THE EFFECTIVENESS OF MONETARY POLICY TOOLS IN CONTROLLING INFLATION IN NIGERIA

Abstract

The study examined the effectiveness of monetary policy in controlling inflation in Nigeria.  In the model specified, inflation is the regress and while cash reserved requirement, liquidity ratio, money supply, minimum rediscount rate and interest rate are the regressor.  Data was collected from CBN statistical Bulletin.  The statistical techniques used for the analysis is the ordinary least square technical with the aid of E-view 5.0 software package.  The research indicates that monetary policy adopted in Nigeria within the period under review failed to influence the inflation rate.  It has been identified that the major problem militating against the poor performance of monetary policy instrument in controlling inflation in Nigeria is time lags involved which makes any policy employed to take many months to achieve its full effect.

CHAPTER ONE

INTRODUCTION

• Background of the study

Inflation occurs when there is a general and continuous rise in the prices of goods and services in the economy. A major cost is related to the inefficient utilization of resources because economic agents mistake changes in nominal variables for changes in real variables and act accordingly. During inflationary periods opportunity cost of holding money is increased causing inefficient use of real resources in transactions. Therefore, inflation weakens the purchasing power of money and sinks the standard of living of the citizenry. Policy makers have tried to adopt appropriate policies that can combat inflation and ensure price stability. Generally, the level of money supply and the stock of goods and services are two crucial factors that determine the level of inflation in an economy. When inflation becomes persistent, the duo becomes the primary targets of policies. An excess or shortage in the supply of money could either induce excess aggregate demand resulting in higher inflation rate or induce stagnation thus retarding economic growth and development. While fiscal policy proves helpful in combating inflationary pressure, monetary policy has been the principal tool often employed by the central banks to ensure price stability. While it is not arguable that monetary authority have formulated various policy measures as an attempt to curbing inflationary menace, the effectiveness of policy pursuit to curb inflationary environments is questionable as most economies, particularly developing ones still experience inflationary challenges. For years, the Nigerian economy faced socio-economic stagnations traceable to inflationary spiral, particularly in the 1970s when inflation increased to a double digit. The analysis of the non-core inflation in the early 1990s reveals inflation rate of 63.6% in late 1994. Headline inflation rose rapidly by 1995 to reach an alltime high of 72.8%, though it decelerated gradually to a single digit in 1997. In the same vein, core inflation, which began a gradual ascent in early 1990, peaked at about 69.0% in the mid-1995 before slowing down in 1997. Since, then inflation remained at single digits between 1998 and 2001. In 2003, macroeconomic stability was restored, following the gains of a comprehensive and consistent economic reform program. The low inflation rate regime did not last for too long with the resurgence of spikes in headline and core-inflation between 2000 and 2001. Headline inflation rate remained at double digits between 2002 and 2005 as it recorded 12.9%, 14%, 15%, and 17.9% in the respective years. However, it decelerated dramatically to 8.24% and 5.38% in 2006 and 2007 before rising astronomically to 11.60% and 12.00% in 2008 and 2009 in that order, although fell marginally to 11.8% and 12.3% in 2010 and 2013 respectively

Monetary policy entails the government policies aimed at changing the quantity of money or credit condition for example, open market operation or changes in required reserved ration etc. Monetary policies involve changes in the quantity of money held by the public. In our economy, there are two types of money most obviously- the naira bills and coins which you have in your pocket and money. In every economy, after fiscal policy, the next most powerful macro-economic stabilization is monetary policy. In fact Monetary and fiscal policies are expected to work together as complements to achieve one goals of a sound macroeconomic management that include amongst other domestic price stability external sector viability as well as enhance efficiency in resource allocation, distribution and utilization. Monetary policy is therefore measure designed to regulate and control the volume, cost, availability and direction of  money and credit in an economy to achieve some specifically micro-economic objectives. It is one policy that seeks to influence economic activities using the tools available to the central bank i.e. money supply (MS) interest rates and exchange rates. It can also mean the deliberate attempt by the authorities to either control the supply of money or to control interest rates or to ration the amount of credit granted by banks.

1.1 HISTORICAL BACKGROUND OF THE STUDY

The history of economic growth shows that, economic transformation started in England in the late eighteen century and gradually spread to other parts of Europe and North America. Economic transformations did not get to other parts of the world until in the 1950s when Japan transformed to become one of world’s major industrial giants. This economic transformation has spread far and wide in the recent times but its spread is highly limited in Africa. It is only South Africa that has experienced it so far. This is clearly demonstrated by the World Bank report of (2001) which states that out of the 46 poorest countries in the World, 35 of them are in Africa. Nigeria with its vast resources of both human and material nature is not left out of the club of poverty stricken countries. This poverty is illustrated by the recent World Bank report (2005), which says that more than 70% of Nigerians are living below poverty line. It is against this background that this study is being undertaken. Poverty can be tackled using both fiscal and monetary policies to help solve this problem and growing poverty, removing the country from poverty trap that seems almost impossible to be solved.

