The performance of monetary policy in the nigerian economy (1980-2010)

Thesis Overview

<p> 1.0 INTRODUCTION<br>1.1 BACKGROUND OF THE STUDY<br>For most economies, the objectives of monetary policy include price stability,<br>maintenance of balance of payments equilibrium, promotion of employment and<br>output growth, sustainable development. These objectives are necessary for the<br>attainment of internal and external balance, and the promotion of long run<br>economic growth. The importance of price stability derives from the harmful<br>effect of price volatility which undermines the objectives. This is indeed a general<br>consensus that domestic price fluctuations undermines the role of monetary<br>values as a store of value, and frustrate investments and growth.<br>Ajayi and Ojo (1981) and fisher (1993), empirical states on inflation,<br>growth and productivity have confirmed the long run inverse relationship<br>between inflation and growth. When decomposed into its components, that is<br>growth due to capital accumulation, productivity growth, and the growth rate of<br>the labour force, the negative association between inflation and growth has been<br>traced to the strong negative relationship between it and capital accumulation as<br>well as productivity growth respectively. The importance of these empirical<br>findings is that stable prices are essential for growth due to capital accumulation,<br>productivity growth, and the growth rate of the labour force, the negative<br>association between inflation and growth has been traced to the strong negative<br>relationship between it and capital accumulation as well as productivity growth<br>respectively. The importance of these empirical findings is that stable prices are<br>essential for growth. The success of monetary policy depends on the operating<br>economic environment, the institutional framework adopted, and the<br>implementation of monetary policy is the responsibility of the central bank of<br>Nigeria (CBN). The mandates of the CBN as specified by the CBN Act of 1958<br>include;<br> Issuance of legal tender currency.<br> Maintaining external reserves to safeguard the international value of the<br>currency.<br> Promoting monetary stability and a sound financial system.<br> Acting as banker and financial adviser to the federal government.<br>However, the current monetary policy framework focuses on the maintenance of<br>price stability while the promotion of growth and employment are the secondary<br>goals of monetary policy. The performance of monetary policy depends on some<br>legal framework upon which it operates. The legal framework are quantitative<br>general or indirect and second, qualitative selective or direct. The effect effects<br>the level of aggregate demand through the supply of money, cost of money and<br>availability of credit. Out of the two types of instruments, the first category<br>include bank are variations, open market operation, and required reserve ratio.<br>They are meant to regulate the overall level of credit in the economy through<br>commercial banks. The selective credit control aims at controlling specific types of<br>credit. This includes changing margin requirement and regulation of consumer’s<br>credit (M.L Jhingan, 2003).<br>In any economy, the conducts of both policies are normally rooted through<br>banking institutions that play in the intermediation process. The role of bringing<br>lenders and borrowers together through this process the central bank plays a very<br>important role in determining the price of money (Ebhodaghe, 1996). Therefore,<br>monetary policy is important in its own right from the past view of monetary<br>economists and policy maker’s interns of its impacts on the economy. Of all tools<br>available to government for directing the cause of the economy, monetary<br>policies have proven to be the most visible instrument for achieving medium term<br>stabilization objectives (CBN guideline 2002). Indeed monetary policy formulation<br>and implementation emerged as a critical government responsibility so that the<br>economy does not go astray. Policies are made not only for their own sake rather<br>for achieving some desired goals over a given period of time.<br>Generally, the primary objectives of monetary policy is concerned with the<br>application of expansionary monetary policy measures during economic recession<br>and contractionary monetary policy controls money supply because it is believed<br>that its rate of growth has an effect on inflation. The basic aim of monetary<br>policies is not to aggregate themselves but the aggregate in the real sectors of the<br>economy such as, level of capital price stabilization and economic development.<br>Policies are designed in order to change the trend of some monetary variables in<br>particular direction so as to induce the desired behavioral change in the monetary<br>policy. The central bank’s role is to conduct appropriate monetary policy that is<br>consistent with the main economic objectives that will help the growth of gross<br>domestic product (GDP), sustainable inflation are and stable balance of payment<br>position. This is done by putting in place the direct or indirect monetary approach<br>so as to control monetary trends. In this regards the CBN determines the amount<br>of money to be supplied that is consistent with the nation’s macro-economic<br>objectives and manipulate the monetary instrument at its disposal in order to<br>achieve the stated objectives. Monetary policy influences the macrocosmic<br>objectives because it is believed that there occurs a relationship between the real<br>variables. Monetary policy affects all aspects of our economic and financial<br>decisions whether to buy a car, build a house, start up a business or to expand the<br>existing ones, whether to send one’s child to school or to make the child learn<br>trade. Money supply or monetary policy tries to influence the performance of the<br>economy as reflected in key macro-economic indicators like inflation, GDP and<br>employment. It works by affecting aggregate demand across the economy, that is,<br>individuals’ and firms’ willingness and stability to spend on goods and services. In<br>doing this, monetary policy has two fundamental goals to promote maximum<br>sustainable output and employment and to maintain sustainable price level in the<br>economy. The job of stabilizing output in the short run and promoting price<br>stability in the long run involves several steps first, the central bank tries to<br>estimate how the economy is doing now and how it is likely to do in the medium<br>term, then, it compares this estimates to its goals for the output and the price<br>level, if there is a gap between the estimates and the goals, the CBN have to<br>decide on how forcefully and swiftly to act to close the gap. Estimate of the<br>current economic conditions are not as even as the most up-to-date data on key<br>variables like employment, growth, productivity etc, largely reflect