THE INTERNATIONAL JOURNAL OF HUMANITIES & SOCIAL STUDIES

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1 THE INTERNATIONAL JOURNAL OF HUMANITIES & SOCIAL STUDIES Monetary Policy Shocks and Inclusive Growth in Nigeria: A VAR Aroach Adediran, Oluwasogo, S. Lecturer, Deartment of Economics & Develoment Studies, Covenant University, Ota, Ogun State, Nigeria Matthew, Oluwatoyin A. Lecturer, Deartment of Economics & Develoment Studies, Covenant University, Ota, Ogun State, Nigeria Oloade, Bosede C. Lecturer, Deartment of Economics, Adeleke University, Ede, Osun State, Nigeria Adegboye, Folasade B. Lecturer, Deartment of Banking & Finance, Covenant University, Ota, Ogun State, Nigeria Abstract: The imortance of monetary olicy to an economy has made its effectiveness very otent in achieving economic growth in both develoed and develoing countries, this is because, an effective monetary olicy is crucial for sustainable develoment and economic stability. Hence, this study will among other things investigate the relationshi between monetary olicy shocks and inclusive growth in Nigeria. With many of the macroeconomic models for measuring the effect of monetary olicy on an economy lacking the analytical secificity to account for the imortance of shocks on aggregate economy. This study, with the introduction of inclusive growth as a new variable, used a develoed model with advanced emirical and quantitative methodology to study monetary olicy shocks and inclusive growth in Nigerian economy. Usually, VAR is more alicable to analyzing the linkage among monetary olicy variables. Hence, while this study will obtain a new evidence for this relationshi, it is exected in Nigeria, that an effective monetary olicy will encourage inclusive growth; stabilize inflation and maintain macroeconomic stability in the economy. JEL Classification: E5; A10, B10; C3 and B40 Keyword: Monetary olicy, economic growth, inclusive growth, model and VAR. 1. Introduction Monetary olicy is an imortant key driver of economic growth through its imact on economic variables. Over the years, the growing imortance of monetary olicy has made its effectiveness in influencing economic growth a riority to both develoing and develoed economies of the world. Monetary olicy can act as growth catalyst by creating an enabling environment with aroriate incentives to emower innovative entrereneurs to drive inclusive growth. Changes in monetary olicy tend to influence aggregate demand, growth, and inflation through various transmission channels and induce changes in emloyment as a result. Extant economic literature (see Bernanke and Gertler, 1995; Mishkin, 1996; Mordi, 2010) has identified five main monetary transmission channels (interest rates, asset rices, exchange rates, credit and exectations) through which monetary olicy can affect real economy and romote inclusive growth. For most economies, the objectives of monetary olicy include rice stability, maintenance of balance of ayments equilibrium, romotion of emloyment and outut growth, and sustainable develoment. The ursuit of rice stability invariably imlies the indirect ursuit of other objectives such as economic growth, which can only take lace under conditions of rice stability and allocative efficiency of the financial markets. Monetary olicy aims at ensuring that money suly is at a level that is consistent with the growth target of real income, such that non-inflationary growth will be ensured. Changes in money suly and interest rates influence consumer sending as well as investment decisions. Consequently, aggregate demand changes in resonse to monetary olicy adjustments. In the Nigerian exerience, the renewed interest in the inclusiveness of the economic growth rocess is not unconnected with the recent growth exeriences of several develoing countries. Nigeria, for examle, has exerienced unrecedented rates of GDP growth for nearly a decade, but the rates of overty, inequality and unemloyment have also risen during the eriod. While the economy had grown by an average of over 6% er annum between 2005 and 2014 (World Bank, 2015), overty and inequality have actually risen. The Gini coefficient, for instance, had risen from in 2005 to in 2013, suggesting a significant rise in income inequality, when indeed GNI er caita (2011 PPP rices) had increased by over 43%, from $3,606 in 2005 to $5,165 in 2014 (World Bank, 2015). In addition, the unemloyment rate has also increased from about 11.9% in 2005 to about 24% in 2014 (National Bureau of Statistics, 2015). Thus, jobless growth seems revalent in Nigeria desite the growth recorded in the time ast. These statistics clearly suggest that the seemingly imressive growth in outut and income over the eriod had excluded a majority of the oulation- the 173 Vol 5 Issue 2 February, 2017

