corporations, and individuals engage in extensive direct financial market borrowing and lending".
1.3 Objectives of the Study
There are a lot of empirical analysis on monetary policy tools and their effect on inflation/inflationary pressures. The research herein undertaken was an investigation into the effectiveness of monetary policy tools adopted by the Central Bank of Nigeria in curbing inflation and restraining inflationary pressures. Monetary policy tools have been used in an attempt to ensure macroeconomic stability and affect the economy in two ways such as in the short run and the long run. Macroeconomic stability is attained when there is the attainment of monetary policy objectives via the adoption of monetary policy tools that where adopted to ensure macroeconomic stabilization. The study herein considered was an attempt to establish the effect of these tools on inflation and inflationary pressures and in essence the attainment of macroeconomic stability.
This study was specifically aimed at the following objectives;
(i)-To assess if the monetary policy variables have a significant effect on inflation.
(ii)-To analyze the total effect of monetary policy instruments adoption on inflation.
(iii)-To ascertain if the Balance of Payments also has an effect on inflation through the actions of the monetary authority (as a control variable).
1.4 Research Questions
The empirical investigation aimed at answering the following questions;
1. Has the Bank reserve requirement movement a significant effect on the inflation rate?
2. Do the monetary aggregates (MS) have a major impact on the inflation rate?
3. Is there a definite impact of the exchange rate on the rate of inflation?
4. When the monetary policy rate (MPR) changes, has it any effect on the inflation rate?
5. Does the treasury bills rate movement have an effect on the rate of inflation?
6. Is the country's balance of payments having a definite effect on the inflation rate?
1.5 Research Hypotheses
We did consider the following hypotheses that were tested in this research;
H01: Bank reserve requirement movement has not made any significant impact in reducing the inflation rate over the period under study.
H02: Bank reserve requirement movement has significant impact in reducing the inflation rate over the period under study.
H01: Broad money supply has no major impact in bringing down the rate of inflation.
H 02: Broad money supply has major impact in bring down the rate of inflation.
H01: The exchange rate movement has no significant effect in checking a spike in the inflation rate for the period under study.
H02: The exchange rate movement has significant effect in checking a spike in the inflation rate for the period under study.
H01: Monetary policy rate has no significant effect in checking a spike in the inflation rate.
H02: Monetary policy rate has significant effect in checking a spike in the inflation rate.
H01: The treasury bills rate does not have a significant effect in restraining an increase in the inflation rate
H02: The treasury bills rate has a significant effect in restraining an increase in the inflation rate.
H01: The balance of payment does not have a significant effect in effecting a reduction in the inflation rate for the period under study.
H02: The balance of payments has a significant effect in effecting a reduction in the inflation rate for the period under study.
1.6 Significance of the Study
Macroeconomic instability frustrates "the efforts of the private sector, depresses investment and exacerbates income inequality" (Penales & Turnovsky, 2006).Hence macroeconomic stability in any given nation cannot be attained without due consideration to inflation or deflationary tendencies within the economy;
(i) Thus a study with respect to the effectiveness of the monetary policy by the monetary authority, in curbing inflation is an essential contribution to the management of macroeconomic goals of the country.
(ii) The determination of the nexus between monetary policy tools and inflation is expected to assist in shaping policy makers approach to influencing inflation.
(iii) Researchers before now have not been able to establish the real impact of the total effect of monetary policy tools used by the CBN on inflation in Nigeria.
(iv) This study is intended to establish whether there is a strong link between monetary policy tools and their impact on inflation.
(v) The study is also expected to provide empirical evidence that supports the use or otherwise of these monetary policy tools to enhance policy tool mix optimization by the monetary authority, taking into cognizance Nigeria's economic setting.
(vi) There is also the provision of material(s) available for further research on monetary policy tools at the disposal of the Central Bank.
(vii) Further need for collaboration between the fiscal authority and the monetary authority was identified as regards macroeconomic stability and growth.
1.7 Scope of Study
The scope of this study did span from 1st January 2009 to 31st December 2014, of precisely 72 months. That was when the Central Bank of Nigeria experienced its highest level of independence whereby the CBN based its policy decision on proven international best practices, rather than on political interference or fiscal dominance. Hence a measure of monetary policy tool effectiveness within that period will be a better means of evaluation.
CHAPTER II
REVIEW OF RELATED LITERATURE
The review of relevant literature on monetary policy and inflation in the Nigerian economy embodies the theoretical framework on which the research work is based and is also a review of previous studies and findings on the subject matter called an empirical literature review.
2.1 Conceptual Framework
2.1.1 The Concept of Inflation and Inflationary Pressures.
Inflation as a concept in finance and economics has been described as too much money chasing too few goods. Inflation is due to an increase in the average level of price (Shiller, 2003). It has also been described as an economic situation where the increase in the money supply is more than the additional output of goods and services produced in the economy considered (Hamilton, 2001). We must realize that an increase in the price of the staple food commodity/crop can have a greater impact on the economy than the increase in average commodity price. Yet, not every price rise is termed inflation. For such a rise in the general price level to be considered inflation, it must be constant, enduring and sustained (Fatukasi, 2015). Economic instability due to increased price rise is a product of inflation and inflationary pressures.
