Project Materials

AN ECONOMETRICAL ANALYSIS OF MONETARY POLICY ON THE ECONOMY OF NIGERIA

Chapter one

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

One of the measures taken by all economies to make the banking sector more effective is the implementation of monetary policy by the federal government and carried out by the country’s apex bank.

Apparently, the existence of a functional banking industry is critical to every economy, and it promotes economic growth and development by acting as a financial interdiction of money supply to deficit economic units. This promotes international trade, investment, economic growth, employment growth, and employment.

Monetary policy is one of the procedures that any economy takes to ensure the effectiveness of its banking system. Monetary and banking policies are solely the responsibility of the monetary authority, which includes the CBN, for initiation, implementation, and articulation of the monetary system.

The CBN carried out these obligations on behalf of the federal government in accordance with CBN decree 21 of 1991 and the Banks and Other Financial Institutions Act (BOFIA A4, of 1991 as modified). The banks’ monetary policy proposals are subjective to the federal government.

The policies to be adopted are frequently communicated to all banks and other financial institutions via ”Audience”. The guidelines are generic in nature and apply throughout the entire fiscal year, but they may be updated throughout the year.

The CBN is also entitled to direct the actions of financial institutions in order to carry out certain obligations in the pursuit of approved monetary policy, with penalties imposed for noncompliance with particular provisions of the guidelines.

Monetary policy has an impact on financial and economic activities throughout the year. To better understand the effects of monetary policy on the banking industry, it would be prudent to conduct a review of shifting opinions on monetary influence.

Usually when the amount of money changes in relation to financial activities, according to FISHER (1932). Fisher, like other neoclassical writers, believed that money influenced real cash balances in the short run. According to him, when the money stock increases, example;

An increase commodities prices since output and velocity were fixes initially. He assumed that a rise in commodity prices would exceed the increase in interest rate which was regarded as a component of a firms operating cost.

Overall, rising commodity prices will raise a firm’s profit, demand, money stock, and deposit, resulting in additional increases in investment and commodity prices. The excess reserve for lending, which was previously high, will fall as interest rates rise.

Fisher substituted the ”Interest-Investment” channel with ”Real Cash Balance” in his analysis of long-term monetary impact transmission. He observed that when wealth rises owing to an increase in the money supply, people seek to reduce their cash balances by acquiring goods and services.

Because the velocity (v) and output (y) in Fisher’s equation of exchange (MVPT) are fixed, rising money stock (M) cannot lead to higher holdings of goods and services, but rather to a decrease in price level (P).

Keynes (1936) acknowledged that changes in the money supply have both substitution and effect, and he believed that investment was quite responsive to interest rates.

Keynes advocated for price-induced wealth effects (i.e., changes in wealth due to changes in yields). His interpreters provide varying accounts of how he incorporates them into his overall idea.

As a result, subsequent writings to Keynes (whether Keynesian or post-Keynesian) identify the cost of capital (interest rate) as the primary method by which changes in the money stock affect the economy.

Thus, the change in volume of money modifies the rate of interest. Typically represented by the long-term government-bounded rate, which influences investment and consumption.

Piguo (1974) and Patikin (1951) examined the relationship between wealth in the private and real sectors and consumption in the form of the “real cash balance effect.”

Changes in money supply, they claimed, would have an impact on aggregate demand even if interest rates remained constant. On the other side, the credit rationing channel of monetary influence explained how market forces would govern financial interdiction in order to constrain credit availability using a non-price method.

Thus, an expansionary monetary policy would boost the force of equity (i.e. reduce the yield on equities). The difference between the market value and the cost of producing current capital goods will encourage further investment in those commodities.

Despite these differences, non-monetarists maintain that monetary policy is just as effective as fiscal policy in determining total economic spending. It has the following viewpoints:

The movement of money is the most dependable indicator of monetary value. Monetary authorities can identify changes in the stock of money over time and over the business cycle.

Changes in the stock of money are the fundamental determinants of total spending, according to Owen’s economic stabilisation scheme.

The monetary impulse is conveyed to the actual economy via an active price or profit adjustment process, which has a wide range of financial and real-world implications.

1.2 Statement of The Problem

Despite the foundation of the Central Bank of Nigeria (CBN) in 1958, the banking industry remained weak and inadequate in terms of the number, quality, and diversity of services offered. The establishment of the CBN created the path for the banking industry to embrace monetary management practices.

Just in case any analysts are waiting in the wings to criticise the CBN for its weak monetary policy performance. Ogwuma (1994:362) offers a defense which says “A less than objective appraisal of the CBN role in the Nigerian economy could interpret the adverse macro-economic trend as evidence of failure on the part of CBN.