An Econometric Analysis of the Effects of Monetary Policy on the Nigerian Economy

An Econometric Analysis of the Effects of Monetary Policy on the Nigerian Economy


This study aimed at analyzing through econometric methodology the effects of monetary policy on Nigeria’s economy. To meet the above objective, output growth was chosen as the dependent variable while real exchange rate, real interest rate, and inflation was chosen as the independent variable. The ordinary least square was used in the regression estimation. From the empirical result, we realized that the entire explanatory variables are insignificant in the t-test, but in the f-test, we rejected the null hypothesis and conclude that the slope coefficient is not simultaneously equal to zero. We realize from the battery test that there is a co-integration between the explanatory band and the dependent variables since their level of stationarity is the same.

The policy implication of the result is that if monetary and banking policies are effectively applied, it will be consistent with determining the level of output growth in the economy.



One of the ways taken by all economies to make the banking sector effective is the use of the monetary policy introduced by the federal government and carried out by the apex bank of the country. The existence of an effective banking industry is vital to every economy and it encourages economic growth and development via its role in the financial interdiction of funds supplied to deficit economic units. This stimulates international trade, investment economic growth as well employment growth as well as employment.

Monetary policy is one of the steps taken by every economy to make the banking sector effective. Monetary and banking policies are the sole responsibilities of the monetary authority, which comprises The CBN for the initiation, implementation, and articulation of the monetary system. The CBN carried out these duties on behalf of the federal government according to CBN decree 21 of 1991 and the banks and other financial institutions BOFIA A4, of 1991 as amended. The bank’s proposal on monetary policy is subjective to the federal government.

The policies to be pursued are usually out in form of an ‘’Audience’’ to all banks and other financial institutions. The guideline is general in operation within a fiscal year but could be amended over the year. The CBN is equally empowered to direct the activities of the financial institutions in other to carry out certain duties in pursuit of approved monetary policy of which penalties are prescribed for non-compliance with a specific provision of the guidelines.


Monetary policy affects financial and economic activities over the year. In other to appreciate the effects of monetary policy on the banking industry, it would be wise to move a review of changing views of monetary influence. Usually when the number of money changes in financial activities as viewed by FISHER (1932). Fisher, take another neoclassical writer who held the view that in the short run, money influences real cash balances. According to him, when the money stock increases, for example;

Increase commodity prices since output and velocity were fixed initially. He assumed that a rise in commodity prices would exceed the increase in interest rate which was regarded as a component of firms operating cost. In the whole analysis, a rise in commodity prices will lead to an increase in a firm’s profit, demand, money stock, and deposit which will eventually lead to a further rise in investment and commodity price. The excess reserved for lending will decline with an interest rate, which was stocky earlier.

In the analysis of the long-term transmission of monetary influence, Fisher replaced the ‘’Interest-Investment’’ channel with the ‘’Real Cash Balance’’. He noted that when wealth rises due to rising in the money stock, people tend to reduce their cash balances by purchasing goods and services. Since the velocity (v) and output (y) in Fisher’s equation of exchange (MVPT) is fixed, the risen money stock (M) cannot lead to the increased holding of goods and services but will lead to a decline in prices level (P). Keynes (1936) accepted the change in money supply relative has both substitution and effect and considered an investment to be quite responsive to interest rates.

Keynes recommended price induce wealth effects, (i.e. change in wealth due to change in yields). There are ranging accounts by his interpreters about the extent he integrates them into his general theory. Hence subsequent write to Keynes (i.e. Keynesian or post Keynesian regards the cost of capital (interest rate) as the main process by which changes in money stock influence the economy. Thus the change in the volume of money alters the rate of interest. Usually approximated by the long-term government bond rate, which affects investment and consumption. Thus the link between the wealth of the private sector and real sectors and consumption was analyzed by Piguo (1974) and Patikin (1951) in form of the ‘’real cash balance effect’’ According to the changes in quantities of money would affect aggregate demand even if they did not alter interest rate. On the other hand, the credit rationing channel of monetary influence explained how financial interdiction, would be controlled by the market forces to ration the supply of credit by a non-price mechanism.

Thus an expansionary monetary policy would raise the force of equity (i.e. reduce the yield on equities). The margin between the market evaluation and the cost of reproducing the existing capital goods will stimulate new investment in those goods.  The non-monetarist argued that monetary policy is as effective as fiscal policy in determining total spending in the economy despite their differences. It holds the following views:

1.   Movement in the quantity of money is the most reliable measure of monetary value.

2.   Monetary authority can detect the movement in the stock of money over time and the business cycle.

3.   Changes in the stock of money are the primary determinant of total spending as emphasized in owen’s economic stabilization program.

4.   Monetary impulse is transmitted to the real economy through an active price process or profit adjustment process which affects many financial and real antes.


Despite the establishment of the Central Bank of Nigeria (CBN) in 1958, the banking industry remained poor, inadequate in terms of the number, quality, and variety of services rendered. The establishment of CBN paved the way for the adoption of monetary management by the banking industry. Just in case any analyst is waiting in the wings to strike CBN for its poor monetary policy performance. Ogwuma (1994:362) offers a defense which says “A less than objective appraisal of the CBN role in the Nigerian economy could interpret the adverse macro-economic trend as evidence of failure on the part of CBN. The key constraint is as follows:


The following issues are the main aims and objectives of carrying out this study;

a. To identify the basic effects of monetary policy to achieve a sound financial system.

b. To examine CBN monetary policy strategies

c. To identify the best policy measure for economic stability.


The importance of this study cannot be overemphasized. It will serve as useful material to the monetary authority, bank management and staff, customers, depositors, students, and indeed the entire economy. Nevertheless, it will add to the volume of studies in this regard. The report shall be useful in ensuring both monetary stability and a sound, safe and profitable banking environment which will facilitate the pace of the economic growth and development in Nigeria.


The following hypothesis has been formulated as a guide to the conduct of the study. They should be tested based on the result obtained from the regression coordinated. The hypotheses are;

b. Ho: Variation in monetary policy does not significantly affect output growth.

c. H1: Variation in monetary policy significantly affect output growth

i.e. Ho= Null Hypothesis

Hi= Alternative Hypothesis


Although there exist many factors affecting the operation or the performance of the banking industry, this study focuses on the impacts of monetary policy on the performance of the banking industry.


It is quite believed that the study of nature needs sufficient time, finance, and materials. The inadequacy of those factors poses enough limitations to this study. The limitations in general include;

a. Financial and monetary constraint

b. Material constraint

c. Time constraint

d. Physical and Geographical constraints



These refer to the total number of banks and other financial institution that performs banking function such as acceptance of deposits, Issuing of credits/loan, and keeping of valuables. Such banks include; Merchant Banks Development Banks etc. The banking industry also consists of monetary authorities such as the Central Bank of  Nigeria and other federal bodies whose duty includes the regulation of the economy.

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