CHAPTER ONE

1.1 Background of the study

Monetary policy as part of the numerous macro-economic policies is the measure taken by
the monetary authority to control the cost, quantity and direction of finance to achieve national
objectives. The term can be defined as the summation of the actions taken by regulatory
authorities in charge of regulating or managing the dynamic economic variables that affect
changes in the price of goods and services and hence the value of money. These dynamic
economic variables that affect the changes in the prices of goods and services are grouped as
short term macro-economic factors and includes instrument like open market operation,
interest/discount rates, reserve requirement, volume of credits. Gbosi (2002) posits that monetary
policy aims at controlling money supply so as to counteract all undesirable trends in the
economy. These undesirable trends may include; unemployment, inflation, sluggish economic
growth or disequilibrium in the balance of payments.
For most developing economies, Nigeria inclusive, the objective of monetary policy
include price stability, maintenance of balance of payment equilibrium, promotion of
employment and output growth, sustainable development etc. These objectives are necessary for
the achievement of the goal of internal and external balance, and promotion of long run
economic growth. The importance of price stability derives from the harmful effect of price
volatility which undermines these objectives. There is indeed a general consensus among
economic researchers and analysts that domestic price fluctuations undermines the role of
monetary values as a store of value, and frustrate investments and growth.
Since the expositions of the role of monetary policy in influencing macroeconomic
objectives like economic growth, price stability, equilibrium in balance of payments and a host of

other objectives. Monetary authorities are saddled the responsibility of using monetary policy to
grow their economies. Monetary policies formulated by the monetary authority may be
expansionary or restrictive/ contractionary depending on the prevailing economic situation. An
expansionary monetary policy aims to increase aggregate demand and economic growth in the
economy. It involves cutting interest rates or increasing money supply to boost economic
activities in a time of recession/depression or when a deflationary gap exists. On the other hand a
contractionary/restrictive monetary policy expands the money supply more slowly than usual or
even shrinks it. A contractionary monetary policy is a type of policy that involves the monetary
authority raising interest rate and reducing money supply to bridge inflationary gap. In the bid to
regulate monetary policy in the economy, the monetary authority in Nigeria, the Central Bank of
Nigeria (CBN) employs various instruments which includes; Open Market Operation (OMO),
Reserve Requirement (RR) and Discount Rate (DR), etc. The success and effectiveness of
monetary policy depends on the institutional framework in place, economic environment and
mix of the instrument used.
Over the year in Nigeria, monetary policy has been used since the Central bank of
Nigeria was saddled the responsibility of formulating and implementing monetary policy by
Central bank Act of 1958. The main objective of monetary policy in Nigeria is to ensure price
and economic stability. This is mainly achieved by causing savers to avail investors of surplus
funds for investment through appropriate interest rate structures; stemming wide fluctuations in
the exchange rate of the naira: proper supervision of banks and related institutions to ensure
financial sector soundness; maintenance of efficient payments system; applying deliberate
policies to expand the scope of the financial system so that interior economics, which are largely
informal, are financially integrated.

Inflation in Nigeria has been a problem and is still a problem, and has also attracted a
whole lot of concern. For years, the Nigerian economy has been faced with socio-economic
stagnation that can be attributed to the effects of inflation. Inflation can be defined as a persistent
and sustained increase / rise in the general level of goods and services in an economy. It
manifests itself in the decline in the value of money. In other words during inflationary periods
the opportunity cost of holding money is increased thereby causing inefficient use of real
resources in transactions. The Nigerian economy has been facing the problem of inflation dating
back to the late 1970s. During this period, there were all sorts of disequilibria in the economy,
resulting from imbalance between the spending power and productive capacity of the economy.
Inflation rate during that period was at a double digit, the further analysis of the non-core
inflation in the early 1990 reveal inflation rate of 63.6%. Late 1994 headline inflation rose to
reach an all-time high of 72.8%; though it decelerated gradually to a single digit in 1997. In the
same vein, core inflation which began a gradual ascent in early 1990 peaked at about 69% in the
mid 1995 before slowing down in 1997. Since then inflation remained at single digit between
1998 and 2001. In 2003, macroeconomic stability was restored, following the gains of a
comprehensive and consistent economic reform programme. This low inflation regime did not
last long with the resurgence of spikes in headline and core inflation between 2001 and 2001.
Headline rate remained at double digit between 2002 and 2005 as it recorded 12.9%, 14%, 15%
and 17.9% in the respective years. However, it decelerated dramatically to 8.2% and 5.38% in
2006 and 2007 before skyrocketing to 11.6% and 12% in 2008 and 2009 in that order, although it
fell marginally to 11.8% and 12.3% in 2010 and 2013 respectively. The cause of this distortion or
disequilibria can be attributed to depletion of the external reserve thus leading to disequilibrium

