THE INFLUENCE OF MONETARY POLICY ON NIGERIA'S ECONOMIC GROWTH

CHAPTER ONE

INTRODUCTION

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 economic growth, 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 (Amato, & Gerlach, 2022).

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 (Anguyo, 2021).

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 (Azam, 2021). 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) (Amato, & Gerlach, 2022).

In the Nigerian case, the design and implementation of monetary policy between 1970 and 1985 had the primary objectives of maintaining relative economic growth, 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 (Anguyo, 2021). 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 (Azam, 2021).

In the specific environment of financial and economic liberalization, monetary policy objectives remained the same – promotion of economic growth, 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 The activities that are taken as part of macroeconomic policy are those that are directed toward the goal of inducing suitable changes in macroeconomic aggregates such as production, employment, and the price level. The fiscal policy, the monetary policy, the debt management policy, the exchange rate policy, the prices and incomes policies are the primary components of macroeconomic policy. The goals of macroeconomic policy include several things, including the expansion of the economy, the maintenance of a stable balance of payments, a suitable rate of growth, and a high employment rate among the working population. The use of monetary policy, which is one of the tools that are accessible to macroeconomic policymakers, contributes to the achievement of these macroeconomic goals (Amato, & Gerlach, 2022).

The activities made by a central bank to impact the availability and cost of money and credit as a method of assisting to accomplish national economic goals are referred to as monetary policy. These acts are performed in the name of the central bank. The policy that aims to control 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. This expectation is based on the assumption that the policy will have a positive impact on economic growth. Because it may go farther than some of the other instruments in assisting with the achievement of the overall policy goals, monetary policy is extremely essential; nonetheless, it is necessary for these other tools to support it. Any nation's central bank will employ several instruments of monetary policy in order to exert some amount of control over the quantity of money in the economy (Anguyo, 2021).

The instruments of monetary policy are the direct methods that the authorities in charge of monetary policy have at their disposal for affecting the intermediate variables in order to attain the policy's ultimate objectives. There are two distinct categories of monetary policy tools: first, quantitative, general, indirect, or market-based instruments; and second, qualitative, selective, or direct control instruments. Both categories are subdivided further into subcategories. The direct control instruments are subject to arbitrary manipulation in order to accomplish certain predetermined goals, whereas the market-based instruments are utilized within an advanced monetary system in order to exert an influence on market participants in such a way that the desired goals are accomplished (Azam, 2021). Variations in bank interest rates, open market operations, and shifting reserve requirements are examples of indirect instruments. These instruments govern the total quantity of credit in the economy by working via commercial banks. Direct instruments, on the other hand, are geared at managing particular categories of credit; examples of direct instruments include modifying margin requirements and regulating consumer credit. These instruments try to restrict specific forms of credit. In highly established market economies, indirect instruments have been employed to a significant extent; but, in economies with less economic development, such as our own, direct instruments have been used more frequently. Both strategies have the end goal of affecting both the cost and availability of loans inside the banking sector. In the direct method, the monetary authorities set loan ceilings and interest rates, and it is the banks' responsibility to comply with such regulations. On the other hand, the indirect method accomplishes the same goal through the functioning of the financial markets. Open Market Operations (also known as OMO) are the most effective instrument of the market-based approach known as indirect technique (Amato, & Gerlach, 2022).

In the case of Nigeria, the key goals of the design and execution of monetary policy between 1970 and 1985 were to sustain relative economic growth, a healthy balance of payments position, and the encouragement of production and employment. This was the case throughout the whole period. During this time period, monetary policy was dependent on the utilization of direct monetary tools such as the prescription of aggregate credit ceilings, the utilization of selective controls, and the imposition of special deposits, amongst other direct monetary instruments. The most common method that was utilized during this time period was the distribution of credit restriction guidelines to various commercial banks. In addition to it, a variety of reserve requirement standards were implemented. The continued employment of these direct controls led to a significant increase in issues and ultimately proved to be counter-productive (Anguyo, 2021). Direct restrictions can have a number of unfavorable outcomes, including a reduction in competition within the financial system, which can lead to inefficiencies and the inappropriate distribution of resources within the banking industry. Credit ceilings resulted in arbitrary and high lending rates, a lack of transparency in transactions, and the employment of various strategies to circumvent the controls. These strategies included window-dressing, the use of off-balance sheet items, and the channeling of transactions through uncontrolled institutions, particularly finance houses, which mushroomed during this time period. Because of this, monetary policy developed inside a liberalized economy (Azam, 2021).

