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Monetary Policy and Inflation in Nigeria

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Inflation Theory

Monetary economic theories postulate that the velocity of money supply higher (an increase in the quantity of money supply) than the rate of growth in the level of output results in inflation. They therefore suggested the need for monetary policies in order to checkmate the high level of inflation. This view of the monetarists is contrary to that of the Keynesians who assert that inflation is the result of pressures in the economy expressing themselves in prices as it was further claimed that the pressure is caused by increase in money supply in the economy. The Keynesians therefore assert that fiscal change bring about inflation. The Keynesians further subdivided the causes of inflation into three main groups namely; cost push factors, demand pull as well as built-in or adaptive expectation factors. These three groups are generally known as triangular model of inflation. As further explained by the Keynesians, increased government and private spending, increase prices of inputs, natural disasters as well as price and wage spiral are responsible for an increase in the level of inflation.

Enzim (2005) however shows with the aid of econometric analysis that monetary factors cause inflation in emerging market such that of Nigeria. The result of his finding is in agreement with the monetary theory school of thought regardless of whether the inflation is money inflation or price inflation. The underpinning assertion is that monetary policies have effect on price inflation by influencing the financial conditions existing in the economy. Savings, deposits, investments, lending / borrowing, proportion of funds meant for effecting demand for goods and services which are known as the financial conditions adjust to the various rates charged by the regulatory authorities for the movement or usage of funds. The monetary authorities use their regulatory tools to control or to regulate quantity of money available in the circulation through the various financial institutions such as the commercial banks among others. The size of money available to people for use in the demand for goods and services is what the monetarists refer to the Quantity of money. Given most activities of the banks are short term in nature, it follows that the lending and deposit activities will affect the long term economic activities. The Fischer’s quantity therefore explains the link between short run (monetary) and the long-run (fiscal) factors which influence inflation. The Fischer’s theory has it that inflation has a link between real and nominal interest rates. The nominal interest rates refer to the short run while the real interest rate on the other hand refers to the long run. Production, aggregate supply as well as the demand for goods and services are all long run economic activities which respond to all adjustment of the short run economic activities. The Fischer’s effect also states that real interest rates equal nominal interest rates when expected inflation rate is deducted. This therefore implies that real interest rate increases as inflation rates falls while holding the nominal interest rate constant.

The interest rate is the underlining factor in the Fischer’s Effect relating the Keynesian to the monetary theories of inflation.

Monetarism, Money and inflation

The monetarism focuses on the long-run supply side of the economy which is described as the quantity theory of money and the Neutrality (independence of the level of money supply in the long-run, which is also abased on the concept of the neutrality of money. The quantity theory of money links inflation and economic growth by equating the total amount of money in existence to the total amount of spending in the economy.

Aksoy (2009) also suggests that control of the quantity of money supply will be help in curbing a high rate of inflation in the economy. Milton Friedman proposed that inflation is the product of an increase in the velocity or in the supply of money at a rate which is greater than the rate of output growth in the economy. Milton Friedman also contested the concept of the Philips curve. Friedman’s argument was premised on an economy where the people have to pay twice as much for goods and services after the costs of goods and services must have doubled and given that their wages are also twice as large; this renders inflation harmless. The monetarism suggests that in the long-run, the general prices of goods and services are only affected by the growth rate in the amount of money supply while it has no effect on the economic growth rate. If the economic growth rate is lower than that of the growth in money supply, inflation therefore results.

Empirical Review on Monetary policy and Inflation

Empirical studies on the impact of monetary policies on inflation have been carried out using both the new Keynesian economics and the monetarist theories, via the application of monetary or credit aggregates the consumer Price Index as well as the quantity theory of money.

Adebiyi (2009) investigated the relationship between inflation and monetary policy in Nigeria and Ghana using a Vector Autoregressive models with some financial variables such as money supply, interest rates, price and exchange rate, the result shows that inflation is an inertial phenomenon in Nigeria and Ghana, and that money innovations are not strong and statistically important in the course of determining prices when compared with price shocks.

Gbadebo and Mohammed (2015) examined the impact of monetary policy on inflation rate in Nigeria. The scope of data adopted for the study ranges from 1980 to 2012 with the use of a time series data, tested using cointegration analysis and error correction model. The study identified oil price, money supply and exchange arte as the major causes of inflation in Nigeria. It was also found by the study that money supply has a positive and significant impact on inflation in the short run and in the long run. Their study concluded that monetary impulses cause inflation in Nigeria.

Emerenini and Eke (2014) examined the determinants of inflation in Nigeria between the periods 2007 and 2014. They adopted OLS technique and co-integration analysis test of the data. The study found out that money supply and exchange rate had a significant positive impact on inflation while Treasury bill rate did not.

Also, Raymond (2014) carried out a study examining the impact of money supply, interest rate, cash reserve ratio, liquidity ratio and exchange rate on inflation in Nigeria. An OLS technique was adopted with data covering the periods 1980 to 2010. It was revealed in the study that liquidity ratio and interest rate were effective exchange rate on inflation in Nigeria.

Akinbobola (2012) examined the impact of money supply and exchange rate on inflation in Nigeria in Nigeria between the periods 1986 and 2008. The study adopted a Vector Error Correction Mechanism (VECM). The result shows that money supply and exchange rate have significant but a negative impact on inflation in the long run while real output and foreign price changes have direct effects on inflation rate.

Danjuma, Jibrin & Blessing (2012) conducted a study on the effectiveness of monetary policy in controlling inflationary pressure on the Nigerian economy. Data ranging from 1980 to 2010 were adopted to examine the impact of broad money supply, interest rate, liquidity ratio, cash reserve ratio of the commercial banks and exchange rate on inflation in Nigeria. Classical least square method to analyze the data. The study found out that the liquidity ratio and interest rate turns out to be the leading monetary policy instruments in combating inflationary pressure in Nigeria.

Odior (2012) carried out a study on ‘Inflation Targeting in an Emerging Market’. Approach for the data analysis. The study was on inflation targeting in developing countries using Nigeria as a case study. The study adopted VAR and impulse Response Function (IRF) to estimate the data collected on consumer price Index, broad money supply, gross domestic product, government expenditure and exchange rate over the period 1970-2010. The study found out that money supply and inflation have a high tendency of impacting on the level of inflation in Nigeria.

Folorunsho and Abiola (2000) investigated the long run determinants of inflation in Nigeria with data ranging from 1970 to 1998. The study found out that inflation in Nigeria is caused by the money supply, public sector balance and the level of outcome. The study concluded that an increase in domestic production, a reduction in fiscal policy and a stable exchange rate should be pursued with a view to controlling inflation in Nigeria.

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Monetary Policy and Inflation in Nigeria. (2019, March 12). GradesFixer. Retrieved January 23, 2021, from https://gradesfixer.com/free-essay-examples/monetary-policy-and-inflation-in-nigeria/
“Monetary Policy and Inflation in Nigeria.” GradesFixer, 12 Mar. 2019, gradesfixer.com/free-essay-examples/monetary-policy-and-inflation-in-nigeria/
Monetary Policy and Inflation in Nigeria. [online]. Available at: <https://gradesfixer.com/free-essay-examples/monetary-policy-and-inflation-in-nigeria/> [Accessed 23 Jan. 2021].
Monetary Policy and Inflation in Nigeria [Internet]. GradesFixer. 2019 Mar 12 [cited 2021 Jan 23]. Available from: https://gradesfixer.com/free-essay-examples/monetary-policy-and-inflation-in-nigeria/
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