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THE EFFECTIVENESS OF MONETARY POLICY AS AN INSTRUMENT FOR ECONOMIC DEVELOPMENT

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

Economic managements and development of nation depend on the information, manipulation and implementation of the suitable economic policies. The policies include monetary, fiscal and external sector. The various policies do not work in isolation but reinforce one another in realizing the economic development of any nation. The development of any economic resolved round the formulation and effective implementation of monetary policies. The nature of monetary policy remain district and ill until recently for two reasons.

Monetary was reviewed in a narrow perspective and influencing aggregates spending via the regulation of interest rate, credit availability and credit allocation view on the role of money and monetary policies were dominated by the preventing perception of the growth process itself and the modern growth theory has not yet assigned a meaningful function to money.

The Central Bank of Nigeria (CBN) has defined monetary policy as the combinations of measured  designed to regulate the value supply and cost of money in an economy  in consonance with the level of economic activities.

The monetary policy in Nigeria is best understood from instance of the mandate set for the Bank. The core mandate of the Central Bank of Nigeria an spelt out in the Central Bank of Nigeria Act (1958), as amended (1997, 1998) include:

-   Insurance of legal lender currency notes and coins in Nigeria.

-    Maintenance of Nigeria’s external reserves to safeguard the international value of the legal currency.

-   Promotion and maintenance of monetary stability and a acting as bankers.

-    Acting as the lender of the last resort to the banks.

Monetary Policy is proposed by the CBN through a memorandum usually titled the “Monetary credit Foreign Trade and Exchange Policy proposals” which is always meant for a particular fiscal year. the memorandum is initially considered by the committee of governments, the highest management body for day-to-day administration of CBN. It is initially discussed, amended if necessary and approved by the board of directors of the bank. The proposals are subsequently out to banks and other financial institution by the CBN in the form of monetary policies circular for compliance, penalties for non-compliance is also indicated in the circular.

In a nutshell, the aims of monetary policy are basically to control inflation, maintain a healthy balance a payment position in order to safeguard the external value of the national currency and promote adequate and sustainable level of economic growth and development.

STATEMENT OF THE PROBLEMS

Monetary policy is one of the major government policy measures in controlling and developing the economy. The Central Bank of Nigeria was established to conduct monetary policy, issue bank notes and supervise and regulate the country’s financial system. Efficient conduct of monetary policy results in price stability, which creates the enabling environment for economic growth, having an autonomous monetary institution, allows for the separation of power to spend money from the power to create money and this separation of the Central Bank of Nigeria from the political process enables it to adopt the medium and long term perspectives essential to conducting effective monetary and financial to conducting effective monetary and financial sector policies. The objectives of monetary policy have remained the attainment of internal and external balance. However, emphasis have been made by the Central Bank of Nigeria by formulating an annual monetary program that set targets for the growth rate of monetary aggregates such as Broad money, Net foreign Asset, Domestic credit among others. These targets are consistent with the rate of growth of the envisaged for the economy that particular year.

The effectiveness of this policy will be more visible if capital flows are liberalized, open market operation (OMO) instrument is made more attractive and the activities of the formal financial markets are understood.

PURPOSE OF STUDY

The research work investigates the transmission channel mechanism through which monetary policy affect economic activities with particular focus on the Nigeria Economy and how effective it has been to the Economy Development of Nigeria.

The effectiveness of the Central Bank of Nigeria in executing its functions hinges crucially on its ability to promote monetary stability: Price stability is indispensable for money to perform its role of medium exchange, store of value, standard of deferred payment and unit of account. Attainment of monetary stability rest on a Central Bank’s ability to evolve effective monetary policy and to implement it effectively.

Even though there is no consensus on how monetary policy affect the economy, the liquidation or interest rate, credit and exchange rate channel of monetary were identified.

Moreso, an in-depth knowledge of how the Central Bank of Nigeria adopted a medium term monetary policy framework to free monetary policy implementation from the problem of time inconsistency and minimize over-reaction due to temporary shock is very vital improving the overall performance of the economy.

RESEARCH QUESTIONS

1.         To what extent has Money Supply (M2) affected output expansion through expansionary monetary policy?

2.         How has the use of Cash Reserve Ratio (CRR) affected changes in money supply and credit availability?

3.         To what extent has the use of Monetary Policy Rate (MPR) affected market /commercial banks interest rate?

4.         What factors hinder the full attainment of the monetary policy instruments objectives?

5.         Could there be any remedy to these problems/hindrances?

RESEARCH HYPOTHESES

According to Asika (2006), a hypothesis is a tentative statement, prediction or a conjecture stated in advance of an observation what can be expected to occur under a stated or given condition. Based on the above, this research formulated the following hypothesis for validation of the following:

Hypothesis One

Ho: There is no significant relationship between Money Supply (M2) and Output Expansion (Real Gross Domestic Product Growth) in Nigeria.

