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CHAPTER ONE

1.0 INTRODUCTION

The monetary policy of a country deals with control of money stock

(liquidity) and therefore interest rate; in order to influence such macro

economics variables as inflation, employment, balance of payment,

aggregate output in the desired direction. There is no standard and ideal

structure of monetary policy target and instrument, the instrument varies

from country to country, depending on the size and stage of development of

the financial market.

Over the years, the objective of monetary policy have remained the

attainment of external balance. However emphasis on

techniques/instrument to achieve this objective have change over the years.

There have been two major phases in the pursuit of monetary policy

namely, before and after 1986. the first phase placed emphasis on the direct

monetary control, while the second relies on market mechanisms.

The monetary policy before 1986: the economic environment that

guided monetary policy before 1986 was characterize by the dominate of

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the oil sector, the expanding role of the public sectors in the economy, and

over dependence on the external sector. In order to maintain price stability

and a healthy balance of payment position, monetary management depend

on the use of direct monetary instrument such as credit ceiling, selective

credit controls, administered interest and exchange rate, as well as the

perception of cash reserve requirement and special deposits. The use of

market – based instrument was not feasible at that point because of the

underdeveloped nature of the financial market and the deliberate restraint

of interest rate.

The most popular instrument of monetary policy was the insurance of

credit rationing guideline, which primary set rate on the change for the

component of commercial bank loan and advances to the private sector.

Globally the problem of the inflationary is not peculiar to Nigeria, but it is a

general problem confronting the majority, if not all countries of the world.

The attempt by Nigerian government to attain a higher level of economic

development at this period, generally lead to inflationary spiral in the

country.

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But whether inflation in Nigeria is due to monetary mismanagement

on the part of the authorizes concerned or caused by interest structural

deficiencies, still remain uncertain. Many factors have been identified to be

responsible for inflationary pressure in the country. In a symposium of

inflation in Nigeria held at university of Ibadan in 1983, November, most of

the participant stressed on money supply, nature of government

expenditure limitations in real output and the inflation (imported) as the

major causes of inflation in Nigeria. In the case of formulating monetary

policy, it is of paramount importance to specify objectives and also

impossible to evaluate performances.

Analysis of the institutional growth and structure shows that the

financial growth rapidly in the mid 1980s and 1990s. the number of

commercial banks rose from 34 – 64 in 1995 and decline to 51 in 1998 while

the number of merchant banks increased only to 12 in 1986, to 54 in 1991

and subsequently decline to 38. in the network, the combined commercial

and merchant bank branches rose from 12,549 in 1996. There was also

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substantial growth in the number of non – financial institutions especially

insurance companies.

The objective of monetary policy since 1986 remained the same as in

the earlier period namely; the stimulation of output and employment and

the promotion of domestic and external stability. In line with the general

philosophy of economic management under structural adjustment

programme (SAP). Monetary policy can be developed for encouraging

investment and controlling inflation, while fiscal policy can be effective to

reducing consumption of luxury and ostentation goods. But our major

concern will be to explore the efficiency of monetary policy in an economy

in controlling inflationary pressure in an economy like Nigeria.

It is generally believed by some economist that inflationary effect are

quite harmful to some business establishment. Thus could be so because

vender often lose in the sense that the valve of the money falls short of it

original purchasing power. The extent of the effect of inflation in Nigeria

could be appreciated from the following examples: in 1985, it stood at 5.5

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percent, indicating an annual percentage increase of 20.1 percent compared

to 40.9 percent in 1989.

It has been accompanied with high level of unemployment rate at 4.3

percent in 1985 and 18.5 percent in 1989. Thus has force Nigeria to adopt

several monetary measures within and the problem of inflation as could be

seen from the associated increases in the cost of production during the

periods under consideration.

It is therefore under the above that we will like to adopt some of the

mix of policy instrument used and hence their efficiency as regard inflation

control.

1.1. STATEMENT OF THE PROBLEM

Many attempts being made by the Nigeria authorities to attain higher

rate of economic growth and development have generally being

accompanied by certain degree of price increase in recent years, the

phenomenon developed into several and prolonged inflation and stag

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inflation. Indeed, it is increasingly being recognizes that a process of rapid

economic growth is likely to provoke inflationary pressures. However,

whether the problem of inflation in this country is due to mismanagement

of monetary policy tools or structural deficiencies still remain a controversial

matter.

During the last decade the problem of inflation and deflation to

economic growth and development have been extensively discussed. The

problem is not peculiar to Nigeria but has assumed a global phenomenon. It

is generally agreed worldwide that inflation is socially unjust. Inflation also

affects general economic behavior and the pattern of resource allocation. By

distorting price relations and undermining general confidence, prolonged

inflation tends sector; and thus slackens growth.

Furthermore, inflation discourages private saving and encourages

speculation among the various economic units. Another consequence is that

it result to balance of payment difficulties and reduces the external valve.

Nigeria being a market economy and therefore having its national economic

management strategies largely informed by Neo-classical and Keynesian

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persuasions have sought over the decide for the solution to this problem

through the adoption of the analysis and recommendation of these school

of thoughts.

Economic aggregate as; national income, savings, investment and

consumption expenditure have been experimental upon to varying degrees

with respect to taxes public expenditure, savings campaign, credit controls

wages adjustments and all the conceivable anti- inflation measures affecting

the propensities to consume, save and invest which all combined should

determine in general level.

All the measure so far adopted were inadequate in solving the

problem of inflation in the country. The suffering of masses are unending

as daily price surges occur indeed a more for reaching solution to the

problem is needed hence, this study seek to find what control has monetary

policy on inflation.

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1.2 OBJECTIVE OF THE STUDY

It is necessary to state the primary objective of this research having

identified the ruling monetary policy instrument in Nigeria and some the

economic objective that they are expected to influence.

These objectives include:

1. to investigate the major causes of inflation in Nigeria during 1980s

2. To investigate if the Nigeria monetary policy is efficient or not in the

achievement of certain objectives of the economy and inflation

control in particular.

3. To see if the non-realization of the economic objective is due to

chosen instrument or inappropriate application of the instrument.

4. To recommend policy solution based on the above finding.

The policy recommendation based on the above findings will be used

as a guide in the further application of monetary policies.

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1.3 STATEMENT OF HYPOTHESIS

Based on the statement of the problem and the purpose of

study, the following hypothesis were formulated.

1. H1: there is a positive and significant relationship between the

stock of money supply and inflation rate in the economy.

HO: There is no positive and significant relationship between

stock of money supply and inflation rate in the economy.

2. H1: There is inverse and significant relationship between

inflationary rate and economic growth.

HO: There is no inverse and significant relationship between

inflationary rate and economic growth.

1.4 SIGNIFICANCE OF THE STUDY

Full employment, equilibrium balance of payment, economic growth

and price stability are the four primary goals of any economy which Nigeria

is not an exception.

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It is therefore the aim of this study first and foremost to study the

efficiency of monetary policy in controlling inflation in Nigeria. The

important of this study to policy makers cannot be over- emphasized in the

economy considering the alarming rate of inflation increment over the years

especially in the 90s.

This study will therefore be of immense help to policy makers,

government and it agent, ministers of finance, investors – both foreign

indigenous and the entire Nigeria populace.

This study will also study the type of inflation, causes and ways of

controlling it and it impact on economic development of Nigeria.

1.5 SCOPE OF THE STUDY

Since inflation arises when aggregate demand exceed aggregate

supply, we shall focus our attention at examining the control monetary

policy has on thus primary variables.

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In this a year period is adopted 1984 to 1985. We hereby try to

analyze the causes effect of Nigeria inflation in terms of some qualifiable as;

money supply, real output etc.

1.6 LIMITATION OF STUDY

The limitation of our study centers around time, availability of material

and money. The time limit with which this study has to be completed is little

more than three months.