2 oor. Over this eriod, a greater majority of the country s oor had been excluded from the economic oortunities associated with economic growth rocess. Therefore, inclusive growth had eluded the Nigeria s economic growth rocess over the recent ast. Well-being indicators suggest that the growth exerienced by the economy has not led to imroving the welfare of the citizens. It has also been suggested in the literature that macroeconomic stability and low inflation rates through a sound monetary olicy have ositive effects on growth and reduction of inequality (Asongu, 2013). Thus, inclusive growth is imortant, because it is a necessary condition for sustaining equitable growth. While, effective monetary olicy initiatives can contribute to job creation both directly and indirectly by allocating more financial resources to consumers and firms that have limited access to such resources. This analysis indicates that well-fashioned monetary olicy initiatives towards inclusive growth have the caacity to rovide financial services that cater for the most vulnerable with a view to raising their standard of living. Though a large body of literature link monetary olicy and growth by examining the monetary olicy-growth nexus, within both bivariate and multivariate frameworks, but the nexus with inclusive growth (reduction in unemloyment, inequality and overty rates) is not been thoroughly examined. This study intends to contribute to the existing literature by investigating the imact of monetary olicy shocks on inclusive growth within a multivariate aroach. Therefore, the imortant issues of concern in this study are: what is the imact of monetary olicy shocks on inclusive growth in Nigeria? How has monetary olicy initiatives contributed to inclusive growth by exanding and stabilizing emloyment in Nigeria? How can monetary olicy initiatives drive inclusive growth in Nigeria? This study intends to rovide answers to these ertinent questions. Because, it is necessary for monetary authority to imlement effective monetary olicy initiatives that are consistent with achieving higher emloyment in order to address rising inequality and attain inclusive growth. It is in this regards that this study aims at examining the imact of Nigerian monetary olicy shocks on inclusive growth. 2. Literature Review To date, the relationshi between monetary olicy and inclusive growth remains inconclusive; many theoretical and emirical studies debate the issues on whether central banks need to include inclusive growth as integral art of their mandates. Two major strands are rominent in the literature. The first strand contend that unemloyment is not the legislative function of monetary authorities and that rice and financial stability as well as banking suervision are enormous task nonetheless of adding unemloyment to these objectives (Bhattacharyya, 2012; Orhanides, 2013; Vinayagathasan, 2013). As a result, they argue that Central banks should not be blamed for every fluctuation in either inflation or unemloyment. They further noted that assigning unreasonable blames to monetary olicy for unemloyment should be reconsidered, that the vital debate on unemloyment was wrongly focused (Bojie and Holmberg, 2007). Similarly, Bhattacharyya (2012) noted that desite the success of emloyment objective documented in Australia, Korea, United State and Jaan by monetary olicy, it still aears inaroriate for monetary authorities to assume this role. Orhanisede (2013) further claimed that overburdening monetary olicy may eventually weaken and comromise the indeendence and credibility of the Central Banks, thereby reducing its effectiveness in maintaining rice stability and contributing to crisis management. Advocates of inflation targeting have argued that central banks should embrace just one clear objective of maintaining rice stability. Many international organizations aear to also suort this view initially, largely before the global financial crisis. For instance, International Monetary Fund (2006) argued that, subject to certain caveats, inflation targeting led to better macroeconomic outcomes than alternative monetary olicy regimes. This line of thought is consistent with conventional economic theory that redicts that rice and financial stability can generally rovide avenue for higher economic growth, which would bring about higher emloyment and reduction in overty level and that monetary authorities need not have exlicit outut or emloyment target. In other words, once rice and financial stability is maintained, economic growth and emloyment would automatically follow. But, this is not enough reason to justify that achieving rice and financial stability will lead to economic growth. Moreover, when not all growth is equally effective in reducing overty and that increase in growth has not resulted in exected comarable increase in the number of job. This argument articularly reflects the exeriences in many emerging economies, where desite high economic growth rates, unemloyment