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MONEY SUPPLY
DETERMINATION IN NIGERIA
ABSTRACT
Money supply
is one of the important macroeconomic variables. The control of money supply is
an essential tool in conducting monetary policy within the monetary targeting
framework. The success of monetary policy critically depends on the
controllability the monetary authority has over money supply.
In view of
this, this research work aimed at identifying the variables that determine
money supply in Nigeria, specifies the correct relationships between these
variables and money supply as well as to provide statistical evidence vis-a-vis
the relationship in Nigeria, and also examines the most current important
issues and questions in Nigerian money supply determination. Thus, the thesis
lays emphasis in monetary policy as well as the viability of money supply and
its determination in Nigerian economy. The period covered is 1983 to 2008.
In the
course of determining the relationship, the study applied the econometric
technique- Ordinary least squares Estimates (O.L.S.E), Error correction
model(E.C.M) to time series data. More so,
correlation matrix, percentage proportion and co-integration technique
using, the unit root and granger causality test is used to verify the
stationarity of the time series in order to avoid analyzing inconsistent and
spurious relationship in the model, thus, ascertain whether past value helps to
explain current value.
From the
regression result, it was found that all the variables put forward i e money
supply in the last period, domestic credit to public sector, domestic credit to
private sector, net foreign assets and net of other items were significant in
explaining money supply determination in Nigeria. By implication, Using
Standard Granger Causality test, this study demonstrates that money supply in
Nigeria for the period 1980-2003 is not exogenously determined.
CHAPTER ONE
1.0. Introduction
Money supply
mechanism has been receiving increasing attention than any other subject matter
in the field of monetary economics in recent years. Because of the importance
of money supply via monetary policy in achieving macro-economic objectives of
nations (developed and developing), persistent concern has always been given
among monetary economists including Ajayi (1972), Mckinnon (1973), Shaw (1973),
Oyejide (1974), Fry Mathieson (1980), Ojo (1993), Ghatak (1995), Odedokun
(1996), Levine (1997), Tomori (1984) ,Asogu (1998) , Ogun and Adenikinju
(2004), and Owoye and Onafowora (2007) to the process of money supply and its
determination.
The control
of money supply is an important policy tool in conducting monetary policy
within the monetary targeting framework. The success of monetary policy
critically depends on the degree of controllability that the monetary authority
has over money supply. The implicit assumption is that the central banks can
determine the growth of money supply, and the level of money stock is the
product of two components: the monetary multiplier and the monetary base. The
monetary base is the quantity of government-produced money. It consists of
currency held by the public and total reserves held by banks. Doguwa (1994).
According to
Bhole (1987), Monetarists in general, argue that the monetary authorities can
exercise effective control over the stock of money while the non-monetarists on
the other hand, hold that the determination of stock of money is part of the
simultaneous solution for all variables in the financial and real sectors of
the economy. He further states that apart from policy action by the central
banks, money stock is determined by the behaviour of the public in various
asset and commodity markets. Opposing such non-monetarist arguments, the
monetarists argue that the behavioural patterns of the public and the banking
system are stable and predictable enough to permit the monetary authorities to
control the stock of money. While such opposing views have been widely debated,
empirical evidence on the issue is critical to conducting monetary policy in
practice.
Akhtar,
(1997) and CBN, (1995), opine that monetary policy influences the level of
money stock and/or interest rate, i. e. availability, value and cost of credit
in consonance with the level of economic activity. Macroeconomic aggregates
such as output, employment and prices are, in turn, affected by the stance of
monetary policy through a number of ways including interest rate or money;
credit; wealth or portfolio; and exchange rate channels
However, Akinnifesi and Philllip (1978), in
their effort, to examine the determinants and control of money stock in
Nigeria, argue that, monetary authorities apply discretionary power to
influence the money stock and interest rate to make money either more expensive
or cheaper depending on the prevailing economic conditions and policy stance,
in order to achieve price stability. This is why Wrightsman (1976), concludes
that monetary policy is nothing but a deliberate attempt to control the money
supply and credit conditions for the purpose of achieving certain broad
economic objectives. In general, most monetary authorities or central banks
have been saddled with controlling inflation, maintaining a healthy balance of
payments position to safeguard the external value of the domestic currency and
promoting economic growth.
