MODELING THE RELATIONSHIP BETWEEN MONETARY POLICY AND ECONOMIC GROWTH IN NIGERIA: AN APPLICATION OF THE ARDL APPROACH IN THE PRESENCE OF STRUCTURAL BREAKS.

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ABSTRACT

The role of monetary policy in sustaining economic growth has been a highly researched subject. The aim of this study is to examine the relationship between monetary policy and economic growth in which the past studies have shown conflicting results in Nigeria. Quarterly time series data was collected from the Central Bank of Nigeria Statistical Bulletin and Website from 1981 to 2021. Motivated by the prevalence of misleading inference in time series occasioned by failure to account for structural breaks in series as volatile as macroeconomic variables in Nigerian specific studies, this study sought to find out whether structural breaks matter in studying the response of Economic growth to monetary policy shocks. The study employed Zivot-Andrews unit root test with structural break to compare the unit root result with the conventional ADF result while the Autoregressive Distributed Lag (ARDL) bounds testing approach is used to investigate the co-integration among the variables in the presence of structural breaks. Also the impulse response function (IRF) was employed to determine the response of Economic Growth to monetary policy shocks in Nigeria from 1981 to 2021. The unit root test shows that failure to account for structural break in unit root of a volatile series can produce wrong inference. After allowing for structural breaks, the study finds no evidence of co-integration relationship between economic growth and monetary policy. Thus it can be argued that there exists only a short run relationship between the variables of study. The estimates of the ARDL short run model suggest that Money Supply (M2) has a significant positive impact on economic growth in the short run at the selected lag length. However, the estimates show that Net Credit to Government (NCG) has a negative significant impact on economic growth in Nigeria. More also, Exchange Rate (EXR), Inflation (INFL) and Maximum Lending Rate (MLRC) have a positive but insignificant effect on Economic Growth in the short run. The Impulse response function (IRF) results suggested that Economic Growth responds negatively to money supply (M2) and Net credit to Government (NCG) shocks. More also the result shows that Economic growth respond positively to Exchange rate (EXR) shocks. Furthermore, the Impulse Response results show that Inflation (INFL) and Maximum Lending Rate (MLRC) possessed no impact on economic growth as their shocks quickly dies or converges back to zero. Therefore this study makes the following recommendations for policy makers and future researchers in Nigeria: the policy makers in Nigeria should increase the level of broad money supply in the country since broad money supply lead to economic growth in the short run. Also the Apex bank in Nigeria should embark on the use of appropriate monetary policy variables that will address non-performance of Exchange rate and maximum lending rate in contributing to the nation’s economic growth.






TABLE OF CONTENT

Title page                                                                                                        i

Declaration                                                                                                     ii

Certification                                                                                                   iii

Dedication                                                                                                      iv

Acknowledgement                                                                                          v

Table of Content                                                                                           vii

List of Tables                                                                                                  viii

List of Figures                                                                                                 ix

Abstract                                                                                                          x


CHAPTER 1: INTRODUCTION

1.1  Background of Study                                                                          3

1.2  Statement of Problem                                                                         4

1.3  Objective of the Study                                                                        5

1.4  Significance of the Study                                                                   5

1.5  Scope of the Study                                                                              6


CHAPTER 2: REVIEW OF RELATED LITERATURE

2.1 Conceptual Review                                                                                   9

2.2 Theoretical Frame Work                                                                          12

2.3 Empirical Literature                                                                                 18


CHAPTER 3: MATERIALS AND METHODS

3.1 Sources of Data and Period of Study                                                        19

3.2 Research Methods Used for the Analysis                                                 35


CHAPTER 4: RESULTS AND DISCUSSION

4.1 Descriptive Statistics                                                                                38

4.2 Testing for Unit Roots and Structural Breaks                                          41

4.3 Autoregressive distributed Lag (ARDL) model estimation                     47

4.4 Impulse Response Function (IRF) estimation                                          49

4.5 Diagnostic Test                                                                                         52

4.6 Stability Test                                                                                            53


CHAPTER 5: CONCLUSION AND RECOMMENDATIONS

5.1 Conclusion                                                                                                55

5.2 Recommendation                                                                                     56

References                                                                                                      59