Theses limitation not with standing the researcher has made every

effort to ensure in realization of the research objectives.

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CHAPTER TWO

LITERATURE REVIEW

2.1 THEORITICAL LITERATURE

Monetary policy refers to that measure or action undertaken by the

government in order to achieve her economic objectives using monetary

instrument of control over bank lending and the rate of interest.

It is government deliberate attempt to influence aggregate demand in

an economy by regulating cost and availability of credit. the government can

influence both cost availability of credit by following measures designed to

affect the economy’s supply of money, these include open market

operation, special deposit, direct control over lending by bank and other

financial institution and various form of request.

Anyanwu (1993), defines Monetary policy as a policy designed to

affect inflation in an economy, through supply of money, cost of money and

availability of credit.

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From the above, it can be seen that monetary policy is concerned with

the relation of the volume of money in circulation at any point in time.

2.1.1 AN OVERVIEW OF NIGERIAN MONETARY POLICY

Nigeria is an economic entity and as an economic entity; it has certain

objectives just like other countries to attain. In an attempt to find solution to

economic problems, most countries adopt policy measures to regulate and

control the volume, cost and direction of money and credit in the economy

in order to achieve some specified macro economic policy objectives.

In other words, expansion and contraction of the volume of money in

circulation for the purpose of achieving certain declared national objective is

known as Ekong rightly puts it (1986:11) “ monetary policy is a deliberate

effort by the government aim at controlling the quantitative and qualitative

supply of money with a view to attain specific objectives.” Since 1985, the

importance of Monetary policy vis-à-vis fiscal policy has changed, reflecting

development in economic theory particularly monetarism, as well as

changes in the macro economic and financial connections nationally and

internationally.

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Monetary policy consist of actions by the government of a certain set

of economic objective. “It is the deliberate action on the part of the

monetary authorities (the central bank and the minister of finance to control

the money supply and general credit availability as well s the level of its cost

that is the rate of inflation”).

The aim of the policy makers is to exercise this control in certain ways

dictated by the governments’ economic objective because they constitute

an important source of money and because they play quite a significant role

in making credit available. Commercial banks are usually the main vehicle of

monetary policy.

Monetary policy is used to influence the level of output, employment,

prices rate of economic growth, and the balance of payment of an economy,

because there is a belief that there is a relationship between the real

variables and the monetary variables. However, this is valid only for a highly

monetarized economy. If the economy is not highly monetarized, the

efficiency of monetary policy is restricted. For instance, in an under

developed economy where a large proportion of output is produced in a

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subsistence sector, the level of output in that sector would be independent

of the supply of money. Monetary policy therefore, would not be efficient in

determing the output level of the subsistence sector.

Monetary policy is expected to influence the level of money supply to

a level of stability in such a way that the strength of the money supply and

the valve of the domestic product should match. Excess of it causes inflation

leading to some economic problems such as rise in prices. In this situation

the economy cannot function because price increases, income remain

stable; therefore there is a decrease in the real income. As a result, that is

now money in nominal terms and in real terms.

When there is inflation, people move from productive activities to

speculative activities. For instance, instead of establishing industries, one

buys land and house because their valve will always increase. People move

away from activities that will generate employment resulting to

unemployment. The purpose of monetary policy is to ensure an appropriate

level of money supply in the economy.

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In advanced economics which posse’s technical phases of the trade

cycle such as expansion, boom, recession and depression; monetary policy

measures can be applied to stimulate the economy into greater activity

during the period of expansion. They can be set to cool an overheated

economy during boom period and for prolonging the phase of property.

When recession set in, monetary policy could be applied to slow down the

economy from rolling down quickly into depression.

The evolution of Nigeria Monetary policy is reliable of the

establishment of CBN in 1958, the stage was set for a new era in which

Monetary policy could be used as an instrument of economic management.

The predecessor of the central bank, the west African Board (WACB) was in

no position and to pursue discretionary Monetary policy and under

circumstances, fiscal policy and price control were the main instrument of

economic control”.

In Nigeria, these objectives include: maintenance of price stability,

reduction in the rate of inflation, increase in employment, acceleration of

economic growth rate, attainment of healthy balance of payment position,

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greater income, greater saving. Higher standard of living, income

redistribution and greater investment. These objectives may be cross

purpose. However, at any particular time, if it is possible to identify the

major problem area to which policy instrument should be addressed. During

the period shifted from relative tightness to relative easy and back to

relative tightness. The main factor that influences policy formation was the

state of the economy.

2.1.2 ADMINISTRATION OF MONETARY POLICY IN NIGERIA

Monetary policy for consideration by the president is proposed by the

central bank of Nigeria (CBN) through a memorandum usually titled,

monetary and credit policy proposal which is for a particular fiscal year. The

memorandum, an input of all the policy departments of the CBN, is co-

ordinated by the research department.

The input takes into account the views and suggestions of financial

system operations, the business community and other interested members

of the public. It also considers the prevailing economic objectives that

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appear most, appropriate to pursue in the immediate future. The

memorandum is initially considered by the committee of governors, the

highest management body for the day- to day administration of the CBN. It

is finally discussed, amended if need be and approved by the board of

directors of the CBN.

Thereafter, it is transmitted by the Governor of the CBN to the

president for consideration and approval. The president, after due

consultation with other organs of government, takes a decision of which

proposal to accept and announces them in the budget. The acceptance of

theses proposal outline for banks and other financial institutions by the CBN

in form of a monetary policy circular for compliance. Penalties for non

compliance with specified guidelines are also indicated in the circular.

As a monitoring device, the CBN conduct periodic and special

examinations of the books of all liensed banks which are also required to

submit regular returns on their operations to the bank. The examination and

returns from the financial institutions as well as current economic

development enable the CBN to asses compliance with the Monetary policy

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circular. Routine amendments to the circular are undertaken by the CBN,

while fundamental changes must be discussed with the president

2.1.3 OBJECTIVE OF MONETARY POLICY

Monetary policy can be viewed as measures designed to regulate and

control the volume, cost and direction of money and credit in the economy

to achieve some specified economic policy objectives which can change

from time to time depending on the economic fortunes of a particular

country. Generally, the objectives of monetary policy include full

employment, rapid economic development, maintenance of price stability

and balance of payment equilibrium. In Nigeria, the over-riding aim of our

development effort remains that of bringing about an improvement in the

living condition of our people.

The board objective of monetary policy includes:

1. The control of inflation and maintenance domestic price and

exchange rate stability

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2. maintenance of healthy balance of payment position

3. development of sound financial system

4. Promotion of rapid and sustainable rate of economic growth and

development.

It is, however, not easy to achieve all the above stated objectives

simultaneously. At times, success is achieved at the expense of failure in the

others since the objectives may not be of equal importance for all times in

any economy, there is always the need to determine the main focus of

policy at any given point in time. Therefore, choice has to be made of a

desired combination of objectives, depending on the prevailing economic

circumstances.

It is however, pertinent to emphasize that Monetary policy is the only

supportive of the national economic development strategy and policy which

also call for the application of fiscal, exchange rate and other sectoral

policies. Consequently, Monetary policy need to be designed to attain a

realistic and consistent set of objectives within the general economic policy

framework of the country.

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2.1.4 INSTRUMENT OF NIGERIAN MONETARY POLICY

In pursuing the objective of price stability, inflation control, full

employment and accelerate economic growth the central banks uses some

method or instruments. The tools used can be broadly categorized into two

such as the qualitative or general controls which aim to regulate the total

quantity, amount or size or the volume of deposite or advances created by

commercial banks. They relate to the valve and the cost of banks credit in

general without regard to the particular sectors or economic activity in

which the credit is used. The general instrument of Monetary policy include

open market operation, discount and interest rate policy, moral suasion,

liquid asset ratio, special deposits. They can reduce the volume of bank

credit available to the economy.