In the context of the unique environment of financial and economic liberalization, the objectives of monetary policy remained the same. These objectives included the stimulation of production and employment, the promotion of economic development, and the maintenance of external balance. Monetary policy was also intended to stabilize the economy in the short-run and to induce the emergence of a market-oriented financial sector for the purpose of effectively mobilizing financial savings and efficiently allocating resources. These goals were to be accomplished through effective resource allocation and effective financial sector market orientation. In the beginning stages of the program, the fundamental structure of the monetary control framework was not significantly altered; nevertheless, as the program's implementation advanced, a number of dynamic changes were implemented. In this instance, direct policy instruments were replaced with indirect policy instruments as the primary mode of action taken by the government. As a response to the challenges brought about by direct monetary control, the Central Bank began the process of selectively removing all credit ceilings imposed on banks that satisfied certain criteria outlined in the prescribed prudential guidelines. At the same time, the Central Bank also initiated an indirect approach to monetary policy (Amato, & Gerlach, 2022).

Early on in the program, deregulatory action regarding interest rates was a significant policy instrument. At the beginning of 1987, the interest rate structure was changed so that savings could be mobilized more effectively and resources could be allocated more effectively. In 1990, the practice of utilizing stabilization securities was restarted in order to serve as a deterrent against the occurrence of surplus liquidity. Additionally, the required amount of minimum paid-up capital for commercial and merchant banks was increased in order to guarantee the robustness of the banking system and facilitate the efficient administration of monetary policy (Anguyo, 2021).

The usage of direct control operating methods was replaced with indirect control operating techniques as of the 1st of September, 1992, resulting in a significant shift in the monetary operating strategies that were utilized. Individual banks that met CBN requirements on a selective basis regarding minimum capital base, capital adequacy ratio, cash reserve and liquidity ratio requirement, prudential guidelines, sectoral credit allocation, and sound management had the credit ceiling imposed on them lifted. This was done by the Central Bank of Nigeria (CBN). On the 30th of June in 1993, the CBN started conducting open market operations (OMO) in treasury securities with banks and discount houses on a weekly basis. With the advent of indirect monetary control instruments, the Central Bank of Nigeria (CBN) now exercises control over the stock of money (originating from banks as well as the general population that does not use banks) through manipulating the monetary base or reserve aggregates (Azam, 2021). This study is of utmost importance because it will shed light on the degree to which macroeconomic goals in the country may be achieved by relying on monetary policy, and it will also give an insight into how this degree might be determined.

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 economic growth 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).

Research Questions

1. How do interest rate, exchange rate and inflation respond to shocks in monetary policy rates (MPR)?

2. What is the impact of monetary policies on economic growth of Nigeria.

Objectives of the Study

The General objective of the study is to find out the extent to which monetary policy (captured by MPR) could bring about Economic growth (stability in inflation, interest and exchange rates) in Nigeria. Consequently, the following is the specific objective of the study:

1. To investigate how interest rate, exchange rate and inflation respond to shocks in monetary policy rate (MPR).

​​​​​​​Hypotheses

(1) H0: Interest rate, exchange rate and inflation do not respond to shocks in monetary policy rate (MPR).

1.6 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.​​​​​​​

Limitations of the Study

One of the major limitations of the study is the use of MPR as a proxy to capture monetary in Nigeria. In practice, CBN uses other instruments like OMO, Liquidity ratio and Cash reserve

Requirement to compliment variation in MPR in achieving Economic growth. The use of prime lending rate (excluding the maximum lending rate) for interest rate could also be a challenge toward producing the accurate and most reliable outcome. In a nutshell, there is likelihood that the research model has omitted some important explanatory variables.

Furthermore, the accuracy and the reliability of the data produced by NBS, CBN etc. used in this study cannot be guaranteed. Finally, the study might be seen as restrictive because any development (in the variables examined) before December, 2006 and after February, 2012 is considered to be beyond the scope of this study.

Organization of 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.