Sloman (2004) saw inflation as a process in which the price level is rising and money seems to be losing value. This can be referred to as a general and persistent increase in the price of goods and services in any given economy (Ojo, 2000; Milberg, 1992). The persistent increase in the level of consumer prices or a constant decline in the purchasing power of money is as a result of an increase in the amount of money (Currency), credit far exceeding the quantity of available goods and services (Asad, Ahmed & Husain 2012). The impact of inflation is far reaching because of its potentials to both impacts positively as well as negatively on any economy, hence the effort to influence its effect via monetary policy. Oner (2015) observed that "inflation has plunged countries into long periods of instability; Central bankers often aspire as a result of the foregoing to be known as "inflation hawks”. As inflation rises, the marginal impact of inflation on bank lending activity and stock market development diminishes rapidly (Boyd, Levine & Smith, 2000).
2.1.2 The Concept of Monetary Policy and Monetary Policy Tools
Monetary Policy is the process by which the Central Bank of Nigeria or the monetary authority in any country controls the supply of money in the economy. It has been the fundamental instrument over the years in attaining macroeconomic stability and as a prerequisite to attaining sustainable output growth. Wrightsman (1976) did see monetary policy as a deliberate effort by the monetary authorities (Central Banks) to control the money supply and credit conditions for the purpose of addressing certain broad economic objectives. Monetary policy can thus be simply put as "the adjusting of money supply in the economy to achieve some combination of inflation and output stabilization" (Mathai, 2012).Monetary policy tools are measures adopted by the monetary authority in order to influence inflation and inflationary pressures as means to ensure macroeconomic stability in the economy. Such tools are the monetary aggregates M1 and M2, Monetary Policy Rate (MPR), Open Market Operations (OMO), Bank Reserve Requirement (Cash Reserve Ratio), etc.
2.2 Theoretical Framework
2.2.1 Demand Oriented Theories of Inflation
Demand-pull inflation is certainly the most important factor that raises the price level based on rising quantity of money that is not accompanied by a proportionate increase in output. When the quantity of money in the hands of the people increases, the aggregate demand for goods and services also increases; and if aggregate supply does not follow such increases in money supply, prices will rise. This is based primarily on Keynesian analysis. Frank and Bernanke (2003) did buttress the forgoing assertion when they stated that inflation occurs from the excessive aggregate demand which creates an expansionary output gap and results in increased pressure on prices.
On the demand-pull view, inflationary pressures occur at the macro level when actual GDP exceeds potential GDP. The result is the occurrence of a positive output gap. David (1997) did explain this further with an illustration that:
If consumers are willing to save (i.e. not spend on goods and services) only 15 percent of national output, and if businesses would like to invest 20 percent of that output, there is a gap of 5 percent between investment and saving. Prices will tend to rise because the demand for investment funds raises business costs. The higher prices, in turn, will become someone else's higher costs, and the result is what is known as an inflationary spiral, in which all prices and costs rise by an amount equal to the inflationary gap times a given multiplier, (p. 87).
Woodford (1999) is of the opinion that if the “output gap” is correctly understood, inflation and output gap stabilization will become sensible tools of macroeconomic stabilization. Parkin (2003) summarized it thus; (1) Increase in quantity of money, (2) Increases in government purchases and (3) Increase in exports.
2.2.2 Supply Oriented Theories of Inflation
The supply view or cost push inflationary pressure refers to increases in either import or raw material prices, unit wage costs and various elements that are part of production costs (Riley, 2011). The pressure on prices can thus also originate from the supply side. When OPEC used its production decrease to abruptly increase oil prices in 2000-2001, production costs did increase in a broad array of industries. To cover higher costs, producers raised output prices. Inflationary pressures could also originate in higher wages. If labour unions were able to abruptly push for wage increase, the costs of production would increase; putting pressures on product prices (Shiller, 2003), where there is a shock that shifts the supply curve upwards indicating that each level of output is associated with a higher price level than previously.
The foregoing might be caused by a rise in the cost of oil, of imported raw materials or domestic wage costs per unit of output, such as from a large increase in the minimum wage (Lipsey & Chrystal, 2011). This impact is regular in Nigeria; Labour unions go on strike for increased wage as a result of inflation. This further increases the pressure on the economy. Cost-Push Inflation was summarized by Parkin (2003) as;(1) increase in money wage,(2) an increase in money prices of raw materials. In a recent research at the International Monetary Fund, Nguyen, Dridi, Unsal and Williams (2015) discovered that both supply and demand shocks have been important drivers of inflation in non CFA-Sub Saharan countries (of which Nigeria is one) and that while supply shocks explain 45% of inflation fluctuations in the region on the average, demand shocks explain 55% of the fluctuations. Ujuju and Etale (2016) observed that the 2002 federal budget, identified three types of inflation as the mother of Nigeria's inflationary situation; namely (1) Demand pull inflation, (2) Cost-push inflation and (3) Wage push inflation.
2.2.3 The Structuralist's View of Inflation
The structuralists' approach was developed mainly in Latin America (Harberger, 1963) where a study showed that though money supply may increase along with price level, yet that money supply increase is only a response to inflation rather than initiating it. They felt the cause of rising prices is due to the pressure of economic growth on an underdeveloped social and economic structure like Nigeria. Wachter (1979) identified agriculture, foreign trade and government sectors as being regarded as suffering from institutional rigidity that cause prices to rise with economic development. The structural factor that was identified as applicable to Chile can also be applicable to Nigeria and that is a weak agricultural sector. The structuralists' were able to identify some areas of analysis in terms of the causes of inflation as regards their assessment as being a structurally induced phenomenon: (i)Agricultural Commodities, (ii) Wage Increase, (iii) Import Substitution,(iv)Tax System, (v) Money Supply.
