1.1 Background to the Study
Macroeconomic policy consists of the actions aimed at inducing appropriate changes in macroeconomic aggregates such as output, employment and the price level. The major components of macroeconomic policy include fiscal, monetary, debt management, exchange rate and prices and incomes policies. The objectives of macroeconomic policy include price stability, balance of payments equilibrium, a satisfactory rate of growth and a high level of employment of the labour force. Monetary policy being one of the available tools of macroeconomic policy assists in the pursuit of these macroeconomic objectives.
Monetary policy refers to the actions undertaken by a central bank to influence the availability and cost of money and credit as a means of helping to promote national economic goals. The policy which aims at controlling the growth of the monetary aggregates is expected to assist the other policy tools in achieving the pre-stated macroeconomic objectives as well as economic growth. Monetary policy is very important because it can go further than some of the tools in helping to attain the overall policy goals but it must be supported by these other tools. The Central Bank of any country makes use of monetary policy instruments to influence the level of money supply in the economy.
The monetary policy instruments are the direct means available to the monetary authorities for influencing the intermediate variables to achieve the ultimate goals of policy. Monetary policy instruments are of two types: first, quantitative, general, indirect or market-based instruments; and second, qualitative, selective or direct control instruments. The direct control instruments are discretionally manipulated to achieve some set targets while the market-based instruments are employed in a well developed financial system to influence market participants in such a way that the desirable targets are achieved. The indirect instruments include bank rate variations, open market operations and changing reserve requirements and they regulate the overall level of credit in the economy through commercial banks. The direct instruments on the other hand are aimed at controlling specific types of credit and they include changing margin requirements and regulation of consumer credit. While the indirect instruments have been used very extensively in the more developed market economies, the direct instruments predominate in less developed economies such as ours. Both techniques aim at influencing the cost and availability of banking systems credit. The direct technique involves fixing of credit ceilings and interest rates by the monetary authorities for compliance by banks, while the indirect technique achieves the same objective through the financial markets. The most potent instrument of the indirect or market based technique is Open Market Operations (OMO).
In the Nigerian case, the design and implementation of monetary policy between 1970 and 1985 had the primary objectives of maintaining relative price stability, a healthy balance of payments position and stimulation of output and employment. Throughout this period, monetary policy depended on the use of direct monetary instruments such as the prescription of aggregate credit ceilings, use of selective controls, imposition of special deposits, among others. The most popular instrument used at this time was the issuance of credit rationing guidelines to the commercial banks. A number of reserve requirement guidelines were also in use. The prolonged used of these direct controls generated considerable problems and became counter-productive. Some of these negative effects of direct controls include reduced competition in the financial system, leading to inefficiency and misallocation of resources in the banking sector. Credit ceilings generated arbitrary and high lending rates, lack of transparency in transactions and the employment of various ploys to circumvent the controls by window-dressing, the use of off- balance sheet items and the channeling of transactions through uncontrolled institutions, especially finance houses which mushroomed. This led to monetary policy under a liberalized economy.
In the specific environment of financial and economic liberalization, monetary policy objectives remained the same – promotion of price stability, maintenance of external equilibrium and stimulation of output and employment. Monetary policy was also to stabilize the economy in the short-run and to induce the emergence of a market-oriented financial sector for effective mobilization of financial savings and efficient allocation of resources. The monetary control framework remained essentially the same at the initial stage of the programme, but several dynamic reforms were introduced ad the implementation of the programme progressed. Here, there was a shift in the policy instruments used from the direct instruments to the indirect instruments. As a result of the problems posed by the direct monetary control, the Central bank embarked on the selective removal of all credit ceilings of banks that met some criteria under the prescribed prudential guidelines and the indirect approach to monetary policy was initiated.
Deregulation of interest rates was a major policy instrument early in the programme. Early in 1987, the interest rate structure was adjusted upward to improve efficiency in savings mobilization and resource allocation. The use of stabilization securities was reintroduced in 1990 to put a check on the incidence of excess liquidity. The minimum paid up capital for commercial and merchant banks was also raised to ensure the soundness of the banking sector for effective monetary management.
In September 1, 1992, there was a major change in monetary operating techniques, from the use of direct control to indirect control operating techniques. The CBN, lifted credit ceiling imposition on individual banks that met CBN requirements on selective basis in respect of minimum capital base, capital adequacy ratio, cash reserve and liquidity ratio requirement, prudential guidelines, sectoral credit allocation and sound management. On June 30, 1993, CBN commenced OMO in treasury securities with banks through discount houses on a weekly basis. With the introduction of indirect monetary control instrument, CBN now controls the stock of money (from banks and non-bank public) through manipulating the monetary base or reserve aggregates. This study is of great importance since it will provide an insight into the extent to which monetary policy can be relied upon for the attainment of macroeconomic objectives in the country.