The second category is the qualitative or selective control which aim at

controlling certain channels or to discourage them from lending for certain

purposes. They include aggregate credit ceiling, credit discrimination in

favour of indigenes, selective control and control on non – bank financial

institutions.

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2.1.5 OPEN MARKET OPERATION

The commencement of open market operation (OMO) in Nigeria at the end

of June, 1993 was preceded by years of preparations because the enabling

environment for the success of the scheme was non- existent. Even at its

commencement all the necessary condition has not been met. Open market

operation, in it classical form, is conducted mainly in the secondary market

government securities, the central bank directly induces changed in the level

of interest rates, the terms and availability of credit and ultimately, the

money supply. When the central bank sells securities in the market, the

transaction lead initially to contraction in the reserve that the bank have

available to meet their cash reserve requirements. The contraction in

reserve leads in turn to higher interest rate and a contraction in bank credit

and money supply.

Conversely, when the central bank buys securities in the market,

banks reserves increase and the ability to expand credit and money supply is

enhanced. The linkage between open market operation and reserve is made

clear by the accounting transaction that occurs when the central bank pay

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for the securities it buys or is paid for the securities it sells. When the central

bank buy securities, it pay for them by crediting the reserve accounts held at

the central bank by the sellers bank. The sellers account at the bank in turn,

are credited. Conversely sales of securities buy the central bank involves

debit to bank reserve account at the central bank and debit to the buyers

account in their banks. Thus when the central bank purchases securities,

reserve increases and when it sells securities, reserves decline.

The central banks portfolio of securities in one of many sources of

reserves. Other sources includes central bank loans to banks and private

sector, central bank float, foreign asset and other assets. The factors

affecting reserves can be divided into two categories those that can be

control by the central banks.

The only factor most central banks can control closely is it portfolio of

securities. All the other factors cannot be closely controlled. Within the

framework of factors affecting reserves, the central bank follows a three

step procedure in conducting OMO as follows

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1. Determination of the target level of reserves consistent with the

objective of monetary policy

2. Estimation of the net change in reserves that will occur due to

movement in controllable factors

3. Conduct of open market operation that increase or decrease security

holdings, enough to bring about the target level of reserve.

Owing to its character as a market based intervention mechanism, as well

as large slope of that if offers for price meal and gradual adjustment of

liquidity on a daily or weekly basis, open market operation would ultimately

be the dominant instrument of monetary policy in the regime of indirect

controls in Nigeria.

The flexibility that it provides permits its use in such a way as to undue

disruption and volatility in the financial markets. Moreover where there is a

large error in the forecast of supply, it demand for reserves occurs,

corrective action can be taken the next day or week. The optimal use of

open market operations therefore depend crucially on relevant data being

available over short intervals such as daily, weekly or fortnightly.

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2.1.6 THE DISCOUNT RATE AND INTEREST RATE STRUCTURE

The discount rate is the rate of interest, the central banks charges the

commercial banks on loan extended to them. If the policy makers wish to

reduce liquidity in the economy they may increase the discount rate. By

doing so cost the borrowing will increase and with these action policy

makers intend to increase liquidity and increase production, they reduce the

discount rate and borrowing becomes generally attractive.

Interest rate is a price of capital of the borrower and a return on capital

to the saver or lender. As an instrument of monetary policy it can be used to

combart inflation, case budget burden promote capital inflow and

discourage capital flight, as well as to avoid miss allocation of resources. It

can also be use to promote the growth of capital and monetary markets.

In Nigeria, interest was first used as an instrument of control between

1987 -1962. It was used as means of making short term investment of banks

in the Nigeria market more profitable enough to encourage them repatriate

short term funding kept abroad for retention in Nigeria.

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In other period when interest rate was used as an instrument of

monetary policy, this was directed to reducing the cost of government

borrowing or at making credit for the private sector more costly. Interest

rate has been relatively stable in Nigeria compared with other countries. It

was revised upward in 1964 and 1977 to curtail credit to the private sector,

and in 1973 – 1976 to reflect the high liquidity position of the economy.

RESERVE REQUIREMENT

The reserve requirement, other wise known as the reserve ration, can

be manipulated by policy makers, to reduce the ability of commercial banks

to make loan to the public by simply increasing the ratio, or enhancing their

lending position by reducing the ratio. As simple, explanation of how it

works is as follows

Assume that the total deposit with the commercial banks is 10 million

naira, and the legal reserve ratio is 10 percent, then the commercial banking

system must deposit 1 million naira with the central bank. If the bank in

term decides to reduce money supply in the economy it may then increase

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the legal reserve ration to say 20 percent. In this situation, a total of 2

million naira must be deposited with the central bank. This later action has

reduced the commercial banks ability to extend credit to their customers by

1 million naira.

Reserve requirement is one of the most powerful instrument of

monetary control. Changes in the required reserve ration have another

effect. A change in the required reserve ratio changes the ratio by which the

banking system can expand deposit through the multiplier effect. If the

required reserve ration increase, the multiplier decreases and thereby

reduces the liquidity position of the banking system cash reserve. Cash

reserve requirement was established between 1972 -1976 precisely to

reduce excess cash holding by commercial banks.

The commercial banks were required to maintain a minimum cash

deposit with the central bank ranging from 5 – 12 percent of their total

demand deposit and time deposit on which they are paid interest rate below

21/2 percent.

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LIQUID ASSETS RATIO

This is a system whereby the commercial banks are required to

diversify their portfolios of liquid asset holding. The use of this techniques

requires redefination of the composition of bank liquid asset portfolios at

different times to reduce or increase their credit base. Variable liquid asset

approach used was between 1959 and 1964 when the policy maker was

trying to

Another period the instrument was used between 1972 and 1976

when the government was pursing easy money policy. Since that period,

government long-term securities of about 3 years maturity were included in

the portfolio of bank liquid assets, this was to increase their ability to lend

the private sectors. However, the introduction has not made any significant

impact on commercial bank liquidity position.

2.1.7 CREDIT CEILING

Credit ceiling as used by CBN monetary policy formulation especially

since the early 1970s, are qualitative limit expressed in percentages to

ensure that domestic credit expansion and the monetary implication of the

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balance of payment target will match the expected increase in the demand

for total liquid in the economy. The qualitative limits are derived from the

monetary survey of the banking system. The result from the survey becomes

meaningful since it permit the matching of aggregate demand with

available resources. The level of the domestic credit consistent with target

changes in the net foreign asset, other asset (net) and the projected demand

for liquidity is optioned as a residual subtracting net foreign asset and other

asset from total liquidity.

The increase in domestic credit is then allocated between the public

and private sectors through an assumed banking system foraging of the

fiscal deficit. As presently practiced, the permissible change in credit to the

private sector is distributed quarterly for the year and the bases of the

observed seasonal behavior of demand or credit.

As well known, it has period difficult to achieve the monetary target

under the use of credit ceiling from their inception. Even during the period

of adjustment, the gaps between the target and the actual growth rates in

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credit to government and the private sectors have been too long for

comfort.

Similarly, the gap between the targets and actual for intermediate

monetary variable (M1) have been disturbing. Without that, credit effective

in retraining monetary growth, especially at the initial stage of their

application. But their implementation tend to be ineffective with time.

Nigeria experience has revealed problems relating to the varying

composition of credit, the enforcement of the ceiling and the relative

efficiency of the control system.

On the composition of the credit limit, many items of credit were in

the past excluded from the credit ceilings, for justifiable reasons, but this

action gradually eroded the effectiveness of ceilings. Some of these

expectations could cancel excessive credit operations. Another possible

source of excessive credit expansion has been allowed large ceilings enable

them grow. The rapid growth in the number of new banks since 1986 would

have added some impetus to this development.