in the balance of payment, and a rapid expansion of overall monetary expenditure in the
economy which helped to drive up prices (Omofa 2006).
The effect of high inflation on the economy is generally considered to be harmful, since it
causes serious discomfort to consumers, investors, producers and the government and it is a
problem that almost all free market economies have experienced. High inflation rate widens the
income gap between those with fixed income (who lose) and others with variable income (who
gain). The real value of fixed nominal payment such as rents, pensions, wages and taxes are
eroded by inflation. High inflation rate also diminish the net present value of current investment
and makes return to investment uncertain. The fundamental and objective aim of macroeconomic
policies in both developed and less developed countries is the attainment of price stability, since
the major aim of any sound economic policy is price stability. This brings us to the main purpose
of this research work, which is to evaluate and analyse the impact monetary policy on the rate of
inflation in Nigeria.

1.2 Statement of the problem

Since the late 1970s, inflation has grown to become a contentious problem in Nigeria. The
continuous rise in the general price level is injurious to Nigerias socio-economic interest, both in
term of current citizens welfare and future economic development. Nigeria government has
adopted various measures (both monetary and fiscal policies) to reduce inflation growth to an
acceptable level but all these policies seem to have no effects. The numerous causes of inflation
are responsible for the unpredictable, inefficient and uncertainty in the Nigerian economy. The
consequence of inflation on the Nigerian economy has been perverse and generally adverse,

ranging from its effect on redistribution of income, investment, agriculture, economic growth and
other aspect of the economy.
The effect of inflation on redistribution of income according to Gittenger (1986) can be
viewed from two perspectives; the fairly popular one is the debtor-creditor case, where due to
inflation the debtor who borrows money from the creditor gains real purchasing power at the
expense of the creditor who lends the money. Inflation also poses a great threat to investment,
such that it chips away at real savings and investment returns. Most investors aim to increase
their long term purchasing power. Inflation puts his goal of investors at risk because investment
return must first be adjusted with the rate of inflation in order to increase real purchasing power.
Also the effect on the Nigerian agricultural sector is very disturbing because contrary to
conventional economic theory, food production has been falling in spite of raising goods prices.
This is explained by the distorting effects of inflation on urban-rural area.
Given the adverse consequences of inflation stated above, the sustainability of a stable price
level is expected, but this objective has proven far-fetched over time. One of the major reasons
can be attributed to the poor and inadequate understanding of the inflationary process in Nigeria
on the part of the monetary authorities. The country has done a great deal of work in a bid to
address the issue of inflation and also putting down anti-inflation measures over time, even
though all this measures have met limited success.
Again, as the controversy on the role of money supply in the control of inflation rages on
between classical, Keynesian, monetary and neoclassical economists; managers and policymakers of emerging economies are tilting towards a combination of the various postulations in
managing inflation, with the main focus on inflation targeting as the guiding framework of

monetary policy actions (Demchuk et al, 2012; Mukherjee and Bhatta, 2011). Inflation targeting,
which is an outshoot of quantity theory of money, considers the after-effect of periods of
inflation, given the various stages of monetary transmission process undergone (Lyziaka et al,
2012). Under inflation targeting, movements in the monetary policy rate and short-term interest
rate (ultimately in retail interest rates) form the key transmission media between monetary policy
instruments and inflation, and any mismatch between the monetary and fiscal policy objectives
makes price stability macroeconomic objective useless (Ezirim, 2005).
For a developing economy like Nigeria, it is vital to analyze monetary policy transmission
effect on inflation for several reasons, such as the determination of the appropriate channel and
the effectiveness of monetary policy in managing inflation, among other reasons (Bussimis and
Magginas, 2006). The dent for effectiveness of monetary policy is deepened in an
underdeveloped financial market like Nigeria (Andreas, 2010). Despite the application of the
monetary policy tools, inflation has continued to pose challenges to the monetary authorities.
Some of the reasons include the inability of the monetary authorities to enforce compliance
through the monetary channel in the banking and non-banking institutions, and fiscal imbalance
characterized with expansionary fiscal policy with deficit budget (Gogor, 2011; Umeredu, 2007).
Therefore this study intends to examine the effect of monetary policy in controlling inflation in
Nigeria.

