The Impact of Monetary and Fiscal Policy on Economic Growth of Nigeria
ABSTRACT:
This work focuses on the impact of monetary and fiscal policies on the growth of the
Nigerian Economy with emphases on determining its effects of both
policies on how the economy can be more efficiently and effectively
managed
The data were collected from Central Bank of Nigeria Statistical Bulletin and Annual
reports with inclusion of money supply, Gross Domestic Product,
Government expenditure, tax etc.
The methodology employed was the ordinary least square to analyze the data making use of multiple regression to capture the relationship between the dependent variable gross domestic
product and the independent variables money supply, government expenditure, taxation and gross domestic product.
Highlighting the impact of the mix policies on the findings, its obvious that the individual
significance test show that money supply, government expenditure and taxation impacted significantly.
It’s recommended that government should create a good environment for economic activities to grow and also implement macro-economic policies that will accommodate both policies.
Conclusively, both policies should be geared towards improving the conductive capacity, of the economy and the infrastructures should be
1.1. BACKGROUND OF THE STUDY:
Since its establishment in 1959, the Central Bank of Nigeria (CBN) 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 anchored on the use of monetary and fiscal policy that is usually targeted towards the achievement of full-employment equilibrium, rapid economic growth, price stability, and external balance. Over the years, the major goals of monetary and fiscal policy have often been the two later objectives. Thus, inflation targeting and exchange rate policy have dominated CBN’s monetary and fiscal policy focus based on assumption that these are essential tools of achieving macroeconomic stability.
The economic environment that guided fiscal and monetary policy in the past was characterized by the dominance of the oil sector, the expanding role of the public sector in the economy and over-dependence on the external sector. In order to maintain price stability and a healthy balance of payments position, monetary management depended on the use of direct monetary instruments such as credit ceilings, selective credit controls, administered interest and exchange rates, as well as the prescription of cash reserve requirements and special deposits. The use of market-based instruments was not feasible at that point because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rates.
The most popular instrument of fiscal and monetary policy was the issuance of credit rationing guidelines, which primarily set the rates of change for the components and aggregate commercial bank loans and advances to the private sector. The sectoral allocation of bank credit in CBN guidelines was to stimulate the productive sectors and thereby stem inflationary pressures. The fixing of interest rates at 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. Minimum cash ratios were stipulated for the banks in the mid-1970s on the basis of their total deposit liabilities, but since such cash ratios were usually lower than those voluntarily maintained by the banks, they proved less effective as a restraint on their credit operations.
In general terms, monetary and fiscal policies refer 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. For most economies, the objectives of monetary and fiscal policy include price stability, maintenance of balance of payments equilibrium, promotion of employment and output growth, and sustainable development (Folawewo and Osinubi, 2006). These objectives are necessary for the attainment of internal and external balance, and the promotion of long-run economic growth.
The importance of price stability derives from the harmful effects of price volatility, which undermines the ability of policy makers to achieve other laudable macroeconomic objectives. There is indeed a general consensus that domestic price fluctuation undermines the role of money as a store of value, and frustrates investments and growth. Empirical studies (Ajayi and Ojo, 1981; Fischer, 1994) on inflation, growth and productivity have confirmed the long-term inverse relationship between inflation and growth.
With the achievement of price stability, the conditions in the financial market and institutions would create a high degree of confidence, such that the financial infrastructure of the economy is able to meet the requirements of market participants. Indeed, an unstable or crisis-ridden financial sector will render the transmission mechanism of fiscal and monetary policy less effective, making the achievement and maintenance of strong macroeconomic fundamentals difficult. This is because it is only in a period of price stability that investors and consumers can interpret market signals correctly. Typically, in periods of high inflation, the horizon of the investor is very short, and resources are diverted from long-term investments to those with immediate returns and inflation hedges, including real estate and currency speculation. It is on this background that this study would investigate the effectiveness of the monetary policy in Nigeria with special focus on major growth components.
1.2. STATEMENT OF THE PROBLEM
One of the major objectives of monetary and fiscal policy in Nigeria is price stability. But despite the various monetary and fiscal regimes that have been adopted by the Central Bank of Nigeria over the years, inflation still remains a major threat to Nigeria’s economic growth.
Nigeria has experienced high volatility in inflation rates. Since the early 1970’s, there have been four major episodes of high inflation, in excess of 30 percent. The growth of money supply is correlated with the high inflation episodes because money growth was often in excess of real economic growth. However, preceding the growth in money supply, some factors reflecting the structural characteristics of the economy are observable. Some of these are supply shocks, arising from factors such as famine, currency devaluation and changes in terms of trade.
