Monetary Policy and Economic Stability in Nigeria: An Empirical Analysis

Transcription

1 Monetary Policy and Economic Stability in Nigeria: An Empirical Analysis 1 Charles Odinakachi Njoku*, 2 Dike Susan 1,2 Department of Management Technology, Federal University of Technology, Owerri, Imo State, Nigeria 1 nj_charlie@yahoo.co.uk Abstract--This study is an empirical analysis of monetary policy on economic stability in Nigeria. It is aimed at investigating the effect of monetary policy on stabilizing the economy of Nigeria and the level of success achieved against its desired objectives. Inflation being one of the indicators of economic stability was measured as dependent variable using liquidity ratio, exchange rate, interest rate and cash reserve requirement as the independent variables which represent instrument of monetary policy. In order to determine the relationship that exists between the dependent variable and independent variables secondary data for the period were collected the collected data were subjected to Stationarity (unit root) test to avoid spurious regression results. The Johansen Co integration test confirms the existence of a long run relation between the variables. Adopting the multiple regression model, the study confirmed the existence of a significant impact of only one monetary policy instrument (exchange rate) on inflationary rate while other explanatory variables (Cash Reserve Ratio, Liquidity ratio and interest rate) failed to contribute significantly to economic stability for the period under review. Based on the findings, the researcher recommends that the Central Bank of Nigeria should not only aim at stabilizing inflation rate, but also put some effort in stabilizing the real economy; Nigeria should diversity the economy to reduce the mono dependence on oil. Nigeria should encourage domestic production and increase exportation to achieve the objective of economic stability. Keywords-- Monetary policy, economic stability, economy, stabilization, Nigeria 1.0: INTRODUCTION Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Monetary policy is the policy of managing the economy to bring about sustainable economic growth and development. It is a deliberate action of the monetary authority to influence the quantity cost and availability of money credit in order to achieve desired macroeconomic objectives of internal and external balance. Monetary policy is the process by which monetary authorities (the Central Bank) of a country controls money supply which usually targets at interest rate for the purpose of enhancing economic growth and stability. The central bank of Nigeria since its inception has continued to play the role expected which is to ensure price stability, maintain external reserves to safeguard the international value of legal tender currency, promote sound financial system which are anchored on the use of monetary policy towards the achievement of full employment, good standards of living and rapid economic growth. Policies in developing countries are designed to stabilize the economy, stimulate growth and reduce poverty. In Nigeria the achievement of these objectives are predicted on the stance of fiscal and monetary policies. Over the years the major goal of monetary policy have often been the two later objective thus inflation targeting and exchange rate policy which dominated the central bank of Nigeria s monetary policy focus based on an assumption that these are essential tools of achieving macroeconomic stability (Aliyu and Englama,2009).Before 1986 the economic environment that guided monetary policy was characterized by the dominance of the oil sector, the expanding role of the public in the economy and over dependence on the external sector. The use of market based instrument was not feasible at that point because of the underdeveloped nature of the financial market and deliberate restraint on interest rate. After 1986 with the central bank of Nigeria amended act, (adeoye, et al 2014) reveal that the apex bank was granted more discretion and autonomy in the conduct of monetary policy and consequently the focus of monetary during this period shifted significantly from growth and developmental objectives to price stability. However Ebiringa et al (2014) submitted that monetary policy implemented in recent years in Nigeria have been aimed at fast tracking economic reform programs with the objective of providing enabling financial system infrastructure and environment to support sustainable growth /Copyright 2016, IJRMST, April

