AN ECONOMETRICAL ANALYSIS OF MONETARY POLICY ON THE ECONOMY OF NIGERIA
Articles on this site are extracts from literature review of research projects, Get the full Project
2.1 CONCEPTUAL FRAMEWORK
The concept and definition of monetary policy in the previous year has no universal acceptability but however, the term monetary policy according to CBN release on monetary policy concept (2006) was defined as “Any policy measure designed by the Federal Government through the CBN to control cost availability and supply of credit. It also referred to as the regulation of monetary supply and interest rate by the CBN in order to control inflation and to stabilize the currency flow in an economy.
However, in the CBN Briefs (Series No 97/03 June 1997).Monetary policy was defined as follows; The combination of measures designed to regulate the value, supply and cost of money on an economy in consonance with the expected levels of the economic activities These imply that the excess supply of money would result in excess demand for goods and services, which would in turn cause a rise in price and determination of balance of payment position. Monetary policy is one of the available tools of macroeconomic objectives. The primary goals of macroeconomic policy are price stability, external stability and a satisfactory rate of output growth.
2.2 THEORITICAL LITERATURE
The effect of monetary policy is a central issue and has attracted a lot of comments both in and out of the country. The theories of monetary policy became success during 1930’s and 1940’s. It was believed that the well being of monetary policy in stimulating recovery from depression was severely limited than in controlling a boom and inflation. These views emerged from the experience of Keynes in his theory. Keynes general view holds that during depression, the CBN can increase the reserve of commercial banks through a cheap monetary policy. They can do so by buying securities and reducing the interest rate. As a result of these, the ability of extending credit facilities to borrowers increases. But the great depression tells us that in a serious depression when there is pessimism among economic actors, the success of such a policy is practically zero. In this situation economic actors have no incentives to borrow even at a reduced interest rate. In this case, the question of borrowing for long-term capital needs does not arise in a depression when the business activities are already at a low level.
The classical view of monetary policy is based on the quantity theory of money. According to this theory, an increase in the quantity of money leads to a proportional increase in price level. The quantity theory of money is usually discussed in terms of ‘’Equation Of Exchange’’ which is given by the expression. P, denotes price level and Y denotes the level of current real GDP. Hence, PY represents current;
’’NORMINAL GDP’’ M denotes the supply of money over which the fed has some control and v denotes the “Velocity Circulation’’ which is the average number of time a naira is spent on final goods and services over the cause of the year. The equation of exchange is an identity which states that the current market value of all final goods and services… nominal GDP must equal the supply of money multiplied by the average number.
Monetarist view of monetary policy dates back in 1950’s, a new view of monetary policy called monetarism, has emerged that disputes the Keynesian view that monetary policy is relatively ineffective. Adherent of monetary argue that the demand for money is stable and not sensible to change the interest rates.
2.2.1 TYPES OF MONETARY POLICY
There are basically two kinds of monetary policy, they are:
- EXPANSIONARY MONETARY POLICY
An expansionary monetary policy is used to overcome depression, recession and deflationary gap. When there is fall in consumer goods and services, and in business investment goods, a deflationary gap emerges. The Central Banks starts an expansionary policy that eases the credit market conditions and leads to an upward shift in aggregate demand. For this the CBN purchases the government securities in the open market, lowers the reserve requirements of member banks, lowers the discount rate and encourages consumer and business credit through selective credit measures.
b. RESTRICTIVE MONETARY POLICY
This is the kind of monetary policy designed to reduce aggregate demand (AD) and inflationary gap. Inflationary pressure takes place as a result of risen consumer demand for goods and services and there is also boom in business investment. The CBN introduces the restrictive policy in order to lower aggregate consumption and investment by increasing the cost availability of bank credit.
2.2.2 AIMS AND OBJECTIVES OF MONETARY POLICY
There appear to be a general consensus that the single most important objectives of monetary policy are the pursuit of price stability. These recognition is perhaps derived from the increasing rate at which many central banks around the world are been given the exclusive power to control inflation and stabilize domestic prices. The perspective which recognizes a focus on inflation as the right approach to macroeconomic stability receives a strong support from the analytical research summarized in Fisher (1996) The study concludes that the fundamental task of the currency and the following;
- Achievement of domestic price and exchange rate stability
- To control inflation
- Maintenance of healthy balance of payment position
- Promotion of rapid and sustainable rate of economic growth and development
- Maintenance of macroeconomic stability
- Development of a sound financial system
- To stabilize the naira exchange rate
- To maintain a high level of employment
2.2.3 INSTRUMENTS OF MONETARY POLICY
The policy instruments are of two kinds, they are;
- Indirect Quantitative or General
- Direct Quantitative or Selective
These affect the levels of aggregate demand and through the supply of money cost and availability of credit. The first category includes the bank rate variations, open market operation and changing reserve requirement. They are meant to regulate the overall level of credit in the economy through commercial banks. The selective credit control aims at controlling specific kinds of credit.