1.3 - Objectives of the study

The broad objective of the study is to examine the impact of monetary policy on inflation in
the Nigerian economy. However, the general overview of the monetary policy in Nigeria will be
looked into. Likewise the tool of monetary policy will be extensively evaluated.
The specific objectives are as follows;
I.
To identify the monetary policy instrument in Nigeria.
II.
To analyze the impact on inflation

1.4 Research Question

Given the major problems and distortions caused by inflation on Nigerias economic growth
and the living standard of its citizenry, it is pertinent therefore to take a careful look at the
relationship between monetary policy and inflation in Nigeria. Questions that arise then include
the following:
I.
II.

What is the relationship between monetary policy and inflation in Nigeria?

What impact does interest rate have on inflation in Nigeria?

1.5 Research Hypothesis

For the purpose of evaluating and to objectively analyse the objectives stated earlier, the
formulated hypothesis are;
1. H0: There is no significant relationship between monetary policy rate and inflation rate in
Nigeria.
H1: There is a significant relationship between monetary policy rate and inflation rate in
Nigeria.
2. H02: There is no significant relationship between money supply and inflation in Nigeria.
H1: There exist a relationship between money supply and inflation on Nigeria.
3. H03: There is no significant relationship between interest rate and inflation in Nigeria.
H1: There is a relationship between interest rate and inflation rate in Nigeria.

1.6 - Significance of the study

This study is significant in that it intends to contribute to the existing body of knowledge,
given the fact that it is commonly said the monetary policies are part of the government and

monetary authority rituals and that only those below-average income earners, are the reason for
poor industrialization of Nigeria as a result of the stringent credit policies of banks and other
financial institutions, and the unpredictability of the Nigerian economy.
This study is however important because its findings will reveal extensively how monetary
policy in Nigeria has been carried out. It will also help the monetary authorities to understand
and know how best to direct monetary policy instruments in order to achieve macroeconomic
goals of the government.
Furthermore, this research work will be of immense value to the different sectors of the
economy, be it the public or private sector, policy makers and both international and local
economic & financial agencies. Also no

leaving out its great relevance to individuals,

economists, students, planners, financial analysts, stock brokers and others who might be
interested in researching into the field in the future, by shedding more light into the widely held
view about the relationship between inflation and money supply in Nigeria.

1.7 Scope and limitation of the study

This research work will entail a survey of monetary policy (its instrument and tools) in
Nigeria. It will take into consideration the various tools of monetary policy and its evaluation and
review the relevant literature on monetary policy. The research work in addition will look briefly
at the limitations. This study seeks to cover a period of 34 years, 1980-2014.

The scarcity of current data may limit the research to the period relevant data available
and accessible. Due to the lack of proper data keeping in Nigeria, the level of confidence in the
available data is low.
Lastly, due to demand by other academic engagement and activities, the time allotted to
this study was relatively short for the intention of the research.

1.8 Data and methodology

1.9 Organisation of the Study

Chapter one of this study has been directed towards the presentation of the problem
giving rise to, and thus, the objectives, justification, and background of this study. Chapter two
will review current literature on the concept of monetary policy and inflation. Therefore it will be
like the bed rock of this study. The third chapter will focus on the theoretical framework and
methodology of the study, thus cementing the approach by which the study aims to fulfill its
objectives.
Chapter four will deal with the presentation and analysis of data gotten in the course of
researching and also their interpretation. Finally, the fifth chapter will focus on drawing
conclusion, summarizing and giving recommendations.
NAME: TEJUOSHO DANIEL OLUWATOBI
MATRIC NO: 130901139
TOPICS;

1. Effect of petroleum exploration on the development of Agricultural sector in Nigeria.

2. Impact of monetary policy on inflation in Nigeria (1980-2014).
3. Import competition and Nigerias Manufacturing sector.