and overty have been a major olicy challenge. Hence, they often argue that rice and financial stability do not necessarily imly macroeconomic stability that can lead to growth and generate emloyment creation (William, 2004; Estein, 2014, Chang and Jaffar, 2014; Sayeed and Abass, 2014; Adeleke et al. 2015). This strand of the literature therefore advocate for central banks to exlicitly incororate emloyment as art of their main mandates, where monetary olicy can rimarily be focused on emloyment creation just like some develoed countries in Euroe, United States and Australia. In Nigeria, Fasanya et al. (2013) examined the imact of monetary olicy on economic growth using time series data covering the eriod The effects of stochastic shocks of each of the endogenous variables were exlored using Error Correction Model (ECM). Findings of the study reveal a long run relationshi among the variables. Also, the core finding of the study shows that inflation rate, exchange rate and external reserve are significant monetary olicy instruments that drive growth in the economy. In a related study, Adeoye and Saibu (2014) analysed the effects of monetary olicy shocks using changes in various monetary olicy instruments on exchange rate volatility in Nigeria. The results from the aer show that both real and nominal exchange rates in Nigeria have been unstable during the eriod under review. In the short, the variation in the monetary olicy variable exlains the movement/behaviour of exchange rate through a self-correcting mechanism rocess with little or no intervention from the monetary authority (CBN). It was concluded that inflation rate, reserves, interest rate and money suly dereciate and cause volatility in nominal exchange rate which further reinforce other findings that monetary olicy is crucial to exchange rate management in Nigeria. 174 Vol 5 Issue 2 February, 2017

3 Sayeed and Abass (2014) examine the roles of Central Banks on economic growth with secific focus on Pakistan economy. The study shows that macroeconomic erformance of Pakistan economy over the last decade had been characterized by stagflation and moderate growth reflecting that unemloyment remains a big concern for Pakistan. It further emhasized that the role of Central Banks must be redefined toward job creation, if any significant rogress will be made in the country. In a related study, Khou (2014) assesses the role of Central Bank in Cambodia and rovide emirical suort to develoment in the context of dollarized economy. It ointed out that raid develoment in Cambodia is attributed to exort of garment and agricultural roducts, tourism and construction but unemloyment remains a challenge and there is need for the Central bank to intervene and salvage the economy. Montiel (2014) argues that there aears to be weak and less reliable monetary olicy transmission mechanism in low-income countries based on the nature of their olicy environment and available financial architecture. Given these reasons, the credit and lending channel is the most likely mechanism through which monetary olicy can be transmitted to aggregate demand in low income countries. However, the credit and lending channel could also be less effective as a result of severe credit-market frictions in the forms of both asymmetric information and moral hazard leading to high costs of contract enforcement and oligoolistic behaviour in the banking sector. In the same vein, Arias (2014) examines the roles of Central Bank in Ecuador on economic growth and give suort for financial inclusion as well as effectiveness of monetary olicy to resolve the recent challenges of unemloyment in the economy. The study further call for the Central Bank to rovide olicy otion that integrates financial inclusion, job creation and reduction in overty while maintaining economic stability. Chatani (2014) also examines role of Central Banks in Mozambique. It identifies overty and income inequality as major concern of the Central Banks in Mozambique and that there is need to accelerate diversification of the economy in such a way that would ave way toward emloyment generation. In general, there aears to be no consensus in the literature on whether monetary olicy objectives should be singly focused on rice and financial stability or that they should focus on multile objectives. It however, clearly shows that it may be inaroriate to assess monetary olicy objectives based on short and medium-term goals; instead overty reduction and roductive emloyment generation should rather be a long-term goal that central banks ought to be in close coordination with fiscal authorities. Hence, the issue of refocusing monetary olicy toward inclusive growth is recent and as such it has not received considerable attention from both researchers and olicy makers alike in this art of the world. 