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AN
ECONOMETRICAL ANALYSIS OF MONETARY POLICY ON THE ECONOMY OF NIGERIA
CONCEPTUAL
FRAMEWORK
The concept
and definition of monetary policy in the previous year has no universal
acceptability but however, the term monetary policy according to CBN release on
monetary policy concept (2006) was defined as “Any policy measure designed by
the Federal Government through the CBN to control cost availability and supply
of credit. It also referred to as the regulation of monetary supply and
interest rate by the CBN in order to control inflation and to stabilize the
currency flow in an economy.
However, in
the CBN Briefs (Series No 97/03 June 1997).Monetary policy was defined as
follows; The combination of measures designed to regulate the value, supply and
cost of money on an economy in consonance with the expected levels of the
economic activities These imply that the excess supply of money would result in
excess demand for goods and services, which would in turn cause a rise in price
and determination of balance of payment position. Monetary policy is one of the
available tools of macroeconomic objectives. The primary goals of macroeconomic
policy are price stability, external stability and a satisfactory rate of
output growth.
2.2Â Â Â
 THEORITICAL LITERATURE
The effect
of monetary policy is a central issue and has attracted a lot of comments both
in and out of the country. The theories of monetary policy became success
during 1930’s and 1940’s. It was believed that the well being of monetary
policy in stimulating recovery from depression was severely limited than in
controlling a boom and inflation. These views emerged from the experience of
Keynes in his theory. Keynes general view holds that during depression, the CBN
can increase the reserve of commercial banks through a cheap monetary policy.
They can do so by buying securities and reducing the interest rate. As a result
of these, the ability of extending credit facilities to borrowers increases.
But the great depression tells us that in a serious depression when there is
pessimism among economic actors, the success of such a policy is practically
zero. In this situation economic actors have no incentives to borrow even at a
reduced interest rate. In this case, the question of borrowing for long-term
capital needs does not arise in a depression when the business activities are
already at a low level.
The
classical view of monetary policy is based on the quantity theory of money.
According to this theory, an increase in the quantity of money leads to a
proportional increase in price level. The quantity theory of money is usually
discussed in terms of ‘’Equation Of Exchange’’ which is given by the
expression. P, denotes price level and Y denotes the level of current real GDP.
Hence, PY represents current;
’’NORMINAL
GDP’’ M denotes the supply of money over which the fed has some control and
v denotes the “Velocity Circulation’’ which is the average number of time
a naira is spent on final goods and services over the cause of the year. The
equation of exchange is an identity which states that the current market value of
all final goods and services… nominal GDP must equal the supply of money
multiplied by the average number.
Monetarist
view of monetary policy dates back in 1950’s, a new view of monetary policy
called monetarism, has emerged that disputes the Keynesian view that monetary
policy is relatively ineffective. Adherent of monetary argue that the demand
for money is stable and not sensible to change the interest rates.   Â
Â
2.2.1Â TYPES OF MONETARY POLICY
There are
basically two kinds of monetary policy, they are:
EXPANSIONARY
MONETARY POLICY
An
expansionary monetary policy is used to overcome depression, recession and
deflationary gap. When there is fall in consumer goods and services, and in
business investment goods, a deflationary gap emerges. The Central Banks starts
an expansionary policy that eases the credit market conditions and leads to an
upward shift in aggregate demand. For this the CBN purchases the government
securities in the open market, lowers the reserve requirements of member banks,
lowers the discount rate and encourages consumer and business credit through
selective credit measures.
b.  Â
 RESTRICTIVE MONETARY POLICY
This is the
kind of monetary policy designed to reduce aggregate demand (AD) and
inflationary gap. Inflationary pressure takes place as a result of risen
consumer demand for goods and services and there is also boom in business
investment. The CBN introduces the restrictive policy in order to lower
aggregate consumption and investment by increasing the cost availability of
bank credit.
2.2.2 Â Â Â
 AIMS AND OBJECTIVES OF MONETARY POLICY
There appear
to be a general consensus that the single most important objectives of monetary
policy are the pursuit of price stability. These recognition is perhaps derived
from the increasing rate at which many central banks around the world are been
given the exclusive power to control inflation and stabilize domestic prices.
The perspective which recognizes a focus on inflation as the right approach to
macroeconomic stability receives a strong support from the analytical research
summarized in Fisher (1996) The study concludes that the fundamental task of
the currency and the following;
Achievement
of domestic price and exchange rate stability
To control
inflation
Maintenance
of healthy balance of payment position
Promotion of
rapid and sustainable rate of economic
growth and development
Maintenance
of macroeconomic stability
Â
Development of a sound financial system
To stabilize
the naira exchange rate
To maintain
a high level of employment
2.2.3Â INSTRUMENTS OF MONETARY POLICY
The policy
instruments are of two kinds, they are;
Indirect
Quantitative or General
Direct
Quantitative or Selective
These affect
the levels of aggregate demand and through the supply of money cost and
availability of credit. The first category includes the bank rate variations,
open market operation and changing reserve requirement. They are meant to
regulate the overall level of credit in the economy through commercial banks.
The selective credit control aims at controlling specific kinds of credit.
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