The first period of inflation in the 30 percent range (12months moving average) was in 1976 (CBN, 2009). One of the factors often adduced for this inflation is the drought in Northern Nigeria, which destroyed agricultural production and pushed up the cost of agricultural food items, a significant increase in the proportion of the average consumer’s budget. In addition, during this period, there was excessive monetization of oil export revenue, which might have given the inflation a monetary character.
In addition, in the late 1980’s, following the structural Adjustment Program, the effects of wage increases created a cost-push effect on inflation. In the long run, it was the structural characteristics of the economy, coupled with the growth in money supply that translated these into permanent price increases. In 1984, inflation peaked at 39.6 per cent at a time of relatively little growth in the economy. At that time, the government was under pressure from debtor groups to reach an agreement with the International Monetary Fund, one of the conditions of which was devaluation of the domestic currency. The expectation that devaluation was imminent fuelled inflation as prices adjusted to the parallel rate of exchange. Over the same period, excess money growth was about 43 percent and credit to the government had increased by over 70 percent (CBN, 2009). In other respects the cause of the inflation may also be adduced to the worsening terms of external trade experienced by the country at that time. It is possible therefore that Nigeria’s inflationary episodes were preceded by structural or real factors followed by monetary expansion.
The third high inflation episode started in the last quarter of 1987 and accelerated through 1988 to 1989. This episode is related to the fiscal expansion that accompanied the 1988 budget. Though initially the expansion was financed by credit from the CBN, it was later sustained by increasing oil revenue (occasioned by oil price increase following the Persian Gulf War) that was not sterilized. In addition, with the debt conversion exercise, through which “debt for equity” swaps took place, external debt was repurchased with new local currency obligations. However, with the drastic monetary contraction initiated by the authorities in the middle of 1989, inflation fell, reaching one of its lowest points in 1991 i.e 13% (CBN, 2009).
The fourth inflationary episode occurred in 1993, and persisted through the end of 1995. Though inflation gathered momentum towards the tail end of 1992, it reached 57 percent by the end of 1994, the highest rates since the eighties, and by the end of 1995, it was 72.8 per cent (CBN, 2009). As with the third inflation, it coincided with a period of expansionary fiscal deficit and money supply growth. The authorities found it too difficult to contain the growth of private sector domestic credit and bank liquidity. Continuous fall of the inflation rate has been experienced since 1996 as a result of stringent monetary policies of the Central bank. It however, increased in 2001 and 2003, 2004, 2005, 2008 and 2009 to 18.9%, 14%, 15%, 17.9%, 11.6% and 12.4% respectively (CBN, 2009).
Structural factors have proven to be important in the inflation spiral. Reduction in oil revenue (a supply shock) led to a reduction in real income, with serious distributional implications. As workers pushed for higher nominal wages, while producers increased mark-ups on costs, an inflationary spiral followed. In addition to these factors the government also had a transfer problem in order to meet debt obligations.
The failure of the monetary and fiscal policies in curbing price instability has caused growth instability as Nigeria’s record of development has been very poor. In marked contrast to most developing countries, its GDP was not significantly higher in the year 2000 that it was 35 years before. As many economic indicators show, Nigeria’s economy has experienced different growth stages. The GDP growth rate recorded negative growth in the early 1980s (-2.7 in 1982, 7.1 in 1983 and -1.1 in 1984). The growth rate increased steadily between 1985 and 1990 but fell sharply in 1986 and 1987 to 2.5% and -0.2%. Except in 1991 when a negative growth rate of -0.8% was recorded, 1990s witnessed an unstable growth. However, the growth rate has been relatively high since 2001. An examination of the long-term pattern reveals the following secular swings: 1965-1968 Rapid Decline (civil war years), 1969-1971 Revival, 1972-1980 Boom, 1981-1984 Crash, 1985-1991 Renewed Growth, 1992-2010 Wobbling (CBN, 2010).
The main thrust of this study shall be to evaluate the effectiveness of the CBN’s monetary policy and the government’s fiscal policy over the years. This would go along way in assessing the extent to which the monetary and fiscal policies have impacted on the growth process of Nigeria using the major objectives of monetary and fiscal policies as yardsticks.
1.3. OBJECTIVES OF THE STUDY
The main objective of this study is to assess the effectiveness of the monetary and fiscal policies in Nigeria. However, the following specific objectives would also be achieved.
(i) To examine the trend and structure of monetary and fiscal policies in Nigeria;
(ii) To empirically investigate the impact of the monetary and fiscal policies on economic growth and other major growth components in Nigeria;
(iii) Evaluate the performance of monetary and fiscal policies in Nigeria over the years.