3. Stylized Facts: Monetary Policy and Inclusive Growth in Nigeria Like every sensitive economy of the world, an imortant macroeconomic objective of Nigerian economy is to sustain high economic growth that is caable of generating emloyment and overty reduction. In site of the continued olicy focus on this objective, high economic growth exerienced articularly in the last decade has not been accomanied with significant emloyment generation and overty reduction. This is because there is coexistence of both increasing overty level and higher economic growth in the same eriod. This evidence run contrary to the conventional economic theory that redicts a direct relationshi between economic growth and emloyment and an inverse relationshi with overty level. This occurrence has been termed non-inclusive growth in the literature. This is exlained by the fact that major growth drivers might have occurred in those sectors that require little labour inut, therefore, accruing job creation and income therefore goes to small segment of the labour force leaving majority of the eole without emloyment and thus remained in overty. Inclusive economic growth on the other hand, is exected to include majority of the sectors and rovide job oortunity for greater number of the labour force. Inclusive growth is resumed to deliver equal access to markets, factors of roduction and rovide conducive contractual environment to all economic agents (Mbutor and Uba, 2013). Hence, both fiscal and monetary olicymakers are exected to ensure that future economic growth are more articiatory and involve many sectors of the economy, by roviding strategies to maximize highroductivity jobs among the labour force. Several olicy initiatives both at the national and state levels have been suggested and imlemented as art of the efforts to combat overty and unemloyment in the country. These initiatives can be broadly categorized into two: fiscal and monetary olicies. Fiscal olicies includes taxation, exenditure and trade olicies of the government while the monetary olicies (which is the focus of this study) includes the interest, exchange rates, credits and other financial olicy intervention rogrammes that romote inclusive growth. The effectiveness of these olicies and reforms need to be rigorously interrogated in the light of the current call for inclusive growth in Nigeria. The table below further buttresses this analysis. It shows five-year eriod average of key macroeconomic variables of interest between monetary olicy and inclusive growth in Nigeria, from 1981 to The Table reveals some interesting results. It clearly shows that increasing economic growth exerienced in the country, articularly from the 1990s, aears not to be inclusive, as unemloyment rate was rising over this eriod. Also, dereciating exchange rate, increasing saving to GDP ratio as well as number of bank branches aears not to translate to reduction in unemloyment in the eriods understudy as exected. Influence of exchange rate dereciation on emloyment can be justified based on the low roductivity level of manufacturing and exortable goods, as the major source of exort for the country is crude oil whose rice are internationally determined. This trend also suggests that increasing savings and availability of bank branches are not directly transforming to credit and investment, thus not generating required effects of job creation and overty reduction. 175 Vol 5 Issue 2 February, 2017

4 Period Average Real GDP Growth Exchange Rate MPR Unemloyment Rate Saving to GDP Ratio Loan to SME(% of total Credit No of Bank Branches , , , , , , , Table 1: Analysis of Key Macroeconomic Variables Source: Adated from Adeleke et al Point of attraction is the drastic and ersistent reduction in roortion of commercial bank loans to small and medium scale enterrises (as a ercentage of total credit) under the review eriod. Economic literature has shown the high otential of SME in generating emloyment and reducing overty in an economy. Reduction in commercial bank loan to small and medium scale enterrises may hamer the ability of the entrereneurs to make investment and create job in the economy. This henomenon may also exlain the observed trend of high saving to GDP and bank branches (roxy for financial inclusion) not having exected influence on emloyment generation and overty reduction. This also justifies why the monetary authorities, articularly in develoing countries, may have to be involved in easing financial access for the majority, rimarily the less rivileged member of the society. This drive has been the recent focus of Central Bank of Nigeria (CBN) financial inclusion strategies and its intervention rogrammes in the real sectors of the economy. 