(i) Agricultural Commodities
In Nigeria, much of the harvest is lost to spoilage due to poor storage facilities. Precisely it is reported that 40 percent of post harvest losses, which has led to an unprecedented reduction in food production occurs in Nigeria (Patrick, 2013 and Mada, Hussaini, Medugu & Adams 2014). Hence, the domestic supply of these commodities is inelastic. Thus, when demand for these commodities rises, the supply being inelastic leads to an increase in the prices of agricultural goods. We can clearly deduce that since supply does not increase at a proportionate rate with the observed price increases as a result of the aforementioned post-harvest losses, poor storage facilities, etc., the next available option for the government in order to meet the increased demand is to resort to importation of these agricultural produce. As the prices of the agricultural commodities imported into the country are relatively higher than those of the domestically produced goods, the prices of the domestic goods tend to rise. The increased importation results in an increased demand for foreign exchange and adds pressure to the domestic currency.
(ii) Wage Increases
Like in any other developing country, when food prices increase in Nigeria, workers will press for an increase in their wage rate, in order to cushion off the drop in real income. Chand (2015) used the following diagram to illustrate the above.
Figure 2.1-Wage rate increase and the effect on demand and supply of goods.
Abbildung in dieser Leseprobe nicht enthalten
Source: Chand (2015)
When there is an increase in the wage rate (P1 to P2), the demand for goods increase from D1 to D2. We see that aggregate supply falls as a result of the rise in labour costs caused by the movement of the aggregate supply curve from S1S to S2S. We have already concluded that supply of goods does not rise or fall proportionately to wage rate changes due to structural rigidities, but beyond point E1 the supply is shown as a vertical line, this is because despite the rise in prices, structural rigidities greatly limit the expansion in supply. The initial equilibrium is at E 1 where the curves D1 and S1 intersect at the output level OY1 and the price level is OP1 (Chand, 2015).
From the above, we observe a shift in the supply curve from S1 to S2 due to increased labour costs and this intersects the demand curve D2 at E2 and the production drops from OY1 to OY2 while the price level rises from OP1 to OP2.
(iii) Import Substitution
It has been observed that the rate of export growth in a developing economy is slow and quite unstable and this is inadequate to support the required growth rate in the economy. Baer (1988) did posit that in the Latin America, import substitution industrialization was an inefficient way of using resources to develop Latin American countries. The effect of the above is seen in rising prices of industrial products and the increases in the incomes of those in the industrial non agricultural sectors will have the macro effect of a further rise in prices based on the fact that structural rigidities limit the expansion in domestic supply as a response to increased demand. The industrial machinery will also be imported and the effect of this will be a further depletion of foreign exchange and limited income from exports will lead to the devaluation of the local currency. Despite substitution, it was discovered that imports increased rapidly and were basically composed of raw materials, spare parts, and capital goods which were essential for sustaining industrial production; this also depletes the foreign reserves of the nation and impacts on the inflation rate positively as the domestic currency's value depreciates, (ECON 4311, 2015).
(iv) Tax System
In Nigeria, the tax system is very inefficient in raising government revenues and this contributes to increasing the budget deficit which has an effect on inflation as the revenue short fall widens the deficit year on year. When there is a rise in price levels, the real value of taxes does not rise proportionately. Abdel-Kader (2013) was of the opinion that complex tax laws and inefficient systems of tax administration can make it difficult to raise sufficient public revenue, which often leads to large budget deficits and accumulation of debt, hence the restriction on government(s) ability to perform its expected developmental functions. Thus, tax revenues do not rise along with rises in the level of inflation.
There are structural rigidities within the tax system. Due to the lower real value of what can be collected as Tax and its inability to keep pace with increased expenditure, there is the problem of increased fiscal deficits, the funding of which leads to increased inflationary pressures on the economy. Such tax problems are peculiar to developing and emerging economies of the world of which Nigeria is one.
(v)Money Supply
The government itself needs more money to finance its fiscal deficits by borrowing from the Central bank and this leads to a further expansion in the monetary system, which raises further the rate of inflation. Hence, where supply inelasticities are observed, we will find, (i) a rise in agricultural prices,(ii) rising costs of import substitutes,(iii) deterioration of the terms of trade.
The theory of structural inflation has its own weaknesses, these are; (a) When there are price and exchange control, the theory does not offer a clear distinction between (i) autonomous structural rigidities and (ii) induced rigidities.(b) It is the failure of the government to exploit export opportunities that result in sluggishness in the growth of export and not due to structural inflation. In general, the structuralist theory of inflation does not have a world wide appeal as it remains strictly an observation in developing countries.
2.2.4 The Monetarists' Theory of Inflation
Modern quantity theorists of the neo classical school of economic thought see inflation as a monetary phenomenon that arises from a more rapid expansion in the quantity of money than in total output (Friedman, 1956). Friedman(1963) was of the opinion that previous attempts to carry out counter cyclical monetary policy had performed so poorly that the best way to conduct stabilizing policy is to prevent altogether and simply keep the money stock constant. Nuutilainen (2016) stated that Friedman further advocated that money stock should be allowed to grow only at a constant rate k corresponding to the growth rate of the economy, a measure the CBN adopted in its monetary aggregate targeting regime in 2008, see Figure 4.2.