1.2 OBJECTIVE OF THE STUDY

The objectives of the study are;

1. To provide the readers with broad knowledge of the different activities carried out by the Central Bank of Nigeria in Nigeria’s macro-economic stabilization process.
2. To Enlighten students, readers and researchers on the significance of Central Bank of Nigeria and its role in the process of Nigeria economic development.
3. To highlight the relevance of monetary policy in combating inflation.
4. To explain the various types of monetary policy that can be used to combat inflation and other macro-economic problems.
5. To discuss the monetary policy problems with particular reference to Nigeria.
6. To explain the various instruments of monetary policy that can be used to combat inflation especially in less developed Countries (LDCS) such as Nigeria.

1.3 RESEARCH HYPOTHESES

For the successful completion of the study, the following research hypotheses were formulated by the researcher;

H₀: there are no various types of monetary policy that can be used to combat inflation and other macro-economic problems

H₁: there are various types of monetary policy that can be used to combat inflation and other macro-economic problems

H₀²: there are no monetary policy problems with particular reference to Nigeria.

H₂: there are monetary policy problems with particular reference to Nigeria.

1.4 SIGNIFICANCE OF THE EXTENDED ESSAY

This research study will however assist the economy to derive possible solution to the research problem e.g. control of inflation using monetary policy measures as adopted by the monetary authorities. Furthermore, the researcher ex-rays the various types of monetary policy measures, which can be used to combat the problem of inflation in the economy. Government will benefit immensely from this research works as the topic is very relevant in the field of macro-economic policy formulation.

1.5 SCOPE AND LIMITATIONS OF THE STUDY

This project covers the role of monetary policy and its controlling inflation in the Nigeria economy. A general overview of monetary policy and inflation in the Nigerian economy is the foundation upon which the project is developed. However, study of this nature is known to be subject to a number of problems or constrains, which are peculiar to the Nigerian society such as financial constraints. This research work was not an exception the problem of visiting the Central Bank of Nigerian and some other places for data collection involved spending a lot of money or transport expenses. Hence, the predicament of the overage students can therefore be imagined. Furthermore, the issue of office protocols time limit, secrecy inadequate research materials also were some setbacks to the researchers in carrying out this research.

1.6 ORGANIZATIONAL STRUCTURE OF THE STUDY

A Central Bank is a financial institution owned by the government of a nations run by Board of Directors, Chaired by Governor appointed by the government and charged with the responsibility of managing the expansion and contraction of the volume, cost and availability of money in the interest of public  welfare. It is primarily a non- profit entity in U.S. it is called the Federal Leisure while in the U.K. it is the bank of England.

1.7 DEFINITION OF TERMS

Expansionary Monetary Policy: Is a monetary policy that seeks to increase the size and volume of money supply, it can be increase by buy bonds in exchange for hard currency payment to adds that amount of currency to the money supply.

Contractionary Monetary Policy: This is the policy that can be implemented by reducing the size and volume of monetary base by the way of sell bonds in exchange for hard currency, by so doing it removes that amount of currency from the economy.

Reserve Requirement: Commercial banks are required to maintain certain reserve requirement in order to control their liquidity and influence their credit operations, these are usually expressed as a percentage of customers deposits.

Discount Rate: The discount rate is the rate of interest the monetary authorities charge the commercial banks on loans extended to them. If the Central Bank wishes to increased liquidity and investment, it reduces the discount rate, and on the other hand if the Central Bank wishes to reduce liquidity in economy, it raises the discount rate.

Liquidity Ration: The Central Bank imposes upon the bank a minimum liquidity ratio, being vary to the needs of the situation. It is designed to enhance the ability of bank to meet cash withdrawals in them by their customers. Such liquidity ratio stands for the proportion of specified assets.

Open Market Operation (OMO): This involves the Central Bank Discretionary power to sell or purchase securities in the financial market in order to influence the volume of credit and interest rate which consequently affect money supply. The securities include treasury certificates, treasury bill and development stock

Moral Suasion: Is the act of public pronouncements or outright appeal on the apart of monetary authorities to the banks requesting them to operate in a particular direction for the realization of specified government objectives.

Economic Growth: This is a process whereby the real per-capital income of a country increases over a long period of time. Economic growth is measured by the increase in the amount of goods services produced deposits are savings and currents account of deposits in a commercial bank.

Money Supply: Is a currency with the public and demand deposits with commercial banks. Demand deposits are savings and current account of depositors in a commercial bank.

Economic Life Cycle: This refers to a view of product design, each stages of the product’s life is assessed in terms of cost, at each stage of this life cycle choice have to be made.

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