Appendices                                                                                                     68

 

 

 


 

 

 

 

 

LIST OF TABLES

 

4.1 Main Descriptive Statistics Result                                                           36

4.2.1 Result of ADF Unit Root Test                                                               40

4.2.2 Result of Zivot Andrews Unit Root Test                                               40

4.3.1 Result of ARDL Bound Test                                                                 43

4.3.2 ARDL Econometric Model                                                                   44

4.3.3 Result of Wald Test                                                                               46

4.5 ARDL Residual Diagnostic Result                                                           50

 

 


 

 

 

 

 

LIST OF FIGURES

 

4.1 Series plot of variables at level                                                                37

4.2 Series plot of variables at first difference                                                38

4.3 Model Selection Summary Graph                                                            44

4.4 Impulse Response function                                                                       48

4.5 CUSUM Stability Test of ARDL(5,5,1,0,2,0)                                          53

4.6 CUSUM Stability Test of ARDL(5,5,1,0,2,0,0)                                       53

 

 

 

 


CHAPTER 1

INTRODUCTION

1.1 BACKGROUND OF STUDY

Monetary policy is a deliberate action taken by the monetary authority to affect the amount, cost, and accessibility of money credit in order to attain the desired macroeconomic goals of internal and external balances (CBN, 2011). To control the amount of money in the economy, the activity is carried out by altering the money supply and/or interest rates. Thus, nations have sought to use monetary policy as a tool for managing the economy in order to achieve long-term economic growth and development. Adams Smith was the first to formally articulate this relationship between money and economic aggregates, and monetary economists later championed it. Because of the explanations of how monetary policy affects macroeconomic goals like economic growth, price stability, balance of payments equilibrium, and a host of other goals, monetary authorities are now charged with utilizing monetary policy to expand their economies.

The expansion of products and services in a nation at a specific point in time is referred to as economic growth. This naturally shows that economic growth occurs when a nation's actual per capita income rises over time. A rising economy generates commodities and services across successive time periods, indicating a rise in the economy's production potential. In general, economic growth entails a rise in average living standards and a decrease in income distribution disparities (Jhingan, 2004).

Since the Central Bank of Nigeria was given the duty of creating and carrying out monetary policy by the Central Bank Act of 1958, monetary policy has been utilized in Nigeria. Treasury bills, a financial instrument used for open market operations and raising debt for the government, have grown in volume and value as a result of this role, becoming a significant earning asset for investors and a source of market-balancing liquidity.

Monetary policy in Nigeria has been primarily characterized by the post-1986 and pre-1986 periods. Prior to 1986, Nigeria maintained direct monetary management to maintain price stability; however, after the market was liberalized in 1986, the focus moved to market mechanisms (Uchendu, 2009). In order to fight inflation and maintain price stability prior to 1986, direct monetary instruments were used, such as selective credit controls, administered interest and exchange rates, credit ceilings, cash reserve requirements, and special deposits. Interest rates were set at relatively low levels primarily to encourage investment and economic growth. Occasionally, special deposits were enforced to limit the banks' ability to provide credit and their excess reserves (Uchendu, 2009; Okafor, 2009).

Given that the implementation of the monetary management system grew less successful with time, it appears that during the aforementioned period, the monetary targets were not met. The unfavorable effect of limiting the growth of money and capital markets may have been greatly exacerbated by the rigorously managed interest rate regime and the lack of coordination between fiscal and monetary policies. Instead of relying on a direct control mechanism for monetary policy during the Structural Adjustment Programme (SAP) era, market-oriented reform was adopted for successful mobilization of savings and efficient resource allocation. The market-based framework's primary tool was open market operations.