Contemporary monetary policy literature is of the opinion that the monetary authority should be involved in carrying out counter-cyclical measures to smoothen out economic fluctuations. Inflation everywhere is said to be based on an increased demand for goods and services as stated in the fact that people try to spend their cash balances (Jhingan, 2003). Their conclusion was that inflation is always and everywhere a monetary phenomenon relying on Fisher's equation;
MV=PQ
where M- money supply, V- velocity of money, P- price level, Q- the level of real output. V and Q are assumed constant, the price level (P) varies proportionally with the supply of money (M).
Jhingan (2011) observed that both Keynesians and the Monetarists believe that inflation is caused by the increase in the aggregate demand pointing to the following factors; (1)increase in money supply, (2) increase in disposable income,(3) increase in public expenditure,(4)increase in consumer spending,(5) cheap money,(6) deficit financing,(7) expansion of the private sector,(8) Black money,(9) repayment of public debt,(10) increase in exports. Factors affecting supply are (1) shortage of factors of production,(2) industrial disputes,(3) natural calamities,(4) artificial scarcities,(5) lop-sided production,(6)increased exports,(7) law of diminishing returns,(8) international factors.
In Nigeria, the attempts made to reduce the inflation rate have mainly been by adopting a monetarist approach and not the structuralist approach (Sanni & Folarin, 2010). The above task rests squarely on the shoulders of the Central Bank of any nation and in Nigeria the Central Bank of Nigeria via its Monetary Policy Committee (MPC).Hence this research adopts the monetarist’s approach to inflation. We adopt the monetarist’s view of inflation as a monetary phenomenon that targets money by keeping broad money percentage growth, divided by GDP percentage growth as applied by the CBN since 2008.
2.3 Monetary Policy and Macroeconomic Stability
Monetary Policy has been the fundamental instrument over the years in attaining macroeconomic stability and as a prerequisite to attaining sustainable output growth. Macroeconomic stability seems to be the basic/essential goal of monetary policy, as it is the main target of overall economic policy which the monetary authorities intend to hit with certain monetary instruments/tools (Onuigbo & Azubuike, 2012). Mishkin (2001) did identify six objectives of monetary policy; employment, economic growth, price stability, interest rate stability, financial sector stability and exchange rate stability. Guerson (2015) did posit that empirical testing indicated that the monetary policy and its frameworks have contributed to the stabilization of inflation, with an effective transmission through the bank lending channel in the case of Bolivia. The goals or objectives of monetary policy can be summarized as follows;
(i) Maintenance of relative stability in domestic prices,
(ii) Attainment of a high rate of or full employment,
(iii) Achievement of a high, rapid and sustainable economic growth,
(iv) Maintenance of balance of payment equilibrium,
(v) Exchange rate stability and
(vi) Financial stability.
(i) Maintenance of stability in domestic prices.
Stability of the general price level is an essential objective of monetary policy. Price stability is closely related to the inflation rate. Jhingan (2011) observed that rising and falling prices are both bad because they bring unnecessary loss to some and undue advantage to others; these are related to business cycles. Rising prices erode the value of money as a medium of exchange and a store of value (Hubbard & O'Brien, 2013).In the 1970's, wages in America went up as workers believed that prices would rise, prices went up because higher wages were passed to the consumers whose demand further spiked price increases (Farmer,2014). Maintenance of relative price stability "is an attempt at avoiding wide gyrations of prices, producing windfall profits and losses" ( Anyanwu, 1993).
Monetary policy is geared towards attaining domestic price stability. Berg, Patillo and Shabsigh (2015) recommended that price stability should be the primary or overriding objective of monetary policy over the medium term, but Draghi (2015) in analyzing its impact on the economy of the Euro zone specifically saw price stability as the major mandate of the European Central Bank, in which the ECB defined price stability as an inflation rate of “below but close to 2 percent” over the medium term. In Bolivia, it was established that monetary instruments affect 20 percent of price variability in the near term, and close to 30 percent in the medium term (Guerson, 2015).
Niculae(2013) saw price stability as both a goal in itself, as well as a means for monetary policy, in that it contributes to achieving a sustainable growth and macroeconomic stability, further identifying three elements of consensus concerning price stability as:(i)-price stability refers to the aggregate level of prices measured by indicators.(ii)-price stability is achieved when money keep their value in time or the erosion speed of buying power slows down.(iii)-the concept of monetary stability overlaps price stability. Hence price stability is an essential consideration in the macroeconomic stability of any economy via the process of monetary policy instruments. Nigeria’s monthly inflation rate for the period 2009- 2014 is given in table 4.1 and figure 4.1.
(ii) Attainment of a high rate of employment (full employment).
The monetary policy objective of full employment does not necessarily mean one hundred percent (100%) employment. Full employment is a situation in which everybody who wants to work gets work. Jhingan (2011) sees it as consistent with frictional and voluntary unemployment. The problem of full employment is one of maintaining adequate effective demand. Ackley (1978) opined that there was always a certain amount of frictional, voluntary or seasonal unemployment that exists at full employment. Hence the goal is to actually arrive at a minimum level of unemployment, though percentages are country specific. The problem of unemployment is greater during periods of increased inflation like what was observed during the Zimbabwean economic crisis. In Nigeria, unemployment is currently a serious issue, whenever there is an opening for employment the multitude that apply for employment is overwhelming, this was reflected during the immigration service's recruitment exercise that led to the death of so many applicants some years ago. There is a natural rate of unemployment at which the gross domestic product (GDP) is at its full employment level with no cyclical unemployment (Hall & Lieberman, 2003).
