TRANSMISSION MECHANISM OF MONETARY POLICY IN NIGERIA
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Date
2011-11-06
Authors
OREKOYA, SAMUEL OLATUNDE
Journal Title
Journal ISSN
Volume Title
Publisher
University of Ibadan
Abstract
The Central Bank of Nigeria (CBN) has pursued, among other goals, low and stable domestic
price level and output growth using various monetary policy instruments. Despite these efforts,
output growth rate averaged 1.32% between 1980 and 1989 and 2.87% between 1990 and 1999.
Also, the monetary authority’s inflation rate target of 5.00% in 1992 and 31.00% in 1995
escalated into 44.59% and 72.81% respectively. There has been limited attempt to investigate the
channels through which monetary policy affects output and prices in Nigeria. This study,
therefore, empirically investigated monetary policy transmission mechanism and sought to
establish the relative effectiveness of various monetary policy instruments in Nigeria.
A Monetary Transmission Mechanism (MTM), predicated on Mishkin framework, that captures
the impact of monetary policy in an economy was employed. The MTM focused on bank
lending, exchange rate and interest rate channels that are evident in most developing economies
like Nigeria. A Structural Vector Autoregressive (SVAR) model, based on monetary policy
transmission dynamics, which identified the magnitude and impact of structural shocks, was
developed to test the importance of these channels. Generic, composite and separate models
including the impulse responses of the channels were estimated. Variance decomposition was
also conducted to determine the magnitude of fluctuation attributable to different shocks. With
quarterly data from 1970 to 2008, the time series properties of the models’ variables were
ascertained using the Augmented Dickey-Fuller and Phillips-Perron tests.
The effectiveness of Reserve Money (RM) as a monetary policy instrument over Interest Rate
(IR) was evident as a marginal increase of 0.15% in RM precipitated output and prices decline
by 0.20% and 0.60% respectively. The weakness of interest rate (IR) as a policy instrument was
shown with an increase of 2.02% in IR yielding no significant response from output and prices.
Bank lending declined from 0.89% in the first quarter to 0.23% below the baseline in the second
quarter following a marginal increase of 0.05% in RM. Output declined consequently below the
baseline by 0.12% and 0.15% while prices rose by 0.15% and 0.10% in the second and third
quarters respectively. By implication, the weak response of exchange rate to similar increases in
IR of 2.02% and RM of 0.15% suggests that this channel did not capture MTM in Nigeria. Also,
output and prices’ non-response to increase in IR of 2.02% and RM of 0.15% suggested that
interest rate channel is weak. Bank lending channel remained the existing MTM in Nigeria,
while the impact of monetary policy shock on output and prices occurred only after a time-lag of
6years.
Reserve Money was a potent policy instrument with output responding more to policy variations
than prices. Bank lending remained a significant channel for propagating policies to target
variables. The CBN should therefore focus more on the use of RM as a policy instrument rather
than a hybrid of reserve money and interest rate. There should also be emphasis on price level
stability since this has the tendency of fostering output growth.
Description
Keywords
Output , Price level , Monetary policy , Monetary transmission mechanism , Structural vector autoregressive.