While
attempting to identify the appropriate definition of money in Nigeria, Ojo
(1978) adopted Chetty’s theoretical approach with the use of 1961-79 data and
found that the wider definition of money is more appropriate when measuring
national income in the Nigerian economy. Uchendu (1997) however, in an attempt
to establish a relation between monetary base and money supply defines money
supply from the Central Bank balance sheet accounting framework as (M1) is the
sum of currency in circulation C, and deposits D. Thus, M1= C+D, and from the
broader definition M2 = C+D+TD, where TD = time deposit
More so,
Nnanna, (2002) and Ojo, (2001) in the process of identifying the assets and
liabilities of the financial sector, define money supply (M2) which is the
expanded of narrow measure of money (M1) to include time and saving deposits at
the money banks (DMBs) which is also term Quasi-money (QM) which are not
directly useable as a means of payment but can in practice be converted into
generally acceptable means of payment. Thus, M2 = M1 + QM
In general
terms, money supply could be defined as comprising narrow and broad money. The
narrow money (M1) includes currency in circulation with non-bank public and
demand deposits or current accounts in the banks. The broad money (M2) includes
narrow plus savings and time deposits as well as foreign denominated deposits
(CBN, 2010).
However,
Ogunmuyiwa and Ekone (2010), in analyzing the relation between money supply and
economic growth, opined that the broad money measures the total volume of money
supply in the economy. Thus, excess money supply (or liquidity) may arise in
the economy when the amount of broad money is over and above the level of total
output in the economy. They further
stress that the need to regulate money supply is based on the knowledge that
there is a stable relationship between the quantity of money supply and
economic activity that if its supply is not limited to what is required to
support productive activities, it will result in undesirable effects such as
high prices or inflation
Oyejide
(2004), stresses the importance money supply in the study of inflation and its
effect on aggregate demand. Availability of money makes demand effective i.e.
it enable such demand to be translated to reality. But if production level in
an economy cannot sustain the level of aggregate demand. The excess demand will
bid up general price level thereby bringing about inflation. Hence, the need to
maintain suitable balance between this is done to provide for easy analysis.
Government
aspiration towards the achievement of broad economic objectives could be
pursued by means of monetary policy strategy among others. Monetary policy refers to a combination of
measures designed to regulate the value, supply and cost of money in an
economy, in consonance with the expected level of economic activity Nnanna,
(2001). Some other theorists refer to monetary policy in terms of the central
bank actions to influence and/or target some measures of the money stock.
However, the definition of monetary policy often incorporated in theoretical
models focus more on the measure of high powered liabilities of the central
bank. This definition was the foundation of the monetarist revolution in the
1960s and 1970s (Rasche and Williams, 2007: 447).
In another
strand, monetary policy is perceived as the high powered liabilities of the
central bank. Such proponents ordinarily refer to monetary policy as the central
bank actions to influence and/or target short-term interest rates or nominal
exchange rate. However, Sargent and Wallace (1975) have contended that in a
model with “rational expectations”, the price level (and all other nominal
variables) could be indeterminate if the central banks set targets for nominal
interest rates, because the economy would lack a “nominal anchor”. McCallum
(1987) advanced the argument and showed that an appropriately defined interest
rate rule which include a “nominal anchor” would avoid such indeterminacy.
In the US,
in the early years of Greenspan, interest rate rules that include a 'nominal
anchor' in the form of a desired or target inflation rate became the basic
specification of 'monetary policy' in theoretical discussions. These various
definitions of monetary policy are influenced in part by developments in
monetary theory and in part by interpretations of monetary history. Thus, the
changing role by the definition of monetary policy is but something of a moving
target. Rasche and Williams (2007:448).