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It should also be noted that credit guideline exclude the increasing

large number of non-bank financial institutions like insurance companies,

pension and provident funds, credit and co-operative societies and financial

institution has increased tremendously.

The above factors have created problem of enforcement which could

be worsened by the lags in obtaining and processing data from the banking

system. Banks are currently given up to the end of the subsequent months

to render returns on their operations for a particular month.

Since a lot of time is needed and reconcile the data, defaulting bank

would not be detected promptly and could therefore continue defaulting.

Another problem of enforcement arises from the growing problem of bad

and doubtful debt which, before the introduction of the prudential

guidelines, were compounded by many banks with due and unpaid interest.

This not only created uncertain assets but could help bank to exceed credit

ceiling very easily.

The credit guideline have encouraged efficiency in the banking system.

Permitting banks irrespective of their efficiency, to grow by the same ratio as

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stated in the guidelines trends to restrict competition in the system. It

protects the weaker banks while it prevent the growth of the more efficient.

This practice also favor the larger banks with the turnover which permits

them to accommodate new borrowers. Under the circumstances, dynamic

banks that aggressively mobilize savings may not be adequately rewarded.

Credit ceiling also promote the growth of credit and general

operations of the unregulated markets. There have been incessant

allegations of banks circumvent the ceiling by acting as brokers between

owners and borrowers of fund which tend to diminish the efficiency of the

financial system.

EXCHANGE RATE

Internationally, the performance of the national currency as measured

by the stability of the exchange is usually regarded as a variable indicator of

the attractiveness of the economy.

According to M.A.Uuebo, Nigeria has experimented with three

approaches in the naira exchange rate. They are pegging, managed float and

import, and weighted basket.

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Under the pegging system, the naira was pegged to dollar. This

became necessary because of the collapse of the `gold standard` in a

monetary system which hitherto guaranteed global exchange rate stability.

A change becomes necessary as it was realized that conditions in the United

State of America which affected the movement in the value of dollar were

different from those in Nigeria.

Consequently, as from April 1974, the naira exchange rate was

allowed to float. At the same time, a policy of gradual appreciation of the

naira was adopted, taking into account factors such as the balance of

payment, rate of domestic inflation, and changes in the value of currencies

of Nigeria’s major trading partners. The managed float also had the problem

that is not guided by developments in the international exchange market.

Since 1978, a new import weighted basket of seven currencies have been

adopted in determining the naira exchange rate. The approach has the

advantage of monishing overtime exchange rate fluctuations, inflating the

development in international exchange market, as well as reflecting the

development in the economy of our major trading partners.

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2.1.8 STABILIZATION SECURITIES/SPECIAL DEPOSITS

This technique may be employed if the prevailing economic condition

does not favour the use of other instruments. In this approach the central

bank may require the financial institution to make special deposits or buy

special securities from it. The idea of special deposits was evolved in 1976,

when the central bank which issued with commercial banks, based on

increase in their savings deposit account within N20,000 limits. However,

stabilization securities were excluded from the count in computing their

statutory liquidity ratios. The main goal of the exercise was to reduce the

excess liquidity position of the commercial banks.

MORAL SUASION

The policy maker sometimes uses the less tangible techniques of

moral suasion to influence the lending policies of commercial banks. Moral

suasion simply means employment of the policy makers of friendly

persuasion statements, public pronouncement or outright appeals. In this

way they explain how excessive expansion or contraction of bank credit

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might involve. Serious consequences for the banking system and the

economy as a whole.

Moral suasion as an instrument of monetary control is one of the

widely used instrument of monetary control in Nigeria. Before 1964 there

was no central bank control of commercial bank loans and advances in

Nigeria. In October 1964, the bank embarked on selective credit control

measures based on moral suasion. The situation was further tightened in

1966.

2.1.9 MONETARY POLICY FORMULATION

In formulating monetary policy, the CBN relies on the techniques of

financial programming whose starting point is a comprehensive review of

recent economic performance as the current and anticipated economic

problems. Projections are usually made on money supply, GDP growth,

inflation rate and balance of payment position.

On the basis of optimum money supply economy’s absorptive capacity

for domestic credit is derived so as to permit growth target to be

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determined for the key policy variables of money supply and aggregate

domestic credit.

Meanwhile, the permissible aggregate domestic credit is then allocated

between the public and private sectors. Then the size allocated to the public

sector is been determined by the size of the fiscal deficit to be financed by

the banking system. While the residual is allocated to the private sector.

2.1.10 EFFICIENCY OF MONETARY POLICY DURING INFLATION

The efficiency of monetary policy is severely limited in checking

inflation. This especially with the inflation that occurs as a result of the

upward shift in aggregate demand, that is demand- pull inflation. In such a

situation, inflation arises due to a rapid expansion of aggregate demand. To

time the demand – pull through open market operations. For instance, we

may find that the public might succeed in increasing the money supply in the

economy by increasing the velocity of the money available. Thus, to the

extent that the cost and supply of money to the extent that the CBN is help

less in checking inflation such a way might include:

37

a) The commercial bank can adjust their portfolio of asset by selling

government bond and using the proceed to lend to their customers

which defeat the intention of CBN to restrict credit through selling of

securities of business loans in their portfolio of assets affects the

ability of the CBN to control inflation.

b) The emergency of non financial institutions that hold government

securities and other asset as well as making loan available to

customers also affect the CBN control of inflation. Although they do

not have credit creating capacity of the commercial bank, never-less,

the fact that use funds obtained from the public saving to lend to the

borrowers in the economy and can adjust their portfolio of asset in the

same way as the commercial banks, limit the efficiency of the

monetary policy whether expansionary or contractionary depends on

a number of factors including the state of the economy, the

consistency and direction of other polices, income policy and other

domestic policies.

38

2.1.11 EFFICIENCY OF MONETARY POLICY DURING DEPRESSION

Monetary policy does not achieve its stated objectives during periods

of severe depression. Thus, during severe depression aggregate output and

income are falling and at very low ebb when there is a high level of

unemployment coupled with severe Bop problem and low aggregate

demand. In such situation although the CBN can pursue an expansionary

monetary policy to pump more money into the system and expand

aggregate bank lending to all classes of borrowers.

An economy that is facing bleak future investors would not be induced

to borrow to finance additions to capital since they ae already having excess

capital. And like wise consumers with falling income and unemployment will

not be induced to borrow to finance additional spending. This expansionary

monetary policy during recession is likely to help the economy out. On the

other hand, a contraction monetary policy at this point in time will only

aggregate the down turn and worsen the state of the economy.

39

2.1.12 OPERATION OF MONETARY POLICY

Monetary policy provides a complement approach to fiscal policy as

means of safeguarding the economy’s property and stability. When the

economy is weakening and unemployment is rising, the federal reserve

Authorities seek to expand money and credit, the resources and then the

federal reserve will seek to the growth of money and credit and thereby

contract aggregate demand.

Increase in money supply affect total spending in the economy directly

by putting more fund in the hands of consumers, business and government

agent and indirectly by reducing interest rate, thereby making it cheaper

and more attractive for the economic agent to borrow and then boost their

spending on available goods and services. On the opposite side, reduction

on the money supply will cause a drop in total spending both directly by

making fewer funds available and indirectly by raising interest rates, which

invariably makes money costly and deter customer’s businesses and

government from borrowing and spending.

40

If there is idle capacity in the economy, increase in total spending can

increase out put and employment without putting much upward pressure

on the price level but if the economy is at full capacity and there are no

many employed resources around, an increase in total demand will tend to

bid up prices. Under some conditions, a cut in total spending is called for,

and we would want to reduce the rate of growth of money supply on the

hopes that restraints upon spending would prevent prices from rising

further, without changing the level of out put and employment.