(iii) Achievement of a high, rapid and sustainable economic growth.
Economic growth has been severally defined as an increase in the quantity of goods and services produced in a country. Jhingan (2011) did see economic growth as the process whereby the real per capita income of a country increases over a long period of time. To Anyanwu (1993) this means the maximum sustainable high level of output, that is, the most possible output with all resources employed to the greatest extent, given the general social and organizational structure of the society at any given time. Ricci (2006) did posit that the results of a number of empirical studies on the impact of inflation on growth suggest a negative effect when inflation exceeds certain threshold levels and that that relationship was nonlinear, hence tackling inflation has impact on economic growth. The nonlinear relationship is such that the lower the inflation rate, the lesser the influence of inflation reduction on the economy.
(iv) Maintenance of balance of payments equilibrium.
The growth in world trade has led to a corresponding growth in liquidity in a global economy that has necessitated the need for the maintenance of the balance of payments equilibrium. This involves keeping international payments and receipts in equilibrium so as to avoid fundamental or persistent disequilibrium in the balance of payments position of any country (Anyanwu, 1993). A disequilibrium or imbalance1 in the balance of payments occurs when the credit in the balance of payments statement exceeds the debits or the debits exceed the credits (positive and negative imbalance respectively).
Monetary policy pursuit of this objective is understandable as a deficit in the balance of payments will negatively impact on the attainment of other objectives such as economic growth, inflation/price stability. Where there is an increase in income and price levels due to rapid economic development in developing countries, there will be an increase in imports and reduction in exports causing a deficit in the balance of payments (disequilibrium), the above increase in income and price levels is inflationary(Gaurav,2010). Xiaochuan (2016) did posit that monetary policy will undoubtedly be affected by the balance of international payments and capital flows and the question that this elicits is "should the balance of payments be an objective of central banks?'' the answer is in the affirmative. The balance of payments for Nigeria from 2009 to 2014 is in table 4.1 and appendix III.
(v) Exchange rate stability.
The maintenance of the stability as regards the value of the domestic currency against a basket of foreign currencies is essential, if there are wide swings in the currency exchange rate, it will impact on inflation, growth, price stability and balance of payment situation (Anyanwu, 1993). Swings in currency movements can impact on a country's revenue inflow in the case of devaluation and where there is an appreciation it makes the exports of the country more expensive leading to a drop in export volume and revenue, these swings will lead to rising prices and price instability. Whether there is an appreciation or depreciation of the value of the local currency, there are some economic implications, thus the attempt to keep an optimal exchange rate is essential thereby reducing variations or instability. Nigeria’s exchange rate vis –a-vi the US dollar is in table 4.1 and figure 4.3
Exchange rate stability was what Mario Draghi was referring to when he said '' Within our mandate, the ECB (European Central Bank) is ready to do whatever it takes to preserve the Euro and believe me, it will be enough.’’ (Draghi, 2012).In 2014, the Central Bank of Nigeria focused on achieving the objective of price and exchange rate stability in anticipation of the effects of the 2015 general elections (CBN,2015). Emefeile (2015) disclosed that due to "pressures on the local currency, that importers’ should restrict their imports to raw materials and equipment rather than finished products and food to reduce the pressure on the scarce foreign exchange".
The primary objective of monetary policy has been to ensure low inflation that will enhance sustained growth and it is in that vein that monetary policy in a country like Singapore is centered on the management of the exchange rate rather than money supply or interest rates, exchange rate is considered the most effective tool in maintaining price stability in that country (Parrado, 2004). The objective of an exchange rate stability policy was said to have played some role in containing inflationary pressures in a number of countries, particularly where there is strong exchange rate pass-through to inflation (Habermeir, Otkerrobe, Jacombe & Giustiniani, 2009).
(vi) Financial stability
The financial markets (money and capital markets) have a huge influence on any capitalist economy like Nigeria. In essence, monetary policy can only be effective if financial markets are fully integrated and function smoothly and efficiently (Oesterreichisch National Bank [ONB], 2015). Financial markets are channels to transmit monetary policy impulses to businesses and households in the economy as a means of achieving price stability. Financial instability can hamper the ability of any monetary authority in a free market economy at achieving price stability. Monetary policy first affects financial markets and institutions, then the real economy. Here high levels of inflation aid debtors at the expense of lenders. According to Blinder (1998) financial markets look for guidance from the Central Bank, the Central Bank looks for guidance from the financial markets. Conversely, financial markets provide useful information for a Central Bank in search of the optimal monetary policy path (Hildebrand, 2006).
Smets (2014) observed that as a result of the 2007-8 financial crises "there is a rethinking of monetary policy frameworks that were focused primarily on maintaining price stability; this has proven not to be a sufficient condition for financial stability and that lack of financial stability can have a negative feedback effects on price stability". The foregoing was confirmed by Blanchard (2009) when he posited that the mandate of monetary policy should include macro-financial stability and not just price stability. Financial markets’ "should be fully operational in order to serve as a conduit of monetary signals so as to enhance the efficiency of monetary policy" (Kireyev, 2015). The conclusion of Montes (2010) was that "financial stability must not be considered as a simple goal of monetary policy, but a precondition for Central Banks to operate their policies and reach goals of inflation and output stability". In Latin America, Al Nasser and Jackson (2012) found inflation to be negatively correlated with market capitalization and domestic value trade, which indicate that the higher inflation rates depress stock market development in Latin American countries.