4. Data Source and Research Methodology Using the annual date set from the Central Bank of Nigeria Statistical Bulletin, covering the samle eriod of This study addresses the research questions by emloying the VAR framework to investigate the linkage between monetary olicy and inclusive growth in the Nigerian economy. A VAR framework constitutes a convenient framework to assess the interrelationshis within a system of variables when the imosition of strong a-riori restrictive assumtions cannot be derived by economic theory. The model is formulated based on reviewed emirical and theoretical studies. This model framework is similar to the one used by Sims (1980). Hence, this framework in the form of VAR is exected to examine the scenario of the relationshis among Money Suly to GDP growth (MSGDP), Per Caita Income growth (PCIG), Exchange Rate (EXR) and Unemloyment Rate (UEMR) in the Nigerian economy. The model is resented as follows: Y = τ(l) Y + ε (4.1) Where; vector Y = MSGDP, PCIG, EXR, UEMR ), L reresents the lag oerator, τ(l) is the matrix of estimated arameters, t = years and ε is the error term assumed to be serially uncorrelated. The variables denoting the vector Y are money suly to the ercentage of GDP growth (MSGDP), er caita income growth (PCIG), exchange rate (EXR) and unemloyment rate (UEMR). The VAR models for individual variables are as follows: MSGDP c PCIG c EXR c UEMR c 1 11MSGDPt i 12 EXRt 13 PCIG t 14UEMRt 1, t (4.2) 3 31PCIG t i 32 MSGDPt 33 EXRt 34UEMR t 3, t (4.3) 2 21EXRt i 22 MSGDPt 23 PCIG t 24UEMRt 2, t (4.4) 4 41UEMR t i 42 MSGDPt 43 EXRt 44 PCIG t 4, t (4.5) Meanwhile, imulse resonse function and forecast error variance decomosition (FEVD) are used in analyzing the interrelationshis among the variables secified from equations (4.2) to (4.5). The imulse resonse functions are resonses of all variables in the model to a one unit structural shock to one variable in the model. It measures the roortion of movement in a sequence attributed to its own shock, to distinguish it from movements attributable to shocks to another variable. 5. Emirical Result and Discussion 5.1. Unit Root Test This section reorts the results of Augmented Dickey Fuller (ADF) stationarity test. 176 Vol 5 Issue 2 February, 2017

5 Variable Intercet Order of Integration MSGDP * [ ] I(1) PCIG * [ ] I(1) EXR * [ ] I(1) UEMR * [ ] I(1) Note: * significant at 1%. Source: Authors comutation using E-views 8 Table 2: Unit Root Test Results The Augmented Dickey Fuller (ADF) stationarity test, confirmed that all the series are stationary at first order i.e. I (1) at 1% significance level. This imlies that money suly as a ercentage of GDP, er caita income growth, exchange rate and unemloyment rate are all stationary after first differencing. While, the lag length is otimally chosen by the Schwarz Information Criterion (SIC) 5.2. Cointegration Test Results Table 3 resents the cointegration results according to the maximum - eigen statistics. This indicates that there are no cointegration at 5% significance level. Therefore, no long-run equilibrium relationshi exists between the variables. This imlies that VAR model can be used to estimate the regression VAR Model Results Hyothesized Max-Eigen 0.05 Eigen value No. of CE(s) Statistic Critical Value Prob.** None At most At most At most Table 3: Cointegration Result (Maximum Eigen Statistic) Source: Authors comutation using E-views 8. Variables Coefficient Std. Error t-statistic Prob. (EXR(-1)) (EXR(-2)) MSGDP(-1)) MSGDP(-2)) PCIG(-1)) PCIG(-2)) (UEMR(-1)) (UEMR(-2)) Constant R-squared Mean deendent var Adjusted R-squared S.D. deendent var S.E. of regression Akaike info criterion Sum squared resid Schwarz criterion Log likelihood Hannan-Quinn criter F-statistic Durbin-Watson stat Prob(F-statistic) Table 4: VAR Model Results Source: Author s Comutation As resented in the table above, the model exlains that over 95 ercent of the variation in the deendent variable (unemloyment), which is the measure of growth inclusiveness is being exlained by the indeendent variables and also significant at and t-statistic values. The value of Durbin-Watson statistics of 1.8 is within the accetable region. This result exlains the imortance of using unemloyment rate to measure the inclusiveness of economic growth. This is under the assumtion that if growth is inclusive, it will increase the job availability and imrove welfare of the oulace. The table reveals the movement in exchange rate as a critical macroeconomic variable that affects the level of unemloyment in Nigeria. With the exchange rate being unstable, this imact has affected all other aggregate variables in the economy. The volatility in exchange rate has affected all other macroeconomic variables in the economy. As a result of this, exchange rate instability, couled with high unemloyment rate could have been artly resonsible for lack of achieving inclusive growth in Nigeria. 177 Vol 5 Issue 2 February, 2017