Monetary policy can be illustrated through the equation of exchange

MV = PQ

Where M = Money Supply

V = Velocity of Money

P = the General Price Level

Q = the Quantity Goods and Services

41

Money supply is a stock at a particular point of time though it conveys the

idea of a flow over time; money supply is defined as currency with the public

and demand deposits with commercial banks.

Money supply is the stock of currency and chequeing accounts. While

total economic activity is a flow of goods and services which is a measure of

Gross National Product. Changes in the stock of money affects economic

activity by its impact on either total demand of total spending.

PQ is the product of goods and services produced and the price level.

This is another way of defining Gross National Product (GNP), which are the

current market value of fiscal goods and services. The above equation can

be rewritten thus, MV = GNP. M, which is the money, seems to embrace all

the number of time at any given period that money turns over. The velocity

of money .

2.1.13 INFLATION IN NIGERIA, DEFINATION OF INFLATION

There has been a proliferation of definition of inflation. Some of these

definitions however express the descriptions of the processes by which the

underlie causes of inflation reveal themselves. Consequently, an

42

understanding of what the phenomenon is really pointing to is obscured.

According to public understanding by inflation is meant to condition which

produces a using trend in the general price level in the economy.

In attempt to define inflation, most economics succeeded only in

pointing to specific aspects of the phenomenon thereby giving the

impression that the term is not amendable to only one definition. some

people have coined the following expression “an increase in the amount of

currency, too much money chasing too few goods’’ when referring to

inflation. Many of these definitions at their best would not help us in using

the term for purpose of further investigations.

According to Griffiths (1976), ‘’ if inflation is defined s too much money

chasing too few goods’’, then the dice is based in favour of monetary theory

of inflation, implying that it can be controlled through monetary policy’’

(Yubwen 1996) however define inflation in

‘’ An economy is commonly regarded as suffering from inflation when

it is undergoing period of continuously rising price’’

43

This definition point to the fact that, for a price rise to be described as

inflation, it must be sustaining over a long period. In agreeing with Garwens

definition of the sustenance of the price rise, went a step further than

Garwen’s and Griffith defining inflation as ‘’a sustained rise in the general

price level” what is meant by ‘’general’’ here is that all prices may not be

rising at the same commodities may even be experiencing downward

trends in their prices. The main advantage of this definition as claimed by

Griffith (1996) is that, it is neutral with respect to the cause of inflation and

the most appropriate policy for bringing it under control. Another definition

worth nothing is that given by Odeh (1968). According to him, inflation is a

‘’significant price increase for number of years’’ he argues that significant

here means that level of price rise that may be regard as inflation for

different countries may not be the same, and that this will depend on their

past experience of the trend of prices in the economy in question. A

definition that seems to be more embracing is the one given by, Garder

Ackely (1972)

44

‘’According to him, inflation is persistent and appreciable rise in the

general level or average of prices’’. In addition to all the above views about

inflation Hagger (1977) maintained further, that inflation really come to the

surface due to constitutional controls.

Some economist in their own strength have defined inflation

quantitatively, in this wise, Parkin and Swoboda (1977) defined inflation as ‘’

the first different of logarithm of some price index’’ elaborating on this,

Pakin and Swiboda however stated, that the breath of the index and the

length of the time over which the change is considered as matters in which

the choice also depend of course, on the problem at hand hence consumer

price index or wholesale price index can be used.

What is significant about these definition is that inflation is a

disequilibrium state. Hence, it must be analyzed dynamically rather than

with the tools of states.

2.1.14 MONEY SUPPLY IN THE ECONOMY

What constitute the money stock of my country are those mediums

that facilitate the exchange mechanism and command general acceptability

45

( I. B. Eziri; 1995:45) these include currency (C) and chequable demand

deposits (DD). In Nigeria this is defines and as M1. Thus M1 = C + DD.

Some economist (the Chicago school) argue that total money stock

must not be restricted to M1, but must include any other asset that

command liquidity or near to currency these other assets have been

described as ‘’quasi’’ or ‘’near money’’ above. In Nigeria, the context of M2

is defined by the central bank of Nigeria (CBN) as

M2 = M1 +TD +SD +TDL

1. Currency outside bank is defined as currency in circulation less cash in

commercial and merchant banks.

2. Money supply (M1) is defined as currency outside banks plus privately

held demand deposits with the commercial and central banks.

3. Quasi – money (QM) is defined as savings and time deposit with the

commercial bank plus total deposit liabilities of merchant banks.

46

1.2.15 CAUSES OF INFLATION

Most economists agree that inflation arises, when aggregate demand

exceed the aggregate supply of goods and services. We analyse the

factors which lead to increase in demand and the shortage of supply.

Factors affecting aggregate demand

This is a considerable aggregate among scholars that inflation is

caused by increase in aggregate demand. They point to some of the

following.

Factors are causative ingredients.

1. The increase in the supply of money which lead to increase in

aggregate demand. The higher the growth rate of norminal money

supply, the higher the inflation rate.

2. Increase in public expenditure stimulate aggregate demand for goods

and service and result in price increase

3. The repayment of internal debt by the government tend to increase

the money supply and consequently price.

47

4. Cheap monetary policy or policy of credit expansion also lead to

increase in the money supply which raise the demand for goods and

services in the economy. When credit expands it raises the money

income of the borrowers which in turn, raises aggregate demand

relative to supply, thereby leading to inflation.

5. Finally, where there is exogenous factor of increase demand abroad

for domestically produced commodities. This foreign demand

increases the income and reverse of the industries concerned and

ultimately the result is increased demand at home which create

inflationary pressure.

FACTORS AFFECTING AGGREGATE SUPPLY

The following operate on the supply side and tend to reduce

aggregate supply of goods and services.

1. Shortage of such factors as raw material spare parts, machinery,

capital etc. These shortages result in excess capital and reduction in

industrial production.

48

2. Drought, floods and such natural disaster are very potent factors that

affect supply their occurrence create shortage on supply which create

inflationary pressure.

3. Inexistence of widespread technologies and know how which lead to

absence of management efficiencies and inadvertently shortages in

industrial output of supply.

4. The activities of hoarders, middlemen, and speculators who indulge in

black marketing. Thus they are instrumental in reducing supplies of

goods and raising their prices.

5. Finally, when the country produces more goods for export than

domestic consumption, this create shortages of goods in domestic

market. This lead to inflation in the economy. The above factors lead

to the erosion of the purchasing power money and consequently

inflation.

49

2.1.16 TYPE OF INFLATION

By ‘’type’’ of inflation, we mean the rapidity of price change. That is

whether price change slowly, rapidly or very rapidly. Economist used the

term, creeping, mild or galloping/runaway or hyper inflation. There is no

agreement on numerical estimations on the type’s mentioned above. It

all depends on how one views the situation

A slowly rising price level is often described as a creeping inflation,

while an extremely fast rate of price is described as hyper inflation. In

between this is galloping inflation. (Akakpan; 1989:71

Three main type of inflation can be mentioned here.

1. Creeping inflation

One that proceed for a long time at a moderate and fairly steady rate.

2. Galloping inflation

One that proceed at an exceptionally high rate, perhaps only for a

relatively belief period, but generally characterized by accelerating

rate of inflation so that the rate is higher one month that it was the

proceeding month.

50

3. Hyper inflation

This is a situation when the rate of inflation becomes immeasurable

and absolutely uncontrollable. Price rise many times every day. Such a

situation brings a total collapse of the monetary system because of the

continues fall in the purchasing power of money.