Mishkin (2009) identified two types of risk that are particularly important for understanding financial instability such as:
(i)Valuation risk-refers a situation where the market realizing the complexity of a security or opaqueness of its underlying credit worthiness, finds it has trouble assessing the value of the security.
(ii)Macroeconomic risk- where there is an increase in the probability that a financial disruption will cause significant deterioration in the real economy. If there is a strain in financial markets, there can be a spill over to the broader economy and these results in adverse consequences on output and employment, (p. 3, 4).
Monetary Policy can be used to offset aggressive aggregate demand, preventing higher inflation from emerging (Frank & Bernanke, 2003). The process that involves the initiation, analysis, implementation and evaluation of policy is what is called a policy framework. In recent years, the Central bank of Nigeria has moved from a short-term monetary policy framework (annual) to a medium-term monetary policy framework (Central Bank of Nigeria [CBN], 2011a). Milton Friedman and other monetarists argued that money is the most important regulatory instrument in an economy and that money has a direct impact on the economy. By the Central Bank of Nigeria's definition, money supply has two basic components; (i) Narrow Money, (ii) Broad Money
(i)Narrow Money (M1)
This is Currency in circulation with non-bank public and demand deposits or current accounts in the banks. Focus is on means of payment (Onuigbo and Azubuike, 2012).
(ii)Broad Money (M2)
Broad money (M2) is made up of Narrow money, savings and time deposit, as well as foreign currency denominated deposits. Hence, Broad money refers to the measure that gives the total volume of money supply in the economy. When the money supply is greater or higher than the amount needed to achieve a non-inflationary output growth in the economy, there is excess money supply (or excess liquidity). Umeora (2010) stated that the Central Bank of Nigeria takes M2 as the generally accepted definition of money supply in terms of money aggregates.
Mordi (2009) opined that the "underpinning theory is the quantity theory and that this explains why the CBN and most other central banks target money. The theory is based on the link between the stock of money (M) and the market value of output that the money finances (PY), where P is the price level and Y is the output. M is said to be related to P with a factor of proportionality k," below is an expression of that relationship:
Abbildung in dieser Leseprobe nicht enthalten
Income (nominal GDP) to money stock or the number of times the stock of money turns over in a given period in financing the flow of nominal income. Thus V is a useful concept in policy making. Hence where this can be actually predicted, the level of money supply that is consistent with the attainment of the desired real growth and inflation rate can be determined by using the derived value of V. The number 3 equation can be written in growth form,
∆ M= ∆P +∆Y+ ∆V. (4)
If V is constant, then ∆ V = 0 so that (4) yields
∆ M = ∆P +∆Y.. (5) and this is the fulcrum of the CBN's monetary targeting.
"The operating target, base money is set based on the relationship between money supply and base money and, on the assumption of a stable money multiplier, k and is illustrated in equation (6),
M2 = kBM (6)
Where M2 is broad money supply, k is the money multiplier and BM is base money. Thus, the CBN controls the money supply by inducing changes in base money" (Mordi, 2009).Yu and Ming(2001) did observe that the monetary authorities adjust the monetary base, then the financial fields will experience changes in money supply and interest rates , this will followed by lending activities of deposit money banks and financial conditions of financial markets. The foregoing they felt will result in ''transmission to the real economy and impact on businesses and households, these in turn will make them to adjust their assets and change their investments and consumption expenditures, which will in turn influence the output and price in the whole society''. There is an assertion that one of the most established folk wisdom in monetary economics is a relationship, which in its practical version for monetary policy might be stated as; (1) long run inflation is related one-for-one with long run monetary growth, this ''Quantity Theory'' relationship seems firmly established at least since Friedman and Lucas, (Tele & Uhlig, 2013).
McCallum and Nelson (2010) criticized the conclusion of Svensson (1999) that monetary policy analysis is not relevant in the short run, citing Assemacher-Wesche and Gerlach (2007) that affirmed the use of money in policy analysis and did not acquiesce to the qualifier that “money growth and inflation are closely tied only in the long run". Their position is based on the fact that such irrelevance in the short run is supportive of the conclusion by Svensson (1999) that '' this long run correlation is irrelevant at the horizon relevant for monetary policy" .But Durevall and Sjo (2012) concluded concerning the economies of Ethiopia and Kenya that money supply growth affects inflation, and that its impact is in the short run, confirming the earlier conclusions of Durevall and Ndugu (2001) that money supply affects prices only in the short run.
Simpasa and Daniel(2012) looking at inflation dynamics in Ethiopia, Uganda, Kenya and Tanzania saw money supply as the main driver of short run inflation as a surge in money supply accounted for a 40% and one-third rise in inflation. In South Africa Akinboade, Srebrils and Niedermeir (2017) observed that in the short run there was a positive correlation between money supply and domestic inflation. Thus Central banks that target money are bound to defer on the conclusions of Svensson as they see money growth as having short run implications for macroeconomic stabilization.
Adedoyin (2006) observed that changes in money supply have a monotonically increasing relationship with prices although with some lags and that evidence from impulse response functions tend to show monetary aggregates as good predictors of price movement in Nigeria. To attain the objectives of Monetary Policy, (which includes price stability and sustainable economic growth), Central Banks in every nation will focus on; (i) Operational targets,(ii) Intermediate targets,(iii) Ultimate targets.
