Monetary policy and inflation in nigeria (1980 – 2010

Thesis Overview

<p> </p><p><strong>6.0 &nbsp; &nbsp; </strong><strong>INTRODUCTION</strong></p><p><strong>6.1 &nbsp; &nbsp; </strong><strong>Background of the Study</strong></p><p>Monetary policy has always been seen as a fundamental instrument over the years for the attainment of macroeconomic stability, often viewed as prerequisite to achieving sustainable output growth. Thus in the pursuit of macro-economic stability, the managers of monetary policy have often set targets on intermediate variable which include the short term interest rate growth of money supply and exchange rate. Among these intermediate variables of monetary policy, the exchange rate argued to have a greater influence on the economy through its effect on the value of domestic currency, domestic inflation, the external sector, macroeconomic credibility, capital flows and financial stability. Increased exchange rate directly affects the prices of imported commodities and an increase in the price of imported goods and services contributes directly to increase in inflation (CBN, 2008). The adverse consequence of inflationary pressure from exchange rate depreciation have been a serious concern for the monetary authorities, economists and policy analysts given that these variables (exchange rate and inflation) are the key barometers of economic performance.</p><p>Consequently assessing the nexus, among monetary policy, exchange rate and inflation rate is pertinent because understanding of the nexus between these variable in prerequisite for the successful conducting and adopting of inflation targeting, which the Nigerian government has also made prime objective in the attainment of its macroeconomic objective. Under inflation targeting, monetary policy stance (through changes short term interest) affects inflation through a large set of variables including exchange rate (Mukherjice, and Bhattacharya, 2011).</p><p>Over the years inflation has become a significant problem for Africa and particularly in Nigeria. Since the first oil shock n the mid 1970s, African inflation rates have averaged more than 15 percent a year (Barkky and Killian, 2004). For Sub0sahara countries (Africa), the average inflation rate has been closer to 20 percent a year. A few sub-Sahara countries have even experienced inflation rate of 50 percent or even more in a year (Batini, 2004). The emergency of substantial inflation in Nigeria has led to wide spread debate about its causes. Many economist that favour traditional adjustment strategies contend that monetary growth, arising particularly from the domestic bank financing of large budget deficits, is the major source of inflationary pressures. By contrast, some critics of the traditional approach, such as the United National’s Economic commission on Africa (UNECA) in its “African Alternative framework for structural Adjustment Programmes” UNECA, (1989) have identified exchange rate depreciations as a major factor. Controversy between these two viewpoints has led to differing prescriptions about the appropriate policy responses.</p><p>Those focusing on monetary factors have emphasized reducing government budget deficits and restraining credit to public enterprises, while advocating exchange rate depreciation to offset any over valuation resulting inflation and deteriorate in terms of trade. Those emphasizing the role of exchange rate depreciation, by comparison, have argued against further exchange rate adjustments preferring instead a combination of incomes policies, price controls and demand reduction measures. Despite its importance, there has been surprisingly little research on the control of inflation in African countries particularly in Nigeria. The few empirical studies on this issue have used traditional econometric techniques best suited to identifying whether individual variables are related to inflation. Thus, the relative importance of monetary policy in the control of inflation remains to be determined. It is on this back ground that this study would investigate the effectiveness of monetary policy in combating inflation in Nigeria.</p> <br><p></p>