Effect of Monetary Policy on the Growth of the Nigerian Economy

1.0 Introduction

1.1 Background of Study

Monetary policy remains a fundamental tool used by governments and central banks across the world to influence macroeconomic performance, especially in controlling inflation, stabilizing exchange rates, fostering employment, and promoting economic growth. According to Mishkin (2016), monetary policy refers to the actions undertaken by a nation's monetary authority, typically the central bank, to control money supply and interest rates with the primary aim of ensuring price stability and supporting economic growth. The Central Bank of Nigeria (CBN), as the apex monetary authority in the country, is saddled with the responsibility of formulating and implementing monetary policies to achieve these macroeconomic objectives.

Awe and Olawumi (2012) asserted that the effectiveness of monetary policy in influencing economic activities is largely dependent on the structure of the financial system and the soundness of the institutional frameworks in place. In Nigeria, despite consistent efforts by the CBN to regulate money supply and influence credit availability, the economy continues to experience persistent inflation, fluctuating exchange rates, and sluggish growth. Adigwe, Ezeagba, and Francis (2015) reported that Nigeria's monetary policy outcomes are often undermined by structural rigidities, policy inconsistencies, and external economic shocks, which limit the ability of monetary interventions to produce the desired impact on economic growth.

Ajayi and Atanda (2012) affirmed that exchange rate volatility and inflationary pressures in Nigeria have persisted despite various monetary policy measures, suggesting a weak transmission mechanism between policy actions and economic outcomes. The authors contended that factors such as over-reliance on crude oil exports, weak financial intermediation, and institutional inefficiencies are critical barriers to the success of monetary policy in Nigeria. Furthermore, Otu, Adejumo, and Essien (2018) stated that the effectiveness of monetary policy in Nigeria is often constrained by poor policy coordination between fiscal and monetary authorities, leading to conflicting policy objectives and outcomes that hinder economic growth.

According to the Central Bank of Nigeria (2022), efforts have been made through the use of tools like the Monetary Policy Rate (MPR), Open Market Operations (OMO), and adjustments in the Cash Reserve Ratio (CRR) to control inflation and stimulate growth. However, the results have been mixed, with the Nigerian economy still battling inflationary trends, exchange rate instability, and high unemployment rates. The situation calls into question the efficiency of Nigeria's monetary policy framework in achieving sustained economic growth and macroeconomic stability.

Monetary policy according to Mishkin (2016) refers to the process by which a country's monetary authority, usually the Central Bank, regulates the supply of money, controls interest rates, and manages liquidity to achieve macroeconomic objectives such as price stability, economic growth, and employment generation (Mishkin, 2016). It is a vital tool for maintaining economic stability and fostering growth, especially in developing economies like Nigeria. Through the adjustment of monetary policy instruments such as the monetary policy rate (MPR), cash reserve ratio (CRR), liquidity ratio, and open market operations (OMO), the Central Bank of Nigeria (CBN) seeks to influence economic activities, stabilize prices, and ensure the soundness of the financial system (CBN, 2022). This study is set against the backdrop of examining the effect of monetary policy on the growth of the Nigerian economy.

1.2 Statement of Problems

The Nigerian economy is facing numerous macroeconomic challenges despite various monetary policy interventions implemented by the Central Bank of Nigeria (CBN). Monetary policy is expected to serve as a critical instrument in regulating the supply of money, controlling inflation, stabilizing exchange rates, and promoting economic growth. However, over the years, Nigeria's monetary policy measures are falling short of achieving these goals, raising concerns about their effectiveness and suitability for the country's economic realities (Awe & Olawumi, 2012).

On the other hand, Nigeria's high dependency on crude oil exports is making the economy highly susceptible to external shocks. These external factors are undermining the effectiveness of domestic monetary policies, often leading to policy reversals or adjustments that weaken investor confidence and economic stability (Ajayi & Atanda, 2012). The inability of monetary policy to shield the economy from such external pressures is contributing to the persistent macroeconomic instability in the country.

Furthermore, the lack of synergy between monetary and fiscal policy authorities is exacerbating the challenges faced by the Nigerian economy. Poor policy coordination, overlapping policy objectives, and conflicting policy signals are resulting in uncertainty and unpredictability within the economic environment (Otu, Adejumo, & Essien, 2018). The repeated cases of policy inconsistencies and inadequate implementation are raising questions about the overall effectiveness of monetary policy in promoting sustainable economic growth in Nigeria. It is against this backdrop that this study seeks to examine the effect of monetary policy on the growth of the Nigerian economy.