Based on the above, the decision taken as a monetary policy could either be expansionary or contractionary actions in order to contain money supply;(i)Expansionary Monetary Policy refers to the actions taken by the Central Banks' of every nation that leads to an increase in the volume of money (money supply) in the economy. This happens when there is a recession in order to stimulate growth or an increase in economic activity. In the US, the expansionary monetary policy of the Federal Reserve, which has been in place since the beginning of the financial crisis has arguably put the US economy on the road to recovery (Artus, 2013).
When the Central Bank of Nigeria reduces the monetary policy rate (MPR) or reduces the bank reserve requirement of deposit money banks, such policy measures are expansionary. Thorbecke (1997) in relating it to the financial markets posited "that expansionary monetary policy increases expost stock returns, exposure to monetary increases and asset ex-ante return'', (ii) Contractionary Monetary Policy refers to actions taken by the Central Banks' in order to reduce the volume of money (Money Supply) in the country's economy. These are the measures adopted to curb or reduce inflation and inflationary pressures in the country's economy. Friedman (1963) argued that "sufficiently tight monetary policy maintained for sufficiently long time could halt even the most deeply rooted inflation".
Handa (2009) was able to identify Monetary Policy Tools, Targets, and Goals as specified below:
Table 2.1Monetary Policy Tools, Targets & Goals
Abbildung in dieser Leseprobe nicht enthalten
Source-Handa (2009)
The Central Bank of Nigeria [CBN] (2011a) identified at least three issues that arise in its selection and use of the goals, intermediate variables, operating targets and instruments;
(i)-Establishing the existence or otherwise of a stable and predictable relationships between the ultimate goal variables, intermediate variables and operating targets.
(ii)-Whether the monetary authorities can actually achieve the desired level of the operating targets with the instruments at their disposal
(iii)-Establishing the nature of the lag structure (short or long i.e. when a policy is made, implemented and when its effect is felt) which has the implication of influencing prediction of the future course of the economy as it becomes increasingly less precise in the presence of long lags.
Monetary policy affects or impacts on the economy in two major ways: the magnitudinal (size) dimension and the time dimension. Wasim(2007) as regards the time dimension of lags stated that monetary policy in Pakistan responds to inflation positively but only after two-quarters (lag period).The time dimension measures the lag in the effect of monetary policy (Friedman, 1968; Culberton, 1961; Ando, Brown, Solow & John, 1963; Ranlett, 1977; & Anyanwu, 1993). The Central Bank of Nigeria [CBN] (2011) further identified two main intermediate targets; Monetary Aggregates and Interests Rates that the monetary authority should adopt. Which policy to be adopted is dependent on;
(i)The structure of the economy, and
(ii)The source of the exogenous shocks to the economy to a lesser extent
The second measure was explained using IS-LM framework, by Poole (1970) as was well illustrated by Handa (2009) in table 1,
(a)Where the shocks to the economy arise from the commodity market, targeting the interest rate produces greater fluctuations in aggregate demand than money supply targeting. Hence, in a situation like this, monetary policy will target money supply, e.g. crude oil price shocks (drop in price), (b) Interest rate targeting will be considered when the shock arises from the money market because targeting money supply will lead to greater fluctuations in aggregate demand than interest rates. Which policy option to be adopted will depend on consideration of the source of the dominant shocks to the economy before making the choice.
2.4 Strategies of Monetary Policy to Achieve Macroeconomic Stability
When a strategy of monetary policy is to modify the amount of base money (M1) in the economy, through the sale or purchase of government securities, the process is referred to as Open Market Operation (OMO) (CBN, 2011a). The Eurosystems regular open market operations consist of one-week liquidity-providing operations in the Euro ( main refinancing operations, or MRO,s) as well as three-month liquidity-providing operations in Euro (longer-term refinancing operations, or LTRO's).Where as the MRO's serve to steer short-term interest rates, to manage the liquidity situation and to signal the monetary policy stance in the Euro area, the LTRO's provide additional, longer-term refinancing to the financial sector, (European Central Bank[ECB],2015). The table below shows that the difference in strategy adopted in Monetary Policy is dependent on the set of instruments/Tools;
(i)Targets
(ii)Variables used by the monetary authority to achieve the goals
Table 2.2 Monetary Policy Frameworks'
Abbildung in dieser Leseprobe nicht enthalten
Source CBN, 2011
The target is the value that the monetary authorities shoot at in determining their appropriate policies. Anyanwu (1993) saw it as a desired value of an endogenous variable chosen by a policy maker and which is observable with little or no time lag. Brunner and Meltzer (1969) saw the target problem as choosing the optimal strategy or strategies to guide monetary policy under the condition of uncertainty and lags, based on when the information is received and when its effect is felt with little or no time lag.
2.4.1 Monetary Targeting
The approach of monetary targeting has the growth in money supply as its target variable and its main long-term objective is price stability (CBN, 2011b).The main approach is to keep a keen watch of the growth in monetary aggregates as a means to be able to determine the future size of the money supply.
(i)When there is a quick growth in monetary aggregate, it will cause inflationary pressures as prices will rise. What the monetary authorities do is to increase the interest rate as a measure to reduce or stop the growth in monetary supply.
2.4.2 Price Level Targeting
Price level targeting takes into consideration past years when there were open market operations. If the price level last year has increased by 30% (from 100 to 130). The next year's price level has to drop by 30% in order to bring the price level back to the 100 target level.