H1: There is significant relationship between Money Supply (M2) and Output Expansion (Real Gross Domestic Product Growth) in Nigeria.

Hypothesis Two

Ho: The effectiveness of Cash Reserve Ratio (CRR) does not have significant impact on changes in money supply and credit availability in Nigeria.

H1: The effectiveness of Cash Reserve Ratio (CRR) has significant impact on changes in money supply and credit availability in Nigeria.

Hypothesis Three

Ho: The effectiveness of Monetary Policy Rate (MPR) does not reflect on market commercial banks interest rate in Nigeria.

H1: The effectiveness of Monetary Policy Rate (MPR) reflect on market /commercial banks interest rate in Nigeria

SIGNIFICANCE OF THE STUDY

From the facts above, this research is recommended relevant and useful for lectures, students, policy makers, investors and financial organizations. This study will keep in upstanding the effectiveness of monetary policy as an instrument for economic development or nation building. Not this alone, it will also give an insight into how the Central Bank of Nigeria alters the level of money in the economy through indirect instruments such as the Required Reserves level, Minimum Rediscount Rate (MRR), Open Market Operation (OMO), Treasury Bill sales in the primary market, discount and rediscount operations and CBN certificates. Through these monetary policy instruments, the bank influences the amount of currency in circulation and interest rates, in such a way as to achieve monetary policy objectives for the year.

SCOPE OF THE STUDY

The research is directed to the effectiveness of monetary policy as an instrument for economic development. The study also looked at how the instrument to achieve the objectives of monetary policy have changed over the years.

The two major phases in the pursuit of monetary policy namely, before 1986 and since 1986. The first phase placing emphasis on indirect monetary controls, while the second relies on markets mechanisms.

This research is also based on the financial statistics which is collated from the submitted returns made by deposit money banks and which are put to rigorous test before its adoption by the Central Bank of Nigeria. Also in the statutory data produced by agencies like the federal office of statistics and federal ministry of finance with the primary data collated by the Central Bank of Nigeria through field survey and complied on the basis of tested theoretical frameworks using various computations methodologies.

LIMITATION OF THE STUDY

In all human endeavours, problem are bound to arise, problem were encountered in the course of conducting this study that is, which serves as limitation in the study.

The following are some of them,

FINANCE          

There are limited fund to do detailed justice to the study, money especially in the area of transportation.

CO-OPERATION 

It was a bit difficult for me to reach the necessary parties and as such to collect necessary materials to be used.

DEFINITION OF TERMS

Money supply: It refers to the total value of money in the economy and this consist of currency (note and coins) and deposit with the commercial and merchant banks. For the purpose of monetary policy, there are two types of money supply in Nigeria M1 and M2

M1:    This is the narrow measure of money supply which includes currency in circulation with non-bank, public and demand deposit (current account) at the commercial bank.

M2:    This is the Board measure of money supply and includes, M1 and saving and time deposits at the commercial and merchant Bank.

Bank credit: Is a major determinant of the supply and it embraces the amount of loans and advances given by the CBN, commercial  and merchant Banks to economic agents, this is the banking system credit to the economy, which can be broken down to government and private sector.

Other Asset (Net) – Is the orders of assets of CBN commercial and merchant banks less their other liabilities.

Net Foreign Assets (NFA):  This constitutes Foreign Exchange holding of the CBN and commercial and merchant banks after netting out the claims of foreigners.

Interest Rate: Is the price of money, it is the opportunity cost of holding money and the return for parting with liquidity.

Cost of capital: Is the cost incurred in security funds or capital for productive purposes.

Reserve Requirement: It refers to the proportion of total deposit liabilities which the commercial and merchant banks are deposited to keep cash in vaults and deposits with the CBN.

Open Market Operations (OMO): It involves the discretionary power of the CBN to purchase or sell securities in the financial market in order to influence the volume of liquidity and the level of interest rate which ultimately will affect the money supplied.

Fiscal multiplies: This refers to the excess of expenditures over revenue of the government.

Money multipliers: Is the factor that relates base money currency outside banks and bank reserves with money supply.

Treasury security: Is money market instrument created by government for financing short time fiscal operations.

Total Reserves: The sum of required reserve and excess reserves.

Vault cash: Commercial and merchant  Banks keep petty cash in their vault for emergency transaction before they can access their accounts with the CBN.

Discount House: Is a financial institution that trade in government securities both at the primary and secondary segments of the money markets in treasury Bills and certificates and other eligible public and private sector instrument.

The Bid rate: Is the interest rate submitted by dealers at which they can buy the securities.

Yield: Is the expected return on securities after taking into consideration to the purchase and sale prices and the stream of dividends or interest payment expected during the period.

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