(iv) To investigate the relationship and relate impact of money supply, interest rate,taxation,and public expenditure on economic growth.
1.4. RESEARCH QUESTIONS:
This research work seeks to find out reliable solutions to the following research questions.
- To what extent has the Nigeria society been given adequate information on monetary and fiscal policies?
- What is the response of the public and financial institutions towards monetary and fiscal policies?
- How has the offenders of these policies been effective in promoting economic growth in Nigerian economy?
- Are monetary and fiscal policies effective in promoting economic growth in the Nigeria economy?
- How best do government synchronize the conflicting nature of policy objectives and structural rigidity existing in the Nigeria economy?
1.5. RESEARCH HYPOTHESES
The hypotheses to be tested in the course of this research work are:
(1) H0 – That the monetary and fiscal policy instruments do not have significant impact on the economic growth in Nigeria.
H1 – That the monetary and fiscal policy instruments have significant impact on the economic growth in Nigeria.
(2) H0 – That the monetary and fiscal policy instruments do not impact significantly on the general price level in Nigeria.
H1 – That the monetary and fiscal policy instruments impact significantly on the general price level in Nigeria.
(3) H0 – That the monetary and fiscal policy instruments do not impact significantly on the Balance of payment equilibrium of Nigeria.
H1 – That the monetary and fiscal policy instruments impact significantly on the Balance of payment equilibrium of Nigeria.
1.6. SIGNIFICANCE OF THE STUDY:
Going by the core objective of this study which is aimed at determining the influence of the monetary and fiscal policy on economic growth in Nigeria. This research work though serving as a useful document enable policy makers to formulate appropriate policies that enable them combat the decline in Gross Domestic Product(GDP), Per Capita Income and high inflation.
This research work also has the potential of indicating to policy makers the direction of relationship that exist between monetary and fiscal policy, economic growth using Gross Domestic Product( GDP) as an indicator.
1.7. RESEARCH METHODOLOGY
The data for this study were obtained mainly from secondary sources, particularly from Central Bank of Nigeria (CBN) publications. This study makes use of econometric approach in estimating the relationship between selected monetary policy components and major growth components.
The Ordinary Least Square (OLS) technique shall be employed in obtaining the numerical estimates of the coefficients in different equations. The OLS method is chosen because it possesses some optimal properties; its computational procedure is fairly simple and it is also an essential component of most other estimation techniques.
In demonstrating the application of Ordinary Least Square method, the multiple linear regression analysis will be used with gross domestic product (GDP), inflation rate and balance of payment as the dependent variables while liquidity ratio, cash ratio, money supply as the explanatory variables. The method would be applied with the use of Statistical Package for Social Sciences (SPSS).
1.8. SCOPE OF THE STUDY:
The economy is a large component with lot of diverse and sometimes complex parts. This study will only focus on major growth components such as the gross domestic product, price level, exchange rate and the balance of payment equilibrium.
This study will cover all the facets that make up the monetary and fiscal policies, but shall empirically investigate the effect of the major ones.
The study would also examine the monetary and fiscal policy regimes that have adopted in Nigeria since 1960 to date as well as evaluate its performance.
1.9. DEFINITION OF TERMS:
Monetary Policy: This involves any conscious measure taken by the monetary authority to change the quantity and availability and cost of money with a view of achieving internal and external balance in the economy.
Interest Rate: This means the price paid for borrowing money for a period of time, usually expressed as a percentage of the principal per year.
Money Supply: This means the total amount of spendable money at any time period.
Fiscal Policy: A policy where the government uses expenditure and revenue programs to produce desirable effects and avoid undesirable effects on the national income production and employment.
Taxation: This means a compulsory non-liquid-pro-quo withdrawal or resources from the private sector of the economy
TABLE OF CONTENT:
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
1.2 Statement of the Research Problem
1.3 Objectives of the Study
1.4 Significance of the Study
1.5 Research Questions
1.6 Research Hypothesis
1.7 Conceptual and Operational Definition
1.8 Assumptions
1.9 Limitations of the Study
CHAPTER TWO
LITERATURE REVIEW
2.1 Sources of Literature
2.2 The Review
2.3 Summary of Literature Review
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Research Method
3.2 Research Design
3.3 Research Sample
3.4 Measuring Instrument
3.5 Data Collection
3.6 Data Analysis
3.7 Expected Result
CHAPTER FOUR
DATA ANALYSIS AND RESULTS
4.1 Data Analysis
4.2 Results
4.3 Discussion
CHAPTER FIVE
SUMMARY AND RECOMMENDATIONS
5.1 Summary
5.2 Recommendations for Further Study
Bibliography
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