6 Furthermore, the monetary olicy variable (MSGDP) at , is significant to influence unemloyment. This is an indication that the monetary olicy framework ut in oeration by the monetary authorities including the CBN, has effect on the inclusiveness of economic growth in Nigeria. This evidence rovided by the result exlains that the success of monetary olicy deends on the oerating economic environment and the institutional framework adoted by the CBN. However, the current framework from the CBN is focusing more on rice stability among other objectives Variance Decomosition Analysis Table 5 below resent the Variance Decomosition (VD) of inclusive growth roxied by unemloyment rate to innovation shocks on the other variables. VD searates the variation in an endogenous variable into the comonent shocks of the model. Thus, it rovides information about the relative imortance of each random innovation in affecting the variables in the model. Hence, it is shown on the table that exchange rate and money suly shocks formed the greater roortion of the total variation in unemloyment rate. This imlies that the volatility in exchange rate as well as the behaviour of the monetary olicy determines the growth attern and the absortive caacity of the economy. While, fluctuation and instability exerienced in the exchange rate over the years may be resonsible for the non-inclusion of the GDP growth rate. This because, the growth exerienced by the economy over the years has not led to reduction in the unemloyment rate in Nigeria. This may largely be due to high volatility in economic aggregate variables. Period S.E. EXR MSGDP PCIG UEMR Table 5: Variance Decomosition of UEMR in Nigeria Source: Author s Comutation using E-views 8 6. Conclusion and Policy Recommendation The study has examined the relationshi between monetary olicy shocks and inclusive growth in Nigeria, using, VAR framework. The results rovided evidence that money suly and exchange rate have a significant imact on growth through unemloyment. Also, findings from the study revealed that inability of the monetary olicy authority to control the instability of the exchange rate are resonsible for non inclusiveness of the growth exerienced in the economy over the years. As a result of these findings, it is recommended that both fiscal and monetary olicies from the authorities should accommodate all and sundry in the economy. Uncoordinated exansionary monetary and fiscal olicies could have worsen exchange rate in the ast. It is therefore, imortant that monetary and fiscal olicies are coordinated and harmonised so as to achieve macroeconomic stability. 7. References i. Adeleke, A. Oboh, V & Shobande, O. (2015) Monetary Policy Towards Inclusive Growth in Nigeria. Proceedings of Nigerian Economic Society (NES) Conference. ii. Adeoye, B. W. and M. O. Saibu (2014), Monetary Policy Shocks and Exchange Rate Volatility in Nigeria, Asian Economic and financial Review, 4(4): iii. Adeoye, B. & Sangosanya, A. (2015) Monetary Policy and Inclusive Growth: The Case of Nigeria. Proceedings of Nigerian Economic Society (NES) Conference. iv. Arias, D. (2014) Role of Central Banks: The Case of Ecuador. International Labour Organization ublication, Working Paer. v. Asongu, S.A. (2013), Fighting Consumer Price Inflation in Africa. What do dynamics in money, Credit, Efficiency and Size tell us?, Journal of Financial Economic Policy, 5(1). vi. Bhattacharyya, N. (2012) Monetary Policy and Emloyment in develoing Asia. International Labour Organization ublication, Asian- Pacific Working Paer. vii. Bojie, R and Holmberg, K (2007) Asect of the Relationshi between Monetary Policy and Unemloyment. Economic Review viii. Central Bank of Nigeria (2015). Statistical Bulletin. Retrieved from ix. Chang, D. & Jaffar, J (2014) Monetary Policy Towards Inclusive Growth: The Case of Korea. The South East Asian Central Banks Research and Training Centre. Working Paer 5/2014. x. Fasanya, I., Onakoya, A. & Agboluaje, (2013) Does Monetary Policy Influences Economic Growth in Nigeria? Asian Economic and Financial Review, 3(5): xi. Khou (2014) Role of Central Banks in Cambodian. International Labour Organization ublication, Working Paer. 178 Vol 5 Issue 2 February, 2017

7 xii. Mbutor, O.M. and Uba, I.A. (2013), Nigeria : High Economic Growth Rate, High Incidence of Poverty, Why? CBN Bullion, Vol. 37, No. 1, xiii. National Bureau of Statistics (2015) Unemloyment and Underemloyment Watch: First Quarter of xiv. Orhanides, A (2013) Is Monetary Policy Overburdened? Bank of International Settlement working Paer 435. xv. Sayeed and Abassi (2014), The role of Central Banks in suorting economic growth and creation of roductive emloyment: The case of Pakistan International Labour Organization ublication, Working Paer No 171. xvi. Vinayagathasan, T (2014) Monetary Policy and Real Economy: A structural VAR aroach for Sri Lanka. National Graduate for Studies, Jaan xvii. Williams, R. C., (2004), "Monetary Policy and Unemloyment: A Disaggregated Analysis," International Advances in Economic Research, Vol. 10, Vol 5 Issue 2 February, 2017