1.3 Aim and Objectives of Study

The aim of this study is to assess the effect of monetary policy on the growth of the Nigerian economy. The specific objectives of this study are:

1. To analyze the impact of inflation targeting by the Central Bank of Nigeria on the stability and growth of the Nigerian economy.
2. To assess the role of monetary policy in addressing exchange rate volatility and its implications for economic growth in Nigeria.
3. To evaluate the relationship between monetary policy tools, such as the Monetary Policy Rate (MPR), Cash Reserve Ratio (CRR), and Open Market Operations (OMO), and Nigeria's economic growth.
4. To explore the challenges faced by the Central Bank of Nigeria in using monetary policy to foster sustainable economic growth.
5. To investigate the effectiveness of monetary policy transmission mechanisms in influencing productive sectors of the economy.

1.4 Research Questions

Based on the stated objectives, the following research questions have been formulated to guide the study:

• How does inflation targeting by the Central Bank of Nigeria affect the stability and growth of the Nigerian economy?
• How effective are the transmission mechanisms of monetary policy in influencing key sectors of the Nigerian economy, including manufacturing and agriculture?
• In what ways does monetary policy address exchange rate volatility, and what is its impact on economic growth in Nigeria?
• What challenges does the Central Bank of Nigeria face in using monetary policy to foster sustainable economic growth, especially in light of structural constraints and external shocks?
• What is the relationship between monetary policy tools such as the Monetary Policy Rate (MPR), Cash Reserve Ratio (CRR), and Open Market Operations (OMO) and economic growth in Nigeria?
• What policy recommendations can be made to enhance the effectiveness of monetary policy in promoting economic growth in Nigeria?

1.5 Research Hypotheses

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.

Hypothesis 1:

• Null Hypothesis (H₀): There is no significant relationship between monetary policy and economic growth in Nigeria.
• Alternative Hypothesis (H₁): There is a significant relationship between monetary policy and economic growth in Nigeria.

Hypothesis 2:

• Null Hypothesis (H₀): An increase in the Monetary Policy Rate (MPR) negatively impacts economic growth in Nigeria.
• Alternative Hypothesis (H₁): An increase in the Monetary Policy Rate (MPR) positively impacts economic growth in Nigeria.

Hypothesis 3:

• Null Hypothesis (H₀): Money Supply (M2) does not have a significant positive impact on economic growth in Nigeria.
• Alternative Hypothesis (H₁): Money Supply (M2) has a significant positive impact on economic growth in Nigeria.

1.6 Significance of Study

It is believed that at the completion of the study, the findings will help policymakers, particularly the Central Bank of Nigeria, to understand the effectiveness of existing monetary policy tools and will guide them in formulating strategies that will promote sustainable economic development.

Furthermore, the Central Bank of Nigeria will find the study useful in evaluating its policy tools and approaches to achieve macroeconomic objectives effectively. It will also serve as a guide for financial analysts and economists in comprehending the impact of monetary policy measures on macroeconomic indicators.

Lastly, this research will serve as a useful reference for economic planners and financial analysts by offering empirical evidence on the relationship between monetary policy and economic growth in Nigeria.

1.7 Scope and Limitations of the Study

The study focuses on the effect of monetary policy on the growth of the Nigerian economy, using the Central Bank of Nigeria (CBN) operations in Lagos State as a case study. It covers the period from 2010 to 2024, analyzing key variables such as monetary policy rates, money supply, inflation rates, exchange rates, and GDP growth.

The study is limited by factors such as the availability of accurate data, accessibility to key stakeholders in monetary policy formulation, and the general economic environment within Nigeria.

1.8 Definition of Terms

Monetary Policy:

Monetary policy refers to the process by which the Central Bank controls the money supply, interest rates, and availability of credit in the economy to achieve macroeconomic objectives such as price stability, employment generation, and economic growth (Mishkin, 2016).

Economic Growth:

Economic growth is the increase in the production of goods and services in an economy over a certain period, typically measured by the rise in a country's Gross Domestic Product (GDP) (Todaro & Smith, 2015).

Inflation:

Inflation is the sustained increase in the general price level of goods and services in an economy over time, which reduces the purchasing power of money (Obadan, 2013).

Exchange Rate:

The exchange rate is the price of one country's currency in terms of another and plays a critical role in international trade and capital flows (Mundell, 1961).

Central Bank of Nigeria (CBN):

The Central Bank of Nigeria is the apex financial institution in Nigeria, established to regulate the monetary and financial system, implement monetary policy, and ensure price stability (CBN, 2022).