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EFFECT OF MONETARY POLICY INSTRUMENTS ON INFLATION IN NIGERIA (1990 TO 2022)

EFFECT OF MONETARY POLICY INSTRUMENTS ON INFLATION IN NIGERIA (1990 TO 2022)

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EFFECT OF MONETARY POLICY INSTRUMENTS ON INFLATION IN NIGERIA (1990 TO 2022)

Chapter one

INTRODUCTION

1.1 Background of the Study.

Monetary policy is an important tool used by central banks to manage economic stability and inflation (Owoye and Oloni, 2019). In Nigeria, the Central Bank of Nigeria (CBN) uses a variety of monetary policy measures to control inflation and foster long-term economic growth. These instruments include open market operations (OMOs), reserve requirements, and the monetary policy rate (MPR).

To control liquidity levels in the economy, the central bank conducts open market operations (OMO) by purchasing and selling government securities.

Depending on the economic conditions, the CBN can use OMO to pump liquidity into the system or absorb surplus liquidity (Owoye and Oloni, 2019). This device permits the CBN to alter the money supply and, as a result, inflationary pressures in the economy.

Reserve requirements are the percentage of deposits that banks must keep as reserves with the central bank. By changing reserve requirements, the CBN can influence bank lending capacity and control the money supply (Ogbonna et al., 2020). Higher reserve requirements restrict the amount of cash available for lending, hence reducing inflationary pressure.

The central bank loans to commercial banks at an interest rate known as the monetary policy rate (MPR). Changes in the MPR affect the cost of borrowing, which influences individual and company spending and investment decisions (Olatunji and Alimi, 2021). By changing the MPR, the CBN can control economic activity and manage inflationary pressures.

These monetary policy instruments have a significant impact on Nigeria’s economic landscape and inflation. The CBN employs a combination of these instruments to maintain price stability, stimulate economic growth, and ensure the overall health of the economy.

The CBN can successfully moderate inflationary pressures and foster long-term economic development by utilising OMO, reserve requirements, and the MPR.

Inflation has always been a source of concern for Nigeria’s economy (Ezike & Chukwu, 2021). High inflation rates have a negative impact on individuals’ purchasing power, reducing their ability to afford goods and services (Ezike & Chukwu, 2021).

Inflation also increases economic uncertainty and volatility, which has a negative impact on investment decisions and overall economic stability (Ajisafe et al., 2021).

According to the National Bureau of Statistics (NBS), Nigeria has seen double-digit inflation rates in recent years (NBS, 2022). In December 2021, the Consumer Price Index (CPI) hit 15.75%, reflecting growing living costs and inflationary pressures (NBS, 2022). These high inflation rates have an impact on people’s purchasing power since their income may not keep up with rising prices for products and services.

The negative consequences of rising inflation go beyond individuals. Uncertainty in pricing levels makes it difficult for businesses to plan and make decisions, affecting their investment and expansion plans (Ajisafe et al., 2021).

Furthermore, inflation can stymie economic development and poverty-reduction initiatives by reducing the real worth of income and savings for disadvantaged populations (Ezike & Chukwu, 2021).

Addressing the issue of inflation is critical to Nigeria’s economic stability and progress. Implementing efficient monetary policy measures, such as manipulating monetary policy instruments, is critical for reducing inflationary pressures and maintaining price stability in the economy.

Understanding the influence of monetary policy tools on inflation allows policymakers to make educated decisions that limit the negative impacts of high inflation rates and promote long-term economic development.

The effectiveness of monetary policy instruments in managing inflation has been researched and debated (Owoye and Oloni, 2019). Researchers and policymakers want to understand the relationship between these instruments and inflation dynamics so that they can design effective policies and strategies to reduce inflationary pressures.

Empirical research have offered useful information about the impact of monetary policy instruments on inflation in Nigeria. Owoye and Oloni (2019) discovered that open market operations (OMO) have a significant impact on inflation, implying that tighter monetary conditions via OMO sales tend to lower inflation rates. This shows that the CBN can use OMO to control liquidity and impact inflationary pressures.

Similarly, researchers have looked into the relationship between reserve requirements and inflation in Nigeria. According to Ogbonna et al. (2020), increasing reserve requirements reduces inflation. This indicates that larger reserve ratios diminish the money supply, lowering inflationary pressures.

In addition, the monetary policy rate (MPR) has been examined in relation to inflation. Olatunji and Alimi (2021) found a strong negative association between the MPR and inflation in Nigeria.

 

Their findings showed that higher interest rates, which imply tighter monetary circumstances, are effective at reducing inflationary pressures.

Understanding the relationship between monetary policy instruments and inflation is critical for policymakers. It assists them in developing suitable policies, such as changing interest rates, performing liquidity management operations, and establishing reserve requirements, to effectively manage inflation and maintain macroeconomic stability.

Policymakers can make more informed judgements to maintain price stability and promote long-term economic growth by assessing the efficiency of monetary policy instruments and their effects on inflation.

This understanding enables them to develop appropriate measures and tactics adapted to the Nigerian economy’s specific demands and difficulties, providing effective control over inflationary pressures.

Several studies have looked at the effect of monetary policy instruments on inflation in Nigeria. Owoye and Oloni (2019) analysed the dynamics of monetary policy tools and inflation, concluding that OMO sales had a beneficial impact on inflation in Nigeria. Their research found that tighter monetary conditions via OMO sales tend to lower inflation rates.

Ogbonna et al. (2020) investigated reserve requirements and their impact on inflation in Nigeria. Their research revealed that increasing reserve requirements reduces inflation. This shows that larger reserve ratios diminish the money supply, lowering inflationary pressures.

The monetary policy rate, often known as the MPR, is an important tool used by the CBN to manage inflation. Olatunji and Alimi (2021) discovered a strong negative correlation between the MPR and inflation in Nigeria.

Their findings showed that higher interest rates, which signal tighter monetary circumstances, are effective at reducing inflationary pressures.

It should be noted that the efficiency of monetary policy instruments in managing inflation in Nigeria is influenced by a variety of factors. One key reason is the Nigerian economy’s structural impediments, which include inadequate infrastructure and supply-side restraints. These considerations may restrict the impact of monetary policy on inflation (Ezike and Chukwu, 2021).

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