1.2 Statement of the Problem
Nigeria as a country has been plagued by many macroeconomic problems, including low level of economic growth and instability. As a result, there has been a need for all stakeholders to contribute their quota in ensuring that the economy’s performance is at its peak. The government, as well as the Central Bank is instrumental in achieving this. The government carries out its obligations of ensuring a healthy macroeconomic environment by way of administering fiscal policies while the Central Bank carries out its own duty by means of monetary policies. The state of economic degradation brings about the need for appropriate and workable monetary policies to ensure that pre-determined macroeconomic objectives are achieved.
The adoption of monetary policies in Nigeria is not a recent development but is one that has been in use since the early 1970s. Since then, there have been a lot of problems in the conduct of monetary policy in the economy. This resulted in the shift from the use of direct monetary policy instruments to the indirect monetary policy instruments that are in use till date.
There has been a growing interest on price stability as a major goal of monetary policy. This is as a result of recent developments in economic theory which tend to show that a reduction in the inflation rate impacts measurably and positively on economic growth (Uchendu, 2000).
1.3 Scope of the Study
The study attempts to examine the relationship between monetary policy and economic growth in Nigeria in the period of 1971 to 2005. The choice of this period is necessitated by various factors. First, both positive and negative effects of monetary policy have been observed especially in the period before the Structural Adjustment Programme. During this period, direct control measures were used to regulate the money supply in the country. This therefore resulted in a lot of malfunctioning in the economy. Also, indirect controls were put in place by the Central Bank. Till date, both the direct and indirect controls are in use by the Central Bank to control the price level in the economy. The choice of the above period is also necessitated by the availability of data for the research work.
The study focuses mainly on the money supply because of the belief that the institution of various monetary policy instruments is meant to change the volume and value of money supply.
1.4 Objectives of the Study
The broad objective of this study is to find out how effective the instruments of monetary policy are in promoting economic growth in Nigeria. The specific objectives are as follows:
To analyze the relationship between monetary policy and economic growth in Nigeria. To assess the effectiveness of monetary policy as a tool for promoting economic growth in Nigeria. To identify challenges facing the proper implementation of monetary policy in Nigeria.
1.5 Justification of the Study
Monetary policy is one of the instruments of economic policy formulation and implementation. There is a general belief in the capability of monetary policy to significantly alter the behaviour and the structure of the financial sector so much that monetary and financial resources are released for development of the economy. This belief which waned from 1940s to 1960s became strong again in the 1970s and 1980s especially during the revival of the importance of monetary policy following the wind of Structural Adjustment Programme introduced in June 1986.
The belief in the effectiveness of monetary policy is based on the premise that monetary policy affects expenditure decisions in the monetary and financial system. This causes variations in the relative asset yields and in wealth, thereby influencing the volume and structure of asset which people want to hold. It is through the substitution effects of the expenditure decisions on the savings and investment decisions of the productive sectors of the economy that monetary and financial resources are made available for economic growth and development. In the light of the importance of monetary policy, this study becomes relevant since it will help to ascertain its relative effectiveness in Nigeria.
1.6 Research Questions
Answers were sought to the following questions in the course of this study
What relationship exists between monetary policy and economic growth in Nigeria? How effective is monetary policy as a tool for promoting growth in Nigeria? What challenges face the proper implementation of monetary policy in Nigeria? Does causation exist between nominal money and economic growth?
1.7 Research Hypotheses
As a means of achieving the above stated objectives, the following hypotheses were tested to determine the relationship between the variables:
H0: There is no causation between nominal money and economic growth.
H1: There is a causation between nominal money and economic growth.
1.8 Research Methodology
The model specification adopted is the Ordinary Least Square technique(OLS) . Descriptive analysis is carried out using the Pearson Product Moment correlation coefficient and the Unit Root Test (Augmented Dickey Fuller) . The causality test is done using the Granger causality tests.
1.9 Sources of Data
The data sources are secondary in nature. All relevant is sourced from the Central Bank Statistical Bulletin and supplemented by data from the United Nations Statistics Division.
1.10 Outline of the Study
The work is divided into chapters to ensure that there is a clear understanding of the issue of monetary policy and economic growth in Nigeria. The study is arranged as follows. Chapter 1 consists of the introduction, statement of the problem, objectives, research problem, justification of the study, scope of the study, and outline of the study. Chapter 2 contains the literature review and analytical framework. This is a simple and brief general review of issues surrounding the topic of study as well as an examination of past and relevant literatures done by others in relation to the topic of study. Chapter 3 comprises the research methodology and it seeks to find and explain an economic theory which can be associated with the study. Chapter 4 shows the empirical analysis which is simply the presentation of results and their analysis and interpretation. Chapter 5 consists of summary, conclusion, policy recommendation, and suggestions for further research.
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