2 The central bank through the deposit money banks implements policies that guarantee the orderly development of the economy through appropriate changes in the level of its various instruments of monetary policy which include the cash reserve ratio, liquidity ratio, open market operations and primary operation to influence the movement of reserve (Ajie,Nenbere,2010 and Masna et al 2014).The sectional allocation of bank credit in CBN guideline was to stimulate the production sector and thereby stem inflationary pressure. The fixing of interest rate at relatively low level was done mainly to promote investment and growth. Occasionally special deposits were imposed to reduce the amount of free reserve and credit creating capacity of the bank. Minimum cash ratio were usually lower than those voluntary maintained by the banks, they proved less effective as a restraint on their credit operations. For most economies the objective of the monetary policy include price stability, maintenance of balance of payment equilibrium, promotion of employment and output growth, sustainable development (Folawewo and Osinubi 2006). These objectives are necessary for the attainment of internal and external balance and the promotion of long run-economic growth (Imougbele 2014). But to ensure macroeconomic stability, the government budget including the country s poverty reduction strategies must be financed in a sustainable noninflationary manner. Macroeconomic stability depends not only on the macroeconomic management of an economy but also on the structure of key market and sectors. To enhance economic stability the needs to support macroeconomic policy with structural reforms that will strengthen and improves the functioning of the markets and the appropriate sectors. Typically it is of equal importance to a country s economic achievement to have a of sound macroeconomic policies aimed at maintaining a conducive environment for long term investment in the economy monetary policy is directed primary at promoting long term economic growth; this is to be constantly re-evaluated to adapt to changing challenges and priorities over time. The economy of Nigeria is faced with macroeconomic problems of high inflation rate and unemployment. But one of the objectives of monetary policy in Nigeria is price stability, despite the monetary regimes that have been adopted by the central bank of Nigeria over the years. We are still faced with the threat of inflation, unemployment, unsatisfactory expansion of domestic output these problems have continued to make our economy less striving. There is a nagging question of whether monetary policy is not an effective instrument of economic stability because the monetary policy instruments have been in operation in Nigeria since the establishment of the Central Bank of Nigeria as the apex Bank. Monetary policy has not has not solves the major macroeconomic problems of economy. The Nigeria economy is also characterized by policy summersaults. Monetary policies initiated by an administration are not sometimes continues or implemented by succeeding administrations, sometimes Monetary policy measures not implemented at the appropriate time. 1.1: OBJECTIVES OF THE STUDY The general objective of this research is to examine the influence of monetary policy on economic stability, this study is also aimed at examining the level of success the policy measures against deserved objective and the appropriate measures for achieving it. It becomes necessary, therefore to state specifically the objective of this study as follows. 1. To examine the level of success of exchange rate in stabilizing the economy. 2. To determine the impact of interest rate on economic stability. 3. To examine how cash reserve ratio affects economic stability. 4. To also examine the role of liquidity ratio in stabilizing the economy. 2.1: MONETARY POLICY NIGERIA The central bank of Nigeria become actively involved in monetary policy in 1964 when it undertook :for the first time a package of monetary policy initiatives to deal with problems of inflationary pressures and a rundown of the country s external reserves (Ndekwu, 1999:98). It is interesting to observe that the monetary policy instrument of the Central Bank of Nigeria even at that time were moral suasion, specifying a ceiling on the growth of commercial banks, loans and advances and providing administrative compositional variation in the commercial banks liquid assets, as well as changes in the level of central Bank s Minimum Rediscount Rate (MRR) (Sec CNBm 1979; Ndekwu, 1990:100). 2.2: ECONOMIC SUSTAINABILITY Monetary policy also seeks to address the problem of inadequate economic growth and sustainability. Economic growth imply change in the amount of real output or income in an economy over the time while sustainability is all about the stability of the growth in the economy which refers to the absence of excessive fluctuation in the macro economy, an economy with fairly constant output growth and low stable inflation would be considered economically stable /Copyright 2016, IJRMST, April