condition in<br>the past. So to get a reasonable estimate of the current and medium term<br>economic conditions, the central bank tries to find out what the most relevant<br>economic developments are such as government spending, economic conditions<br>abroad, financial conditions at home and abroad and the use of new technologies<br>that boos productivity. These developments are the incorporated in an economic<br>model to see how the economy is likely to evolve over time. In doing this, the<br>central bank is confronted with some unexpected development such as the NigerDelta<br>crisis that disturbed the oil production and slowed down the revenue<br>generation by the government they therefore, have to build uncertainties into<br>their model. Uncertainty seems to be problem at every part of the monetary<br>policy process there is yet no set of policy and procedures that policy makers can<br>use to deal with all situations that may arise. Instead, policy makers must decide<br>how to precede by analysis the issue is far from being settled. Indeed, the central<br>bank spends a great deal of time and effort in researching into the various ways<br>to deal with different kinds of situation. Since these issues are not likely to be<br>resolved very soon, the central bank is likely to continue to look at everything.<br>Nigeria did not have any stable macroeconomic policy enforcement before and<br>during the inflammation of structural adjustment programme (SAP). The terms of<br>trade deteriorated for most of the period between 1980 to 1985 and some<br>previous years before the 1980. The consumer price index (CPI) growth rate was<br>on the average of 17.1% between 1980 and 1985 and though this fell to about<br>5.0% in 1986 and 1987, if again started to rise from 1988, peaking at 47.5% in<br>1989. It has remained consistently high in the 1990s reading an all time high of<br>54.7% in 1994. The current account reported as surpluses between 1989 and<br>1993 after a fairly long period of deficit between 1981 and 1988 (there was a<br>moderate surplus in 1984 and 1985 due to the austerity measures embarked<br>upon by the federal government under the then military administration of general<br>Babangida). Domestic savings as a ratio of GDP, which stood at an average of<br>27.7% between 1970 and1980, started to fall in 1981. Between 1981 and 1986, it<br>stood at 13.8% the instrument ratio has followed the same pattern although,<br>reporting slightly lower figures. Fiscal deficit has been chronic and is financed by<br>borrowing from the banking system. The share of commercial banks in total<br>financial assets has shown a structural shift from about 57.7% in 1986 to 36.4% in<br>1993, the major gainer has been the central bank whose share has increased from<br>33.1% to 46.4% during the same period. It is doubtful if the structural adjustment<br>programme has improved competitiveness in the system as the three largest<br>banks still amount put a third of total deposits. One major feature of banking in<br>the period of deregulation is the occurrence of large distress in the banking<br>system. Close to 42 banks were severely distressed in the system in the system<br>with 45 percent of loans classified as non-performing loans (CBN 1994). The<br>performance of major monetary and commercial banks ratios did not show any<br>appreciable improvement during reforms. For example, total loan and advances<br>measured as a ratio of GDP declined from 25.6 percent in 1986 to 14.3 percent in<br>1990. The aggregate domestic credit, GDP ratio which peaked at 50.3 percent in<br>1986, reduced by half in 1993 (24.5%) with credit to government commanding a<br>larger proportion. The ratio of both narrow money MI save trend. From a high<br>trend of 19.2 percent in 1981, MI/GDP ratio phi-meted to 11.5 percent in 1993<br>and M2/GDP ratio from 30.6 to 20.1 percent following the same pattern severely<br>negative before the liberalization exercise the deregulation exercise in 1987 yield<br>interest rate that were mildly negative to positive in the period 1987-1990. But<br>with pressure on prices thereafter real interest rates have turned severely<br>negative, again for the period of 1991 to 1994. It can be observed that most<br>macro-economic aggregates have become severely unstable in recent times it is<br>in this environment that indirect monetary control was initiated in 1993. Much of<br>difficulty in achieving the objectives of SAP resulted largely from failure to achieve<br>fiscal balance and the consequent reliance on borrowing from the central bank to<br>finance the fiscal deficits. This has adversely affected both the market for foreign<br>exchange, money and goods and the expected role of market in allocating<br>resources efficiently. The extent to which open market operations in government<br>bills can help to successful manage the excess liquidity in the system which is<br>created by government borrowing from the central bank is one of that while<br>should be of interest given the enormity of this problem in the attainment of<br>stabilization goals in the economy.<br>1.2 STATEMENT OF THE PROBLEM<br>one a yearly basis, the monetary authority formulate guidelines geared towards<br>the enhancement and development of policy variable designed to ensure optimal<br>performance of the banking industry and ultimately to advise the macroeconomic<br>goals or objectives but in the implementation of such policy variable certain<br>conflicting issues are to be addressed ranging from the ability to comply with<br>various monetary policy goodliness as well as satisfying depositors and<br>shareholders. In fact, commercial banks are reluctant in their responsibility to<br>comply with the rules and regulations set by the central bank such as the open<br>market operation (OMO), required reserve ratio (RRr), bank rate, liquidity ratio,<br>selective credit control and moral suasion. These are the instruments of central<br>bank in controlling the activities and operations of commercial banks in other to<br>achieve the macroeconomic objective such as growth, price stability balance of<br>payment equilibrium, full employment. The central bank of Nigeria (CBN)<br>guidelines helped in setting of the interest rates charged by the commercial<br>banks, sales or purchases of securities to control the money supply, and changes<br>in the required reserve ratios of banks and other financial institutions. The<br>guidelines affected other interest are both through open market operations to<br>affect the probability that the banks are going to need to borrow at its own<br>lending rate, and by the announcement effects of changes in the central bank’s<br>minimum lending rate, which are regarded by the markets as statement about the<br>authorities forecasts and objectives. The CBN guideline on monetary policy works<br>through the effect of the cost and availability of loans to real activity, and through<br>this on inflation, and on international capital movement and thus on exchange<br>rate. <br></p>