In recent years, Nigeria's monetary policy has been built on a framework with a medium-term vision. The change was made to reduce overreaction to transient shocks and liberate monetary policy implementation from the issue of time inconsistency. To influence interbank rates and subsequently other market rates in the desired direction, policies have ranged from focusing on monetary aggregates to monitoring and altering policy rates (Okoro, 2018; Uchendu, 2009). Policymakers and researchers are extremely concerned about how much these policies have contributed to economic stabilization and growth.

In Nigeria, there have been numerous monetary policy regimes. Monetary policy, which is primarily employed to stabilize prices, can be lax or tight at different times. The economy has had periods of expansion and contraction, but it is clear that the growth that has been reported has not been sustainable given that there are signs of rising poverty in the population. The question is, can sound monetary policy be credited with the current expansion? And could causes other than weak monetary policy be held responsible for periods of economic downturn? What measures need to be considered if monetary policy is to be effective in bringing about sustainable economic growth and development? These are the concerns that remain unsolved in Nigeria, which this study would aim to answer.

 

1.2 STATEMENT OF PROBLEM

Despite the efforts made by the Central Bank of Nigeria (CBN) through the implementation of monetary policy measures, the Nigerian economy continues to experience a myriad of issues that are related to the amount of money in circulation. This is so because the amount of money in the economy dictates its economic stability and, consequently, whether or not economic growth is increasing or decreasing. Lowered price levels are thought to be connected with long-term, sustainable growth, according to theory and actual data in the literature. In other words, sustained economic growth and wellbeing are harmed by rising inflation. Financial circumstances in the economy are greatly influenced by monetary policy, not just in terms of costs but also in terms of loan availability, banks' willingness to take certain risks, etc. The prices of goods, the value of assets, currency rates, as well as consumption and investment are all impacted by expectations about the future course of the economy and inflation.

However, there is conflicting evidence in both theoretical and empirical literature about the effect of monetary policy on economic growth in Nigeria and elsewhere. While some studies contend that monetary policy has a favorable and considerable impact on economic growth, others hold the opposite view. According to studies like those by Ajibola and Oluwole (2018), Lacker (2014), Lashkary and Kashani (2011), monetary policy's expansion of the money supply has a negative impact on economic growth through inflation.

While studies such as those by Anowor and Okorie (2016), Chipote and Makhetha-Kosi (2014), and Fasanya and Onakoya (2013) concluded that monetary policy has a positive and statistically significant impact on economic growth, these empirical literature outcomes demonstrate inconclusiveness. Therefore, there is a need to identify the actual influence monetary policy tools have on economic growth in Nigeria across the periods stretching from 1981 to 2021.


1.3 AIM AND OBJECTIVE OF THE STUDY

The aim of the study is to evaluate the long-run and short-run causation between monetary policy variables and economic growth as measured by real gross domestic product (RGDP).

The specific objectives are:

1. To investigate whether there is stability or a break in the mean level of the variables over the periods under review.

2. To investigate the long-run relationship between Monetary Policy Variables and Economic Growth.

4. To identify the short-run relationship between Monetary Policy variables and Economic Growth

5. To trace out the responsiveness of Economic Growth to the shocks of each monetary policy variables in the system

 

1.4 SIGNIFICANCE OF THE STUDY

This research work is significant in many ways:

Firstly, it would help in determining actual and potential impact of the monetary policy on the economic growth process of the country;

More importantly, it will be of immense importance to policymakers at the Central Bank of Nigeria who issue guidelines governing foreign trade practices and will be of specific importance to employers and employees, importers and exporters, industry and trade officials, politicians, academics, and the general public as well.

Finally, scholars who will find the thesis interesting and who want to conduct their research in this area are welcome to utilize this work as a source of inspiration for their own.


1.5 SCOPE OF THE STUDY

This research work is limited to monetary policy indicators and the economic growth of Nigeria. Quarterly secondary time series data on economic growth proxied by Gross Domestic Product (GDP), Broad Money Supply (M2), Exchange Rate (EXR), Inflation Rate (INF), Maximum Lending Rate of Commercial Banks (MLRC), and Net Credit to the Government Sector (NCG) for a period of 40 years from 1981 to 2021 was collected.

 

 

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