3 Economic growth is because it obtains increased goods and services, increase resources or use the resources more efficiently and should be able to maintain the level of growth at every point in time, growth is also associated with raising the standard of the population over time and increase in the wealth of the citizens. The most used measures of economic growth is gross national product (GNP) GNP is a money value of the goods and services produced in a country in a given year, but sustaining an economy is a bigger task stable economy maintains the achievement of the economy over time at least maintain the employment level close to the economy natural rate and eliminate relatives price movement of rate and financial asset. A financial system is said to be stable when it dissipates financial imbalance that arises endogenously or as a result of significant adverse and unforeseeable event. Conceptual economic growth could be expressed in two ways: (i) (ii) An increase in per capital real GNP over time. An increase in total real GNP OR NNP over time. The first situation above describes economic growth in terms of the standard of living of the population while the second view examines economic growth from the perspective of the expansion in goods and services in the country over time. For a developing country like Nigeria growth and sustainability is necessary to ensure: (i) Improvement in the standard of living of the citizens, (ii) Sustained basis for poverty alleviation especially in the face of wide spread poverty in developing countries, (iii) Absorption of new entrant in the domestic labour market and into gainful employment, (iv) A sustainable basis for managing the external debt burden of a country the economic growth has a direct relationship with improvement in the domestic currency and thus the debt profile and burden, (v) Checking the level of population, (vi) Sustainable basis for local production abstaining from too much importation, (vii) Monetary policy ensures that capital resources are available for increased productivity. Also, it ensures the achievement of non inflationary growth and increased foreign investment and capital flows. The policy thrusts create an environment for sustaining faster economic development and growth. 3.0: RESEARCH METHODOLOGY This study seems to examine the empirical analysis of monetary policy on economic stability. This section will give an insight into the methodology adopted in the collection, analysis and interpretation of data collection for the study. It attempts to provide a dissolved analysis of the research plan and tools utilized in the actualization of this study. 3.1: SOURCES OF DATA A pool of material were collected and synthesized by the researcher from which his own personal view and interpretation was brought into the work. The materials used for this research were mainly collected from: CBN Publication, Annual report and statement of account of the Central Bank of Nigeria and CBN economic and financial reviews (various issues) Model specification The model to be adopted will specifically be based on the following functional relationship: INFR = f(intr, CRR, EXR, LQR) This equation reads that inflation is a function of interest rate, cash reserve ratio, exchange rate, liquidity ratio. However to hold firm the influence of the random variable, the equation is explicitly transformed into the following INFL = B O + B 1 CRR +B 2 LQR +B 3 INT + B 4 EXC +..U t Where INFL = Inflation Rate CRR = Cash Reserve Ratio LQR = Liquidity Ratio EXR = Exchange Rate [Naira/US Dollar rate] U = error term or stochastic variable The parameter estimates are B 1, B 2, B 3 and B 4 while B 0 is the parameter constant and U is the error term. 4:1: DATA PRESENTATION This section will present and analyze data collected using the techniques and methodology already discussed /Copyright 2016, IJRMST, April

4 TABLE 4.1: INFLATION RATE, EXCHANGE RATE, INTEREST RATE, LIQUIDITY RATIO, CASH RESERVE RATIO ( ) YEAR INFR EXR INTR LQR CRR This table shows figures of Inflation Rate (INFR), Cash Reserve Ratio (CRR), Interest Rate (INTR), Liquidity Ratio (LQR) and Exchange Rate (ECR) for the period of 1986 to : RESULT OF THE ANALYSIS TABLE 4.2: RESULT OF STATIONARITY (UNIT ROOT) TEST The Table below shows the result of the Unit Root Test VARIAB LES ADF- STATIS TIC INFR EXR INTR LQR CRR Source: eviews result (see appendix I) CRITI CAL VALU 5% ORDER OF INTEGRA TION Stationary at First Difference Stationary at First Difference Stationary at First Difference Stationary at First Difference Stationary at First Difference /Copyright 2016, IJRMST, April