2.1.17 INFLATION RATE IN NIGERIA

YEAR INFLATION RATE

1984 39.6

1985 5.5

1986 5.4

1987 10.2

1988 38.3

1989 40.9

1990 7.5

1991 13.0

1992 44.5

1993 57.2

1994 57.0

1995 72.8

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1996 29.3

1997 8.5

1998 10.0

1999 6.6

2000 6.9

2001 18.9

2002 12.9

2003 14.0

2004 15.0

2005 17.9

2006 8.2

The table above show data indicating inflation rate in Nigeria for the

period 1984 to 2006. In the year of our study (1984), inflation rate of the

economy stood at an almost 40% (39.6% precisely). This was as a result of

ban in importation of food and other agricultural product by the authorities,

motivated by several balance of payment pressures.

The following year, the rate of inflation was 5.5%, this showed a fall.

The measure adopted by government then was the result. The inflation rate

52

mildly raised double digit to 10.2% again in 1987. This was due to structural

adjustment programme (SAP) measure taken in the economy. In the peak of

the economic crises, capital inflow had not but dried up, which the economy

or country’s foreign exchange earnings were far from adequate to support

the already expressed level of economic activities.

The situation continued further with higher level of idle industrial

capacity, plant closures, labour retremachment and alike. Shortages

generally through the proceeding years to an all times high of 40.9% in 1989.

It then clopped sharply to 7.5 in 1990 and 13.0 in 1991, it ascended to 44.5

in 1993, 57.2 in 1993, 57.0 in 1994, 72.8 in 1995, 29.3 in 1996, in other to

improve price stability, efforts were directed toward management of excess

liquidity; thus a number a measure were introduced to reduce liquity in the

system, this is done by increasing the commercial banks reverse

requirement in 1999 which reduced the inflation rate to 6.6%, in 2000 it was

6.9% and later increased to 18.9% in 2001, with the reintroduction of the

Dutch Auction System (DAS) of foreign exchange management in 2002

engendered inflation rate to 12.9%. in the year 2003 the inflation rate

53

increased to 14.0 %, the following year it increased to 15.0% and 17.9 in

2005.

In 2006, the new monetary policy framework for monetary policy

implementation was introduced, which aimed at achieving price stability

and non inflationary growth, as enunciated in the national economic

empowerment and development strategy (NEEDS). The target for single

inflation was however, achieved in 2006, the inflation stood at 8.2%.

2.1.18 MONETARY POLICY AS A CONTROL MEASURE ON

INFLATION IN NIGERIA

There is the traditional indication that knowing the cause of a problem

is bold step toward rectifying it. Thus having known that money supply

influence inflation at least from the literature review and the appraisal of

monetary theories, it should be reasonable also to suggest just like the

monetarist and the quantity theorists. That a proper adjustment or

manipulation of the money supply by the authorities concerned will help in

controlling inflation.

54

This measure has thus been adapted by the Nigeria government and

its mentalities (i.e CBN and the ministry of finance) to control inflation. The

CBN carries out this function via it monetary policy measure.

Essentially, monetary policy is the deliberate action on the part of the

monetary authorities to control the money supply and general credit

availability as the level of its cost, that is the rate of interest, the policy

makers exercise this control in either way that is they can use to stimulate

the economy by reducing the money supply. Thus in a period of inflation,

the policy makers contract the level of money supply by setting all these

instrument in motion. Operationally, the reserve requirements ratio are

raised, government sells it securities in the open market operation (OMO)

interest rate are raised etc, theoretically, however, this is simple, but it has

not be easy to manipulate these instrument due to; policy inconsistency,

2.1.19 EFFECT OF INFLATION

Inflation affects different people differently. This is because of the fall in the

value of money, when price rises or the value of money falls, some group of

55

the society gains and some lose and some stands in between. Broadly

speaking, there are two economic groups in every society, the fixed income

group and the flexible income group. people belonging to the first group

lose and those belonging to the second group gains. The reason is that the

price movement in the case of different goods, services, asset, etc are not

uniform. When there is inflation, most price are rising, but the rate of

increase of individual price differs much. Prices of some goods and services

rise faster, and others slowly and still other remain unchanged. The effect

are discussed below.

1. Salaried persons. Salaried power such as clerks, teachers and other

white collar persons lose when there is inflation. The reason is that

their salaries are slow to adjust when prices are rising.

2. Debtors and creditors: debtors gain and creditors lose when price rise

the value of money falls though debtor return the same amount of

money, but they pay less in term of goods and services. This is because

the value of money is less than when they borrowed the money on the

other hand creditors lose although they get back the same amount of

56

money which they lent, they receive less of the real terms because of

the value of money falls.

3. Government: the government as a debtor gains at the expense of

household who are its principal creditors. This is because interest rate

on government bond are fixed and raised to offset expected rise in

prices. The government in turn, levies less tax to service and retire its

debt. With inflation even the real value of taxes is reduced. Thus

redistribution of wealth in favour of the government accrues as a

benefit to the tax payers.

4. Reduction in production. Inflation adversely affect the volume of

production because the expectation of rising price along with rising

cost of inputs brings uncertainty. This reduces production.

5. Balance of payment: inflation involves sacrificing of the advantage of

international specialization and division of labour. When price rise

more rapidly in the home country than in foreign counties, domestic

product becomes costlier compared to foreign products. This tend to

increase import and reduce export, thereby making the balance of

payment of a country unfavorable.

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6. Collapse of the monetary system: if hyper inflation persist and the

value of money continue to fall many times in a year, it ultimately lead

to the collapse of the monetary system.

2.0 EMPERICAL LITERATRE

According to Soludo (2001) the pursuit of sound monetary policy and

strong moderating influence on the exogenous factors that have militate

against it development.

Central bank of Nigeria (1999) review monetary policy as a

combination of measured designed to regulate to value supply and cost of

money in an economic activity. Excess demand for goods and services will

cause inflation or balance of payment problem. On the other hand

appropriate to assume sustainable economic growth and maintain internal

and external stability.

Oyejide (2004) maintained that money supply is important in the

study of inflation due to its effect on aggregate demand. Availability of

58

money makes demand effective. It enables such demand to be translated to

reality. But if production level in an economy cannot sustains the level of

aggregate demand. The excess demand will bid up general price level

thereby bringing about inflation. Hence, the need to maintain sustainable

balance between this is done to provide for easy analysis.

Fried man (1963) went further to say that inflation is essentially a

monetary phenomenon. Assuming that economic agent are rational,

increase in money supply lead to appropriate price increase, leaving real

money balance and output unchanged. He argues that change in the

quantity of money will work through to cause changes in nominal income.

Inflation everywhere is based on an increased demand for goods and

services ass people try to spend their cash balance since the demand for

money is fairly stable, this excess spending is the outcome of a rise in a

norminal quantity of money supplied to the economy. So inflation is always

a monetary phenomenon.

59

Moser (1995). Studied inflation under long run dynamic error

correction model, he found out that monetary effect was substantial as well

as real income and exchange rate at a one percent significance level.

However, the important of price stability drives effect of price vitality

which undermines the ability of policy maker to achieve other laudable

macroeconomic objectives. There is indeed general saying that domestic

price fluctuation undermines the role of money as a store of value and

frustrate investment and growth (Ajaji and Ojo 1981, fisher 1993)

Bermanke (2005) observed that inflation is driven by bottleneck in the

real economy. In developing country food supply is relatively inelastic,

occasionally excess demand arising for example after an increase in non

agricultural income cannot be absorbed quickly enough to avoid price

increase, like wise foreign exchange constraint often lead to inflation. If food

import are restricted, negative supply shock such as drought or locost

invasion will lead to food stage and price increase further more when wage

are indexed and monetary policy is accommodative and initial increase in

60

price will lead to wage adjustment to compensate for the lost real income

and reinforcing inflation in Nigeria.