In the last
three decades the discourse on the effectiveness and role of monetary policy is
still a major debate in macroeconomics. The risk of 'monetarism' subsequent to
the works of Friedman and Schwartz (1963); Anderson and Jordon (1968); Meltzer
(1976 and 2003) have presented several planks. Firstly, some monetarists
contend that sustained inflation was a monetary phenomenon and that central
banks should be held accountable for maintaining price stability. The
contention here is that central banks should control the stock of money in the
economy rather than focus on targeting short-term nominal interest rates as a
mechanism to achieve long-run inflation objective. (The reason for this is
that, in a fiat money economy, the money stock provided the nominal anchor for
the system (Rasche and William, 2007).
There are
some other monetarists from the above group who equally believed that inflation
control was not the only concern of the monetary authorities. Anderson and
Carlson (1970) viewed monetary policy as having significant effects on
short-run fluctuations in real output, though it does not affect long-run
output growth. Meltzer (1976, 2003) among others believe that monetary policy
was responsible for the historical cyclical fluctuations in real output.
In the 1970s
and early 1980s, macroeconomics witnessed the plantation revolution of the
“rational ineffectiveness proposition” of the New Classical Macroeconomics.
Some common works during this era were Sargent and Wallace (1975); Fischer
(1977); Taylor (1980), among others. The initial interpretations of the
rational expectations paradigm were that, if expectations are rational, they
would render monetary policy ineffective in influencing real output both in the
short-run and long-run. Thus, monetary policy has no role in output
stabilization. Further demonstration eventually revealed that it was the
interaction of the rational expectations and perfectly flexible wages and/or
prices assumptions that generated the “policy ineffectiveness proposition”. This
integration of ideology saw an emergence of a new thought known as the “New
Keynesians”. The popularity of the New Keynesian models has eventually eroded
the monetarist tenets of how monetary policy affects economic activity. Money
in this cycle is less often spoken about especially when included in the
discourse on “inflation”. King (2002) equally cited in Rasche and Williams
(2007:449) notes that:
“There is a
paradox in the role of money in economic policy. It is this: that as price
stability has become recognized as the central objective of central banks, the
attention actually paid by central banks to money has declined” (p. 162).
The
implication of this is that although monetary policy is essential in economic
growth and development process of modern economies, its role in macroeconomic
policy objective is becoming more passive. This is because its fundamental role
has been streamlined to price stability and in recent times inflation
targeting.
In
contemporary literature and policy discussions, on some economies (New Zealand,
Norway, Switzerland, Thailand, UK, Chile, Hungary, Colombia, Canada, etc), more
attention is given to the role of an inflation objective in a central bank
'policy rule' as the nominal anchor. This constitutes the basis of the discussion
on inflation targeting. Inflation targeting is a framework for policy decisions
in which the central bank makes an explicit commitment to conduct policy to
meet a publicly announced numerical inflation target within a particular time
frame (Egbon, 2006).
As so far
reported in the literature on inflation-targeting, a number of inflation
targeting countries as listed above have recorded effectiveness in their
monetary policy and that central banks that have announced explicit numeric
inflation objectives have been quite effective in achieving the stated
inflation stabilization objective (Rasche and Williams, 2007); however, this is
not without some problems in the implementation.
In Nigeria,
the Central Bank of Nigeria (CBN) is the sole monetary authority. Its core
mandate is to promote monetary and price stability and evolve an efficient and
reliable financial system through the application of appropriate monetary
policy instruments and systemic surveillance. The 1958 Act establishing the
Central Bank of Nigeria gave it the following specific functions (which have
endured in the 2007 CBN Act):
· issuance of legal tender currency notes
and coins in Nigeria;
· maintenance of Nigeria's external
reserves;
· safeguarding the international value of
the currency;
· promotion and maintenance of monetary
stability and a sound and efficient
· financial system in Nigeria; and
· Acting as banker and financial adviser
to the Federal Government.