2.4.3 Inflation Targeting
Under inflation targeting the monetary authority (Central Bank) sets out and declares publicly a projected or “Target” inflation rate and implements or rather uses monetary policy tools to arrive at the inflation target. Truman (2003) in Uchendu (2009) saw it as a constrained discretion “in which the constraint is the inflation target which may be a point or a range, and that the discretion is the scope and flexibility to take account of economic and other considerations. Inflation targeting affects investors’ decisions as they know the target inflation rate and can estimate the changes in interest rate and factor it into their decisions.
Svensson (1998) concluded that inflation targeting is characterized by; (a) An explicit quantitative inflation target, (b) An operating procedure, inflation forecast targeting, which uses an internal conditional inflation forecast as an intermediate target variable, (c) A high degree of transparency and accountability. He explained further that the explicit inflation target is either in the form of an interval (as in the Nigerian case 6-9%) or a point target. The inflation rate becomes the nominal anchor for monetary policy as every other intermediate and operating strategy became subservient to the inflation rate focus. In Nigeria, the Central Bank has not transited into a full-fledged inflation targeting regime. Though the target from the range of 6-9% is still in focus as part of its monetary policy considerations, yet elements of the monetary targeting regime such as target variables and operating variables are still in place. Ojo (2013) observed that inflation targeting framework for the conduct of monetary policy takes into consideration the fact that monetary policy takes time to have an impact on the economy.
The policy of the central bank is thus based on changes of a forecast of inflation and not on the historical rate. The policy adjustment is based on monetary aggregates as well as the secondary focus on the range of inflation. Jahan (2012) did posit that inflation targeting was the product of a pragmatic response by many Central Banks to the failure of other monetary policy regimes that focused on money supply or the value of the currency in relation to another more stable currency.
2.5 Tools of Monetary Policy
Monetary policy is used by the central bank or any other monetary authority to control the supply of money in order to arrive at price stability as well as a lower rate of inflation. Aluko (1986) stressed that an effective monetary policy is judged according to whether it is able to maintain not only monetary and economic stability, but also whether it assists in increasing utilization of the country’s economic resources and securities in the economy, and the highest degree of the welfare of the largest number. The instruments/tools adopted by the monetary authority to carry out monetary policy are based on the level of economic development. There are two broad instruments/ tools. (i)Direct tools of Monetary Policy, (ii) Indirect tools of Monetary Policy
2.5.1 Direct tools of Monetary Policy
The approach adopted by the monetary authority can be summarized thus as direct tools of monetary policy, (i) directing Deposit Money Banks on the amount of credit (maximum) that can be given to separate sectors of the economy e.g. Agriculture etc.(ii) Interest rate caps,( iii) Liquid asset ratio and (iv) Issuing of credit guarantee to preferred loans.
2.5.2 Indirect Instruments of Monetary Policy
(1)The reserve requirement
This is used by the monetary authority to control the ability of banks' to grant loans. Onuigbo (2012) observed that central banks require the commercial and other banks to hold a fixed proportion of assets in a certain form. The imposition of these reserve requirements is effective because when these banks find that their ratios of reserve assets have fallen to their minimum permitted levels, they will do one or two;(a) Stop increasing their holding of non – reserve assets, i.e. stop making loans and advances or (b) Try and borrow more from their depositors. The bottom line is raising interest rate and so restricts the growth in the money supply. Hence, if they are to stop lending they will; (c) Raise their lending rates to discourage borrowing. (d) Try to acquire additional reserves by bidding more actively for deposits. They will increase the cost of capital or funds which will in turn increase lending rates and so check borrowing, Onuigbo (2012).
The reserves requirements follow two paths; (a) when the money supply is to be increased, it is lowered in order to increase the capacity of banks to grant loans and positively increase money supply. (b) When the money supply is to be decreased, the reserve requirement is increased in order to reduce the ability of banks to grant loans in order to influence the reduction in the money supply. An example is the decision of the Uruguayan Central Bank in March 2013, when it raised the reserve requirement on local and foreign currency deposits as part of its effort to bring inflation within the official target range. Local pesos-25% from 20%, foreign currency 45% from 40% (Reuters, 2013).Nigeria’s cash reserve requirement for the period covered by our research is in table 4.1( i.e. 2009-2014).
(2) Open Market Operation (OMO)
(i) The buying and selling of government securities in the open market (primary or secondary). This is done to increase or reduce the amount of money in the banking system and indirectly in the economy. The purchase and sale of securities in the open market by a Central Bank is a key tool used by the Federal Reserve in the implementation of its monetary policy (Federal Reserve Bank [FRB], 2003). Bordo and Sinha (2016) discovered that "the 1932 open market operations conducted by the Federal Reserve during the Great Depression, were effective in lowering Treasury yields and boosting output growth as was evident in the Federal Reserve response in the 2008-2009 crises." (a) If there is a purchase of government securities (Treasury Bills etc), then the monetary authority is simply injecting money into the banking system and this increases growth. (b) Where there is a selling of government securities the monetary authority is indirectly trying to remove the excess liquidity from the economy or the banking system. The treasury bills rate for Nigeria 2009-2014 is given in table 4.1 and figure 4.5.
Open market operations are used to control the cost and availability of reserves and this influence changes in bank credit and money supply (CBN, 2011c). Onwumere, Imo and Ugwuanya (2012) did observe that open market operation (OMO)
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- Tonprebofa Okotori (Autor:in), 2017, Monetary Policy and its Effects on Inflation in Nigeria 2009 - 2014, München, GRIN Verlag, https://www.grin.com/document/433182
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Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen. -
Laden Sie Ihre eigenen Arbeiten hoch! Geld verdienen und iPhone X gewinnen.