Hagfer (1964:12) believes in the theory of total absence of money and

monetary influence in combating inflation. According to him once there is a

tendency toward capacity shortage in a country it will produce inflationary

effect which cannot be ignored if the problem of inflation is persistent what

they need are measures that will maintain investment despite the reduction

in the growth of income. The most direct way to accomplish the desired

result would be to reduce interest rate and government expenditure. This

combine policy would then provide a stimulus to investment combined with

a reduction to total demand. He argued that a general reduction of

government expenditure would offset the effect of this increase.

INFLATION AND ECONOMIC GROWTH

There is a widespread belief that inflation and economic are related.

Inflation may be associated with a rapid or slow economic growth.

61

H.G .Johnson (1986) in his studies argued there is no convincing

evidence of any clear association, positive or negative between the rate of

inflation and the rate of economic growth.

Tomori .S: (1982) says, there are some countries which have

developed with varying degrees of inflationary situation. That Britain, United

State of America and Japan for example grew without inflation; while india

and South American countries had varying rate of recorded inflation with

economic growth. Some others no inflation and no growth e.g Venezuela

and European countries between wars (first and second world wars)

In Nigeria, S. Tomori observed

“it is becoming increasingly evident that we cannot count on

maintaining the measurable level of economic development(growth) and

simultaneously achieving reasonable price stability.

Consider the table below. It is observed that inflation rate and growth rate

to the period have moved in almost the same direction. This is comfirming

the observation of Tomori above.

62

COMPOSITE TABLE OF GDP AND INFLATIONARY RATES (BILLION

Year Annual total

GDP

Annual growth rate

of GDP (%)

Inflation rate

1984 63.0 5.1 39.5

1985 68.9 9.4 5.5

1986 71.1 3.2 5.4

1987 70.7 0.6 10.2

1988 77.8 10.0 38.3

1989 83.5 7.3 40.9

1990 90.3 8.1 7.5

1991 94.3 4.7 13.0

1992 98.4 4.1 44.5

1993 100.84 2.5 57.2

Source: CBN statistical bulletin, it is observed from the table that annual

GDP in billion (N) has grown steadly over the years. Meanwhile, the annual

63

growth rate of GDP in percentage has been series of ups and downs from

the peak of 9.4% in 1985 to 6.0 in 1987 and declined steadily.

The inflation rate however has tend to move in the direction of GDP

(growth rate). From 39.6% in 1986, and upwards two digits to 40% in 1989,

from there on it rose again to all high rate of 57.2%. Nigeria can be said to

be enjoying both an increasing growth rate and increasing inflation.

However, the success of monetary policy depend on the operating

economic environment, the institutional framework adopted in Nigeria, the

choice of mix of instrument used, the design and implementation of

monetary policy.

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CHAPTER THREE

3.0 RESEARCH METHODOLOGY

3.1 RESEARCH DESIGN

The original least square method of the classical linear regression

model is the econometric technique adopted in this study which covers a

period of (1984 – 2006) the preference of the use of this model is because of

certain assumption underlying the classical linear regression model.

ASSUMPTIONS:

1. The relationship between the regressor and the regress is linear

2. The expected mean value of ui is zero. That is ∑(ui/xi) = 0

3. Homosecdasticity or equal variance of ui given the value of x, the

value of ui is the same for all observation

4. The error term is normally distributed.

5. There is no perfect linear relationship among the explanatory

variables.

Base on the above assumption, the estimator BLUE

65

i the estimate are symmetrically unbiased

ii the estimate are consistent i.e as sample size increase the B

approaches it true value

iii the estimators are efficient i.e among a group of unbiased consistent

estimate Bs have the smallest variance.

iv the estimator are linearly and normally distributed.

On the above four basis assumption and properties lies the

justification for the procedure.

3.2 METHODOLOGY

This research work follows econometric research methodology with

measurement of parameters of economic relationship. The choice of this

method is necessary since we will analyze the efficiency of monetary policy

in controlling inflation in Nigeria. This is studied using these variables.

Economic growth, money supply, and interest rate.

66

3.3 MODEL SPECIFICATION

Specification of econometric model is based on economic theory and

on any valuable information relating to the phenomenon being studied.

In order word to test our working hypothesis, there is need to specify

the appropriate relationship between the dependent and independent

variables. This is because it is the relationship of economic theory which can

be measured with one or other econometric techniques as casual, that is

they are in relationship in which some variables are postulated to be causes

of the variables of the other variables thus, the relationship between

inflation and monetary variables can be presented as follows

INF = F (ms, int, GDP) …………………………………………………………………(1)

Where

INF = inflation

MS = money supply

INT = interest rate

67

GDP = Gross domestic product

The econometric model can be specified as shown below in equation two.

INF = BO + B1MS +B2INT + B3GDP +ui …………………………………………(2)

Where

B0 = Constant

B1, B2,B3 are constant of the parameter

Ui = error term.

3.4 METHOD OF EVALUATION

The evaluation of the research finding consist of deciding whether the

parameter estimates of the economic relationship or model are theoretically

meaningful and statistically satisfactory. According to Koutsoyiannis

(2001:25), the estimates or result are obtained from the estimation of an

econometric model are evaluated on basically three criteria include.

1. A priori criteria

68

This refers to the supposed relationship between and or among the

dependent or independent variables of the model as determined by the

postulations of economic theory. The result or parameter estimates of the

models will be interpreted on the basis of the supposed signs of the

parameters as established by economic theory put differently, the

parameter estimates of the model will be checked to find out whether they

conform to the postulations of economic theory.

The relationship between money supply and inflation are positive.

Because an increase in money supply will lead to an increase in inflation.

Vice visa.

Inflation and interest rate are positively related because an increase

inflation, increase the interest rate, while a decrease inflation will lead to a

decrease in interest rate.

1. Statistical criteria: First order test

The theories of statistic prescribe some test of finding out how

accurate the parameter estimates of a model are, these test help to suggest

69

whether or not the parameter estimates of the model. It will tell us whether

it’s a good fit or not

Such statistical criteria test are:

T tests: The co-efficient of the model will be tested for significance using the

t- test. The T testing procedure is based on the assumption that the error

term ui follows the normal distribution.

F test: The F test will be used to test the overall significance of the model

Durbin- Watson test: to test the validity of the assumptions of non-

autocorrelated disturbances, an econometric technique known as the

Durbin – Watson will be computed.

2. Econometric criteria: second order test

These are set by the theory of econometrics and are aimed at investigating

whether the assumption of the econometric method employed are satisfied

or not. Thus, the assumptions of OLS will be investigated.

70

3.5 SOURCES AND DATA REQUIRED

In order to ensure an adequate and comprehensive research, I

collected secondary data of money supply, Gross domestic product, interest

rate and inflation from (1984 – 2006). The data used in this project are

sourced from the central bank of Nigeria statistical bulletin volume 17

December 2006.

71

CHAPTER FOUR

PRESENTATION AND ANALYSIS OF RESULTS

4.O PRESENTATION OF RESULTS

The result of the original least square regression are presented below

as stipulated in the previous chapter, the OLS and the result of our model

was estimated using a computer software package E – view 6.0

The empirical result is presented in a table. The table shows the

estimated parameters, their t – statistics and other diagnostic test of

equation. The result obtained from the estimation techniques are presented

in the table below.

4.1 PRESENTATION OF REGRESSION RESULTS

Variable Coefficient Std error T–statistic prob

C 28.32041 21.82756 1.297461 0.2100

M2 162E.06 2.31E.06 0.700168 0.4923

INT 2.050578 1.208025 1.697463 0.1059

GDP -9.62E.05 5.28E-05 - 1.821298 0.0843

72

This model has the following result

R2 = 0.210532

F = (3, 19) = 1.688945

D* = 1.035564

Where

R2 = coefficient of multiple determination

D* = Durbin – Watson statistic

4.2 ANALYSIS OF RESULT

4.2.1 STATISTICAL CRITERIAL (1ST ORDER TEST)

We shall apply the student t test, R2 and F test to determine the

statistical reliability of the estimated parameter.

