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Monetary Policy is an instrument given to the Central Bank of Nigeria (CBN) by the federal government that is, it is a function which is a documentary policy to control the aggregate demanded in the circulation or cost. The policy is to see to the stability in wages and prices of goods and services. It is also necessary to control the volume of money in circulation and to give the domestic money a value via other controls. In the monetary policy, there are many tools used in the Central Bank of Nigeria (CBN) to achieve the over all objective. Fiscal policy is used in order to compliment the effect of monetary policy of the Central Bank of Nigeria (CBN). If the monetary policy have been effectively used, there will be low inflationary trend in the economy, there by increasing or enhance the purchasing power of the citizens. In order to effectively used the Money Policy, the government or the Central Bank of Nigeria (CBN) must be pro-active in respect of the financial sector and its important or   relevance as the pivotal to the economic development. However, the monetary policy in Nigeria have been always ineffective due to some factors such as, irregularity over loan, oligopolistic structures of the banks, dual markets, poverty and low valuation of financial assets in the market.


Monetary policy aims at controlling the activities of banks and other financial sectors in the economy, but in spite of the key position this control occupies in the economy, care had not been taken to really exploit the trend of events in the economy so as to come up with the appropriate regulation and deregulation policy. If this is done, positive indicators will begin to appear in the economy. For now, there is instability in the economy and the inflationary rate is very high. Economists have been interested in the effect of fiscal and monetary policies in the economy. Recent studies have analysed the impact of market structure on profitability in the banking industry. In general, some of these studies have concluded that market structure does not significantly influence profit-ability. In contrast, most studies of pricing policy have found that ‘the prices of bank services increase with the degree of monopoly in the banking sector. In view of this, it is therefore pertinent to evaluate the impact of mone-tary policy on commercial banks. Ajayi (1978) emphasized that the instrument of monetary policy will vary depending on the economy in question. The criteria for choosing any instrument cannot be stated in any ambiguous terms. Schwartz (1969) said that the three criteria often used in judging the short term target of any monetary instrument are whether it is measurable and can be controlled by the Central Bank and whether the instrument can be used as an indicator of monetary conditions. Crockett (1973) highlights the main technique by which the Central Bank may achieve monetary policy objectives into market intervention and portfolio constraints. He stressed that market intervention relies on the power of Central Bank as a dealer in the financial markets to influence the availability and rates of returns on assets while portfolio constraints places restrictions on a particular group of institution (banks) to limiting their freedom lo acquire assets and liabilities. Classifying monetary instruments into quantitative and qualitative tools, Ramlett (1969) remarked that though quantitative tools operate customarily by influencing the cost, volume and availability of bank reserves and thereby affecting the supply of credits, the effect is generally impaired and impersonal. Qualitative tools however, typically seek to regulate the demand for credit of specific users and are therefore selective.


2.4.1    The Cbn’s Monetary Policy Framework


A major distinguishing feature of a central bank from other financial institutions is the formulation and implementation of monetary policy. This is predicated on the use of monetary policy as a tool to enhance the macroeconomic environment generally and in particular to nurture the evolution of a dynamic, efficient and strategic financial system that would to promote economic growth.


There are different strategies used by central banks in the conduct of monetary policy. These strategies affect the operating, intermediate and ultimate targets through different channels. The common strategies include; monetary targeting, interest rate targeting, exchange rate targeting, nominal gross domestic product or output targeting and inflation targeting.


Since inception, the CBN has used two frameworks for the implementation of its monetary policy namely: exchange rate targeting and monetary targeting.


Exchange rate targeting framework was used between 1959 and 1974, while monetary targeting has been in use from 1974 to date. The shift to monetary targeting was largely informed by the collapse of the Bretton Woods system of fixed exchange rates in 1972 and a change in strategy to demand management as a means of containing inflationary pressures and balance of payments imbalances.


2.4.2    Monetary Targeting


Monetary targeting is one of the traditional strategies of monetary policy. It involves targeting one of the monetary aggregates such as money supply or any other measure of money stock as the intermediate variable through an operational target in order to impact the ultimate objective i.e. inflation.


The use of monetary targeting as a framework of monetary policy means a central bank announces a certain target for the annual rate of growth of the monetary aggregate of choice. The central bank is therefore responsible for achieving the target. In Nigeria, the central bank tries to control base money (as the operating variable) using the accelerator and multiplier principle. The base money is the liability of the central bank comprising currency in circulation plus DMBs‘ reserves with the central bank. The reserves are further broken down into legally required reserve and other reserves voluntarily kept as buffer stock.