According to
Omotor, (2007), embedded in these objectives are two separate but highly
related roles: A developmental role and
financial surveillance (stability) role. The roles demand, among others, that
the CBN focuses on both price stability and growth. In order to ensure the
realization of the goals of price stability and economic growth, the CBN
deploys its monetary policy instruments in such a way as to ensure optimality
in inflation and growth outcomes. It follows, therefore, that the efficient
conduct of monetary policy is a major responsibility of the Central Bank of
Nigeria. This is also true of most central banks.
Monetary
policy therefore, involves the adjustment of money stock, to influence the
level of economic activity and inflation in a desired direction Teigen, (1995).
It is a combination of measures designed to regulate the value, suppliers and
the cost of money in an economy in line with the expected level of economic
activity Ojo, (1992). Monetary policy is construed to be actions by the
monetary authorities to influence the national economic objectives by
controlling or influencing the quantity and direction of money supply, credit
and the financial accommodation for growth and development programmes, on the
one hand, stabilizing various sectors of the economy for sustainable growth and
developments, on the other hand.
Monetary
policy is also defined by Johnson (1962) as policy employing the central bank’s
control of the money supply as an instrument for achieving the objectives of
economic policy. Similarly, from a synthesis of most of the literature and in
the context of the Nigerian situation, Ubogu (1985) defines monetary policy as
an attempt by the monetary authorities to influence the level of aggregate
economic activities by controlling the quantity and direction of money and
credit availability.
An issue
which has occupied the minds of governments for decades is the effectiveness of
monetary policy in influencing economic variables, and money supply is a key
variable to the understanding of monetary policy and its effectiveness. The
majority of studies on finance in Less Developed Countries (LDCs) have
concentrated on long or medium-term issues, but studies on short-term issues of
money and finance have been sparse. Empirically-oriented studies in this area
have been hampered by the lack of concrete information and data (Fakiyesi,
1999). Moreso, in Nigeria, research in the area of monetary policy especially on
money supply determinants have been minimal when compared with the efforts into
other components of the financial sector such as financial reform, trade
liberalization and exchange rate. Even when research is available on money
supply, the emphasis has been on the portfolio, stability, and mechanism of
money supply.
Ajayi
(1972), in a critique, examines the money multiplier Approach to money supply
determination. In a related issue, Ajayi and Ojo (1981), analyze money supply
in Nigeria, and specified behavioural model that exist among the money stock,
high-powered money and money multiplier. Tomori (1984), among other issues,
examines the proportion of money stock in Nigeria that is accumulated by the
Central Bank. Uchendu (1997), investigates the relationship between money
supply and base money in Nigeria, and tends to explain the stability of the
relationship. More so, Doguwa (1994), analyses the stability of money
multiplier in Nigeria by comparing the explanatory powers of the regression of
the growth of money stock on the monetary base. While, the CBN’s Research
Department (1990, 1991), Oriesotu (1993), Oke (1993, 1994), tend to articulate
theoretically, the basis for the operation of the indirect method of monetary
control in Nigeria, Akinnifesi and Phillip (1978) and Oriesotu (1993), examine
the implication of the indirect approach on monetary stock control in Nigeria.
Ogun and Adeenikinju (2004), investigate and analyze the process of money
supply mechanism in Nigeria. Equally, efforts have been made to investigate the
impact of the impact of money supply on economic growth in Nigeria, Ogunmuyiwa
and Ekone (2010).
It is also
well-known that in less-developed countries, there is a tendency to predicate
monetary and financial policy on models are which are in the spirit of the
money multiplier analysis (Taylor, 1974; Coats and Khatkhate, 1978; Ajayi, 1981
and Fry, 1978). This is in spite of the fact that when policies are predicated
on such models, they do not reflect the true structure and process of money
supply in these countries. These models tend to misrepresent; therefore the
true nature and process of money supply and thereby likely to mislead
policymakers. It is therefore with this background in view, that this study is
undertaken.