The value of R2 is 0.210532. this implies that 21% of the variation in

inflation is explained by independent variables which are interest rate,

money supply, and gross domestic product. This indicate that the goodness

of the model is not a good fit.

73

4..2.2 THE STUDENT T TEST

Evaluation is carried out to ascertain if the independent variables are

individually significant. If the calculated t is greater than the critical t at 0.05

level of significant then reject the null hypothesis Ho, otherwise accept the

alternative hypothesis H1.

From the statistical table, critical t 0.025 = 2.09. the result of the

evaluation is summarized in the table below.

Variable T value T – tab Decision Conclusion

M2 0.700168 2.09 Accept Ho Insignificant

INT 1.697463 2.09 Accept Ho Insignificant

GDP -1.821298 2.09 Accept Ho insignificant

From the table above B1(MS), B2(INT) and B3(GDP) are not statistically

significant. We conclude that B1, B2 and B3 has no significant effect on

inflation rate in Nigeria in the period under review.

4.2.3 THE F – STATISTICS TEST

74

This evaluation is carried out to determine, if the independent

variables in the model are simultaneously significant of not. If F* if greater

than critical F at 0.05 level of significant, then reject the null hypothesis H0

and accept the alternative hypothesis.

DECISION RULE

Reject H0 if F- cal > F0.05 (V1/V2)

VI = K – 1 (numerator)

V2 = N – K (denominator)

From the result in the model, F cal = 1.688945. From the F table F0.05

(3/19) =3.13.since F – table of F0.05 (3.13)> F-cal (1.688945), we accept

H0 and conclude that the independent variable in the model are not

significant.

4.3 ECONOMETRICS TEST OF SECOND ORDER TEST

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This test will be based on whether the assumption of the classical

linear regression model are satisfied. The assumptions underlying the

statistic are:

1. The regression model include intercept term

2. The regressor or explanatory variables are nonstochastic of fixed in

repeated sample

3. The error term is assumed to be normally distributed

4. The regression model does not include the lagged value of the

dependent variable as one of the explanatory variables.

5. There are missing observation in the data.

When these assumption are not satisfied it is customary to re-

specify

The model, for instance, one may introduce new variable or omit some,

transform the original variable, so as to produce a new form that will satisfy

these assumption.

4.3.1 AUTO CORRELATION TEST

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We will adopt the Durbin Watson d – statistic to test the randomness

of the residuals. Based on this we state our hypothesis as thus

H0: P = 0 (No positive first order autocorrelation)

H1: P = 0 (positive first order autocorrelation)

DECISION RULE

Reject Ho if d* < du or d* > 4 -du

Accept Ho If d*> du or d* < 4 -du

Where:

d* = estimated Durbin – Watson

du = Upper Unit Durbin - Watson

from the Dw d table

du = 1.66 (n= 23, k = 3) at 5% level of significant. And d* = 1.035564

since our d* = 1.035564 is less then du = 1.66,we conclude that there is no

evidence of positive autocorrelation in the regression result.

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4.4 SUMMARY OF FINDING

1. The relationship between money supply and inflation is positive and

conformed with the a priori expectation but is statistically insignificant

2. The result indicate a positive relationship between interest rate and

inflation rate which conform with the apriori expectation but is

statistically insignificant

3. The relationship between GDP and inflation is negative which conform

with the apriori expectation but is statistically insignificant.

From the above study, it shows the performance of monetary policy as

an instrument to check inflation in nigeria. The null hypothesis of this

study posit that the use of monetary policy variable in controlling

inflation in Nigeria is not effiecient. This is proves ture as monetary policy

variables (interest rate, money supply, and GDP) do not show statistical

significant relationship between them and inflation rate.

CHAPTER FIVE

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5.0 SUMMARY OF FINDING, RECOMMENDATION AND CONCLUSION

5.1 SUMMARY

In this study, we have tested for the relationship between inflation,

money supply, Interest rate and GDP, to find out if monetary policies are

efficient in controlling inflation. Using secondary data from 1984 to 2006.

It is discovered that all the monetary target variables exert an

insignificant impact on inflation control in Nigeria. The relationship which

exist between the monetary instrument and inflation shed more high on the

use of monetary policy for controlling inflation in Nigeria. A combination of

monetary variable such as money supply, interest rate and GDP, may not be

efficient for the purpose of controlling inflation.

5.2 CONCLUSION.

The monetary policy of a country is an important aspect of its overall

economy policy. Appropriate money supply instrument therefore contribute

to economic growth by adjusting money supply to need of growth by

directing the flow of funds in the required channels and by providing

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institutional faculties for credit in specific fields of economic activities. In this

way, a healthy growth of the economy could be masterminded.

Therefore, a proper monetary policy utilizing appropriate instrument

is not sufficient condition but a necessary condition in stimulating economic

growth.

In the final analysis, the operation of money policy instrument depend

on the intention of the regulating authorities and the degree of the

operation and response from banks. They should endeavour to respond

whole heartedly in carrying out the gigantic work of planned development.

Economic development is a joint venture between the government, the

various financial institutions. As it may be difficult to separate the spheres of

operation of the different component making up general economic policy,

there is a need for a continuous close co-ordination in the relationship

between the various monetary authorities. As monetary policy is an

important aspect of intervention in the economic process, it must there be

tuned to the larger economic objectives of the state. the choice of

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alternative policy instrument depend upon economic environment,

administrative ability and political situation.

From a broad economic viewpoint, monetary policy instrument can be

regarded as mere catalysts that accentuate the pace of economic

development. Their efficiency can largely depend on the economic will of

the people to implement genuine decisions of the government especially

concerning inflation control.

5.3 RECOMMENDATION

Firstly, the monetary authorities should use more important monetary

instruments than hitherto adopted. For example, the special deposit and

credit guidelines (selective credit control) should be impose on the

commercial banks whenever need arises.

Secondly, loans and advance should be given to production sectors of

the economy so as to increase productivity. Policy maker should adopt

monetary incentives or measures that would pave the way for an increase in

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the number of financial institutions in the country. Since the commercial

banks are inadequate and inefficient in their service to the public, most

people are discouraged from saving with the banks. If the whole economy

becomes adequately monetized through adequate banking system, the

incidence of outside money will be minimized.

Thirdly, Nigeria’s should be encouraged to have confidence in the

banks and the use of cheques in transacting business. If this is done, the

genuine effort of the central bank to control inflation through money supply

is easier in developed countries because the bulk of business transaction

are done with cheque which are controlled by their monetary authorities.

Fourthly, there is a need for a thorough reappraised of our tariff

structure a switch from our foreign dominated consumption pattern to

consumption of home goods should be encouraged. Importation of

machinery and production of capital equipment should be favored over

consumables or luxuries.

Moreover, there is need for price control board to critically examine

and monitor the cost structure and profit margin of producers and

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distributors. This involve fixing prices, to avoid excessive profit. If this is

done; there is no doubt that the prices of goods produced will be stable.

Furthermore, the most appropriate solution to inflation is supply

management, which entails increase in the domestic production of

consumer goods to meet the ever increasing consumer effective demand.

Hence, for a complete realization of this objective, there is need for a rapid

transformation of the economic system especially in the rural area. One of

such ways is to improve agricultural strategy, an effective adoption of

integrated rural development and the basis need approach application.

Finally, firm and industries located in the country should be persuaded

further to source a greater proportion of their raw material requirement

locally more than is being done. This will reduce the effect of imported

inflation in the economic activities, conserve foreign exchange and generate

employment.