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The study has investigated the effect of monetary policy on inflation in Nigeria. Using secondary time series data, the study covers a period of 37 years ranging from 1980 to 2016. The study also adopted a restricted VAR model using Inflation as the dependent variable while monetary policy rate, money supply and exchange rate were the explanatory variables. The study revealed that there is a positive and insignificant relationship between exchange rate and inflation. Also there is a positive and insignificant relationship between money supply and inflation rate in Nigeria. Finally, there is a negative and significant relationship between monetary policy and inflation rate in Nigeria. It was thus recommended that. The current monetary tightening stance of the CBN is a step in the right direction but should be used with caution. Considering the dual objective of CBN, the monetary policy should be tailored to promote real sector lending while trying to achieve low and stable inflation. The study therefore concludes that there is monetary policy rate is a more efficient monetary policy tool in stabilizing inflation rate in Nigeria.
1.1 BACKGROUND TO THE STUDY
Monetary authorities in Nigeria consist of the central bank of Nigeria (CBN) and the federal ministry of finance. The central bank promotes and maintains monetary stability and supervises the activities of other banks, together with the Nigeria deposit insurance cooperation (NDIC). Over the years, the central bank has relied in the direct instrument of monetary control as a means of stabilizing the economy. This implies the use of credit ceiling and sector credit allocation. (Brown, Lynn Eliane 2001)
In general terms, monetary policy refers to a combination of measures designed to regulate the value, supply and cost of money in an economy; in consonance with the expected level of economic activity (Okwu et al 2011; Adesoye et al 2012). For most economies, the objective of monetary policy may vary from country to country but there are two main views .The first view calls for monetary policy to achieve price stability while the second view seeks to achieve and other micro economic objectives. The central bank of Nigeria like other Central banks in the developing countries, achieve the monetary policy goal through the amount of money supplied. CBN (2006) defined money supply as comprising narrow and broad money. The definition of broad money (m1) includes currency in circulation with non- bank public and demand deposit or current account in bank. While the broad money [m2] includes narrow money plus savings and time deposit as well as foreign dominated deposits. The broad money measures the total volume of money supply in the economy. Objective of monetary policy are necessary for the attainment of internal and external balance of payment equilibrium and the promotion of long- run economic growth and development.
The importance of price stability derives from the harmful effect of price volatility which undermines the ability of policy makers to achieve other laudable micro economic objectives. In fact, there is a general agreement that domestic price fluctuation undermines the role of money as a store of value and frustrates investment and growth (Ajayiand Oyo, 1981; Fischer, 1994) on inflation, growth and productivity have confirmed long- term inverse relationship between inflation and economic growth. The economic environment that guided monetary policy in Nigeria before 1986 was characterized by the dominance of the oil sector, the expanding role of public sector in the economy and over- dependence of the external sector.
The establishment of CBN on 1st July 1959 has continued to play the traditional role expected of a central bank, which is the regulation of the stock of money in such a way as to promote the social welfare[Ajayi,1999]. This role is based on the use of monetary policy that is usually targeted towards the achievement of full employment equilibrium, rapid economic growth, price stability and external balance of payment. Indeed, an instability or crises-ridden financial sector will render the transmission mechanism policy less effective, making the achievement and maintenance of strong Macro Economic stability goal difficult or unrealistic. Monetary Policy consists of a government’s formal effort to manage the money in its economy in order to realize specific economic goal. Three basic kinds of monetary policy decisions can be made; the amount of money in circulation, the level interest rate, and the function market in the credit system. The combination of these measures is designed to regulate the value, supply and cost of money in an economy, in line with the level of economic activity. Excess supply of money will result in excess demand of for goods and services, prices will rise and balance of payment will deteriorate. The most popular instrument of monetary policy was the insurance of credit rationing guide line, which primarily set rates of change for the components and aggregate commercial bank loans and advances to the sector. The sectorial allocation of bank credit in CBN guidelines was to stimulate the productive sector and thereby stem inflationary pressures. The fixing of interest rate is relatively low levels was done mainly to promote investment and growth. Occasionally, special deposits were imposed to reduce the amount of free reserves and credit creating capacity of the banks. (Ajayi 1999)
The challenges of monetary policy management rest wholly on CBN which has over the years been committed to its effective control. Although the performances of monetary authority in the area of financial institution stability seemed to have improved greatly in recent times, macroeconomic indicators of interest rate and inflation remained at immoderate levels. This is why the huge increase in the country’s economic growth have failed to translate into high standard of living for the citizenry.(CBN 1992)
1.2 STATEMENT OF THE PROBLEM
One of the major objectives of monetary policy in Nigeria is price stability. However, despite the various monetary policy measures adopted by the central bank of Nigeria over the year’s inflation still remains a major threat of Nigeria’s economic growth. Nigeria has experienced high volatility in inflation rate .Since the early 1976, which was the first period of inflation, the inflation rate was 30 percent. During this period, there was excessive monetization of oil-export revenue, which has given inflation a monetary character .during the late 1980s, following the SAP, the effect of wage increase created a cost –push effect on inflation growth at 39.6 percent at a time of relative little growth in the economy. Over the same period, excess money growth was about 43 percent and credit to government had increased by over 70 percent (CBN 2010).
1.3 OBJECTIVE OF STUDY
The broad objective of the research work will be to find out the extent to which monetary police could bring about price stability in Nigeria (stability in inflation, exchange rate and interest rate). The following specific objective of the study is as follows:
1.4 RESEARCH QUESTION
1.5 HYPOTHESIS OF THE STUDY
This study will be guided by the following hypothesis:
H01: Monetary policy does not have significant impact on price stability in Nigeria.
H02: Money supply does not affect price stabilization in Nigeria.
H03: There is no relationship between exchange rate and price stabilization in Nigeria?
1.6 SIGNIFICANCE OF THE STUDY.
The study will be of significance in the following ways:
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