1.1 The Statement of the Problems
An
understanding of the potency of monetary policy and transmission mechanism of
the aggregate money is very important to the success of monetary policy. An
efficient implementation requires policy makers to know the direction the
policy could take to impact on the macro economy and the time lag of the
impact. Key policy issues in the current policy framework arise. For example,
do changes in reserve money actually lead to change to money broadly defined
(M2) and/or inflation? If so, how long do these changes take to impact
inflation? Thus inflation would then aid policy maker to know which instrument
are useful and which time horizon should be used to target inflation.
Conducting
monetary policy is a difficult task since it affects the economy with a lag.
Achieving goals requires some ability to peep into the future. Consequently,
decision makers should make forecast to assist in policy formulation. To
conduct this forecast, most central banks take a number of variables into account.
An aspect of this thesis attempts to evaluate the information content of
monetary aggregate used by the central bank of Nigeria to target inflation and
other key variables such as interest rate, domestic dept and exchange rate,
which have the potential of being useful indicators of inflation. The more open
the economy, the greater the importance of the exchange rate in the policy
process and the more important this variable becomes as an optional policy
tool.
Thus, the
very nature of economic activity in Nigeria gives room for so many questions
and problems that beg for urgent attention.
There is
inflationary acceleration in money supply in the country.
There is
unstable general price level which is always moving up
There is
high level of unemployment in the country
There is
wide gap between saving rate and interest rate which is not encouraging savings
as well as deterring borrowing.
The level of
economic activity in the country coupled with the global financial crisis show
that there are plethora problems in the economy Thus, there is need for
effective monetary policy vis-Ã -vis the estimation of money supply, which is an
unavoidable task of Economists.
1.2 Motivation and Objective of the Study
In addition
to the arguments in the concluding part of introduction section above, the
desirability of a sound micro-economic foundation for macro-economic policy has
assumed increasing importance in recent times. In order to provide a solid
foundation and to allow monetary policy to be conducted to the best advantage
of a given country, it is necessary to develop a satisfactory model of money
supply. Such a model would be an indispensible tool for understanding the
working of monetary transmission mechanism in the economy. Such model may also
act as a prerequisite for understanding better the workings of the financial
sector, especially as it reflects the role of the sector within the economy in
general and the importance of money supply and other financial variables in
particular.
The aim of
this study is to look at the factors that affect money supply in the Nigeria
context and also examine the most current important issues and questions in the
Nigeria money supply determinations. The primary purpose of this study is to
critically examine the supply of money in Nigeria in the period 1983 – 2008 and
also identify the variables at play in determining money supply in the Nigeria
economy. Thus, the research work lays emphasis on the monetary policy as well
as the viability of money supply and its determinants in Nigeria economy. The
objectives of this research work could be itemized as follows;
· To examine the balance sheet of the
central bank of Nigeria (CBN) and the deposit of money banks (DMBs) from 1983
to 2008.
· To consolidate the balance sheet of
the financial sector, thus, identify the monetary assets and the liabilities of
the financial institutions within the period of study.
· To examine the aggregate domestic
credits and establish empirically its impact on money supply within the period
of study.
· To determine the causal links between
the foreign assets and the monetary aggregates in Nigeria.
· To see whether or not, the transmission
mechanism of the monetary policy in Nigeria changed within the period of study.
· To establish empirically, whether or
not, monetary aggregates have useful information for forecasting inflation.
· To examine whether or not, the
development of financial sector has any significant effect on economic growth.
1.3 Significance of the Study
A lack of
understanding of the factors influencing the variables in the money supply
determination could lead to so many problems in an economy. More so, the
process of money supply on the Less Developed Countries (LDCs) is largely due
to the level of development of the institutional and organizational structure
of financial sector and to some extent the lack of adequate bases for policy by
the authorities. These developed institutional and organisational structures
can aid and induce the bases for efficient policy. The prevalence of adequate
bases for policy would guide policy-makers on how to improve the system. (see
Fakiyesi, 1999, pp. 2 ).
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