5 Unit root test: Since carrying out regressions on non stationary time series data would lead to spurious regression outcomes, we employ the widely used Augmented Dickey-Fuller (ADF) test (Dickey and Fuller, 1979) to ascertain the stationarity of the data. The econometric views (E-views package was employed) to carry out the regressions. The unit root result above confirms the absence of unit root in the data set employed in this analysis. Both the dependent variable (INFR) and the independent variables (EXR, INTR, LQR and CRR) are stationary at first difference. Johansen Cointegration Test The cointegration test following the approach of Johansen and Juselius (1990) two likelihood ratio test statistics were utilized to determine the number of cointegrating equations in the model under the assumption of no deterministic trend in the data. Comparing the Maximum Eigen value and critical value at 5% significance level, indicates that there is a single contegrating equation in the model as the test rejects the null hypothesis of no cointegrating equation and accepts that of at most one cointegrating equation. Therefore, the research concludes that a long run relationship exists between the variables. (see Table 4.3 below). Table 4.3: Cointegration Test Result Unrestricted Cointegration Rank Test (Maximum Eigenvalue) Hypothesized Max-Eigen 0.05 No. of CE(s) Eigen value Statistic Critical Value Prob.** None * At most At most At most Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values The regression equation is estimated using the Vector Autoregression Model INFR = CRR LQR NTR EXR+ U 4.3: DISCUSSION OF RESULTS The adjusted R Squared indicates that the explanatory variables (Exchange rate, Cash Reserve ratio, Interest Rate and Liquidity ratio) jointly account for 55.8% of the total variations in Inflation rate, whereas the remaining 44.2% of the variation is attributed to other factors captured by the inclusion of the Error term. Also, it certifies that the model is not over-fit. From the results estimated, Cash Reserve Ratio (CRR), Interest Rate (INTR) and Liquidity Ratio (LQR) in Nigeria from 1986 to 2013 are not statistically significant in explaining the variations in Economic Stability. Whereas, exchange rate (EXR) is statistically significant in stabilizing the Nigerian economy for the period under review. In addition, a 1% increase in Cash Reserve Ratio and Interest Rate will induce a 1.13% and % positive changes on Inflation rate in Nigeria respectively while a 1% change in Liquidity ratio will cause a 0.673% negative change on Inflation rate in Nigeria, but these changes are not statistically significant at 5% level of significance and therefore cannot be relied upon for meaningful evaluation. A unit increase on Exchange rate will reduce the Inflation rate by 0.16%. This means that the key to controlling inflation rate in Nigeria is the stabilization of exchange rate. Exchange rate (EXR) and Liquidity ratio (LQR) met the apriori expectation of this model. The R squared result in appendix II shows a 66.38% relationship exist between the dependent variable (Inflation rate) and the independent variables ( Exchange rate, Liquidity ratio, Cash reserve ratio and Interest rate). 4.4: CONCLUSION AND RECOMMENDATION The study is an empirical analysis of monetary policy on economic stability in Nigeria. The study covers the period of 28 years ( ) with the aim of examining the effect of monetary policy on economic stability and the level of success of these policies against its desired objectives. The main objectives includes findings how, these monetary policy variables: Interest rates (INTR), Exchange Rates (EXCR), Liquidity Ratio (LQR) and Cash Reserve Ratio (CRR), impact on economic stability using inflation as the economic stability indicator. From the findings, it can be seen that CRR, INTR, LQR are not statistically significant in explaining the variations in the model while only exchange rate prove to be statistically significant in explaining the variation on inflation. Therefore, research recommends that monetary authority should re-evaluate these policies to suite the present macroeconomic challenges in Nigeria /Copyright 2016, IJRMST, April

6 Nigeria should develop and strengthen every sector that contributes to economic growth of Nigeria. The monetary authority should not only aim at reducing inflation, but also ensure that the real economy is stabilized. Nigeria should diversify their resource base and not solely depending on oil as its major export earner. On the basis of the findings the researcher concludes that monetary policy in Nigeria has not done well in stabilizing the economy of Nigeria as such this policies should be revisited and match it to the prevailing macro economic problems of Nigeria. REFERENCES [1] Akujuobi, L. E.,(2010); Monetary policy and Nigeria Economic Development, International Multi-Disciplinary Journal Ethiopia, Vol.4(4) no. 17, October, [2] Aliyu and Englama,2009; Is Nigeria Ready for inflation Targeting? Journal of Money, Investment and Banking Issue 11 September, 2009 [3] Andrea V. (2010); Inflation and Growth in the long run; a new Keynesian Theory and further semi parametric evidence [4] Anyanwu, J. C., (1995); Modern Macro economic Theory and Application in Nigeria. [5] Central Bank of Nigeria (2012); Statistical [5]Bulletin, Central Bank of Nigeria, Abuja Nigeria. [6] Chuku, A. C (2009); Measuring the effects of Monetary policy innovation in Nigeria, Structural Vector Autoregressive (SVAR) Approach, Journal of Accounting, Economics Finance and Banking Research Vol.5 no 5 [7] Ebiringa, O. T. (2014) Behavioral Pattern of Monetary Policy and effect on economic growth, Journal of economic and sustainable development Vol. 5 pp [8] Fasanya I.O., Onakoya, B.O.A & Agboluaje, M.A.(2013) Does Monetary Policy Influence [9]Economic Growth in Nigeria? Asian Economic and Financial Review Vol. 3(5) [9] Folawewo and Osinubi (2006); Monetary Policy and Macroeconomic Instability in Nigeria :A Rational Expectation Approach, Journal of Social Science Volume, 12(2): Pg.: (2006) [10] Ndekwu, E. C. (2013); An analysis of the Monetary Policy Transmission Mechanism and the Real Economy in Nigeria Central Bank of Nigeria, Abuja. [11] Nenbee, S. C & Madume J. V (2011) The impact of Monetary Policy on Nigeria s Macro Economic Sociability ( ), International Journal of Economic Development Research and Innovation, Vol. 2 no. 2 August [12] Gujarati, D. N (2004); Basic Econometrics (4th edition), New Delhi-Tata McGraw-Hill Publishers Ltd. [13] Hammed, K. S. (2012); Linkage Between Monetary Instruments and Economic Growth, Universal Journal of Management and Social Science, Vol. 2No.5 May [14] Olajide, A. (2013); The Nigeria Fiscal and Monetary Policy Challenges, Olajide and Associates Nigeria (Chartered Accountants) Lagos Nigeria. [15] Okpara, G. C (1997); Money, Finance and Banking in Theory and Practice, Aba Chiwins Educational Consultancy and Publishers LTD, Aba, Nigeria. [16] Writeman, D (1976); An Introduction to Monetary Theory and Policy, The Free Press, New York /Copyright 2016, IJRMST, April

