ROLE OF MONETARY POLICY ON INFLATION IN NIGERIA
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ROLE OF MONETARY POLICY ON INFLATION IN NIGERIA
Chapter one
INTRODUCTION
Background for the Study
Nigeria’s economic environment has been characterised by changes in inflation rates over time, emphasising the importance of monetary policy in determining the country’s financial stability (Ogbuagu & Ewubare, 2020).
Monetary policy, which includes the employment of tools like interest rates, exchange rates, and cash ratios, has a significant impact on inflationary patterns.
To understand the influence on the Nigerian economy, the complex interaction between these monetary policy instruments and inflation dynamics must be carefully examined.
Interest rates are critical components of monetary policy, with a considerable impact on inflation. The Central Bank of Nigeria (CBN) frequently modifies interest rates to combat inflationary pressures (Gbadebo & Mohammed, 2021).
The CBN seeks to regulate the money supply by manipulating interest rates, which has an impact on consumer spending and investment. Monetary policy transmission through interest rates entails changes in borrowing costs, which can have an impact on spending patterns and, as a result, inflationary pressures.
For example, when interest rates are high, borrowing becomes more expensive, resulting in less spending and investment, lowering inflation (Ogundipe and Alege, 2021).
Exchange rates have a significant impact on Nigeria’s inflationary dynamics. Because the country relies heavily on imports for a variety of goods and services, exchange rate changes are quite important.
Changes in exchange rates can alter the prices of imported items, hence influencing overall inflation rates. A falling local currency can raise import prices, contributing to cost-push inflation. However, an appreciating currency may have the opposite impact.
Bayramoglu and Allen (2019) emphasise the necessity of understanding inflation dynamics and monetary transmission mechanisms in the context of inflation-targeting regimes, as well as a full investigation of exchange rate effects on inflation.
Cash ratios, another tool in the monetary policy framework, refer to the percentage of deposits that banks are required to retain as reserves. Adjusting these ratios can have an impact on how much money circulates in the economy.
The Central Bank of Nigeria frequently uses cash reserve requirements to manage liquidity and inflation (Onwachukwu, 2020). The central bank can control the money supply by adjusting the cash reserve ratio, which has an impact on inflation.
Higher cash reserve requirements limit bank lending, reducing consumption and inflation (Demchuk & Łyziak, 2022).
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