7 Null Hypothesis: D(LQR) has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=6) International Journal of Research in Management, Science & Technology (E-ISSN: ) APPENDIX I: unit root results t-statistic Prob.* Augmented Dickey-Fuller test statistic Test critical values: 1% level % level % level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(LQR,2) Method: Least Squares Date: 11/02/14 Time: 13:47 Sample (adjusted): Included observations: 26 after adjustments Variable Coefficient Std. Error t-statistic Prob. D(LQR(-1)) C R-squared Mean dependent var Adjusted R-squared S.D. dependent 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) Null Hypothesis: D(INTR) has a unit root Exogenous: Constant Lag Length: 1 (Automatic - based on SIC, maxlag=6) t-statistic Prob.* Augmented Dickey-Fuller test statistic Test critical values: 1% level % level % level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(INTR,2) Method: Least Squares Date: 11/02/14 Time: 13: /Copyright 2016, IJRMST, April

8 Sample (adjusted): Included observations: 25 after adjustments International Journal of Research in Management, Science & Technology (E-ISSN: ) Variable Coefficient Std. Error t-statistic Prob. D(INTR(-1)) D(INTR(-1),2) C R-squared Mean dependent var Adjusted R-squared S.D. dependent 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) Null Hypothesis: D(INFL) has a unit root Exogenous: Constant Lag Length: 4 (Automatic - based on SIC, maxlag=6) t-statistic Prob.* Augmented Dickey-Fuller test statistic Test critical values: 1% level % level % level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(INFL,2) Method: Least Squares Date: 11/02/14 Time: 13:46 Sample (adjusted): Included observations: 22 after adjustments Variable Coefficient Std. Error t-statistic Prob. D(INFL(-1)) D(INFL(-1),2) D(INFL(-2),2) D(INFL(-3),2) D(INFL(-4),2) C R-squared Mean dependent var Adjusted R-squared S.D. dependent 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) /Copyright 2016, IJRMST, April

9 Null Hypothesis: D(EXR) has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=6) t-statistic Prob.* Augmented Dickey-Fuller test statistic Test critical values: 1% level % level % level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(EXR,2) Method: Least Squares Date: 11/02/14 Time: 13:46 Sample (adjusted): Included observations: 26 after adjustments Variable Coefficient Std. Error t-statistic Prob. D(EXR(-1)) C R-squared Mean dependent var Adjusted R-squared S.D. dependent 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) Null Hypothesis: D(CRR) has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=6) t-statistic Prob.* Augmented Dickey-Fuller test statistic Test critical values: 1% level % level % level *MacKinnon (1996) one-sided p-values. Augmented Dickey-Fuller Test Equation Dependent Variable: D(CRR,2) Method: Least Squares Date: 11/02/14 Time: 13: /Copyright 2016, IJRMST, April

10 Sample (adjusted): Included observations: 26 after adjustments International Journal of Research in Management, Science & Technology (E-ISSN: ) Variable Coefficient Std. Error t-statistic Prob. D(CRR(-1)) C R-squared Mean dependent var Adjusted R-squared S.D. dependent 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) Vector Autoregression Estimates Date: 08/06/15 Time: 10:35 Sample (adjusted): Included observations: 26 after adjustments Standard errors in ( ) & t-statistics in [ ] APPENDIX II: VECTOR AUTOREGRESION RESULT INFL INFL(-1) ( ) [ ] INFL(-2) ( ) [ ] C ( ) [ ] EXR ( ) [ ] INTR ( ) [ ] LQR /Copyright 2016, IJRMST, April

11 ( ) [ ] CRR ( ) [ ] R-squared Adj. R-squared Sum sq. resids S.E. equation F-statistic Log likelihood Akaike AIC Schwarz SC Mean dependent S.D. dependent International Journal of Research in Management, Science & Technology (E-ISSN: ) /Copyright 2016, IJRMST, April