The monetary aggregate as a nominal anchor performs well provided the assumption of stable multiplier and income velocity of money holds.


The attraction of the use of monetary targeting lies in its advantages including allowing central banks to cope with domestic considerations, for example inflation rate and/or output growth, in solving the monetary policy question.


Others include its ability to immediately signal monetary policy stance and help fix inflation expectations; and accountability of central banks. It is easy to implement under direct and market-based systems of monetary policy regimes even in under-developed financial markets. Its quantitative nature makes it a ready benchmark in many countries‘ monetary programme, especially when involved in stabilization or other programmes with the International Monetary


Fund (IMF). A major short-coming of monetary targeting is that its efficacy depends on a strong, predictable and reliable relationship between output/income and base money. If the relationship is weak, monetary targeting would not work. For instance, the assumed stable relationship between money supply and nominal GDP as measured by income velocity may not exist especially in the short-run in some countries, including developed economies.


2.4.3    Interest Rate Targeting


Interest Rate Targeting involves making the interbank rate the anchor rate for monetary policy. In this case, the central bank targets the interbank rate which it uses as the policy rate. Under the regime, the central bank stabilizes the rate with the use of repo and reverse repo operations. Thus, short term liquidity shortages which often lead to gyration of the interbank rate are evened out with repo operations which restore the liquidity condition of the banks. Reverse repo operations are also used for similar purposes.


The understanding is that the interbank rate functions both as an operating instrument and also as an operating target. Changes in the operating target are expected to impact the intermediate target (broad money, bank reserves, etc) in the desired direction (through the interest rate channel). Such changes will ultimately impact on the ultimate target (inflation) in the desired direction.


2.4.4    Nominal Gross Domestic Product Targeting


Nominal Gross Domestic Product (nominal GDP) targeting is a monetary policy strategy based on the assumption that the monetary base can be influenced to keep nominal GDP close to a path consistent with price stability. This school of thought relies on the philosophy that price stability is better achieved with the adoption of monetary policy rules. Such rule, it is further argued, would maintain price stability without inhibiting long term economic growth. The proponents of this strategy conclude that as long as the monetary authorities play by the rules, price stability would be achieved.


This process entails the central bank setting specific targets in terms of a variable or variables that the monetary authorities can monitor. Such variables as M1, M2 or long term interest rates, are useful. However, the GDP should be interpreted as nominal (and its decomposition, into prices and output), and not as money stock or interest rates. The following factors are relevant to output targeting:


GDP is the ultimate target or goal; and

No single variable can be used to properly gauge the impact of monetary policy on GDP.

The procedure involves a combination of variables that influence the course of GDP growth. Proponents of GDP targeting also recognize the existence of an intermediate target, but maintain that as a goal, the monetary authorities only need the intermediate targets to get at the GDP objective. The implicit nominal anchor strategy does not rely on a money-inflation relationship. Rather, the central bank is saddled with dual mandates, for instance; to maintain the long run growth of the economy and growth in credit aggregates commensurate with the economy‘s long-run potential to increase production, so as to promote effectively, the goals of high employment, stable prices and moderate long-run interest rates. The greatest drawback of an implicit nominal anchor strategy as a framework of monetary policy is its lack of transparency which more often than not keeps the market guessing on the thrust of monetary policy.


2.4.5    Exchange Rate Targeting


Exchange rate targeting is also known as exchange rate peg. It refers to the fixing of the value of the domestic currency in respect of another low inflation currency. The strategy had its origins in the pre – World War I era, when the gold standard was in use. At that time, the currencies of most countries were convertible directly to gold at fixed exchange rates.


In recent times, exchange rate targeting involves the fixing of the value of a domestic currency to another called the anchor currency. The choice of the foreign currency to which the domestic currency is anchored usually depends on the relative stability and low rate of inflation of that country as well as the relative weight of its trade in the anchoring country‘s international trade with the anchored country‘s currency.




Monetary policy instruments are classified into the distinct groups namely; traditional, direct control and qualitative methods. Ndiomu (1993) is of the opinion that, the traditional instruments requires the existence of a developed and a properly functioning money market and these are confined to the short-term. The market direct control instrument are non-market weapons used in developing countries to strike at the liquidity of com-mercial banks while qualitative instruments are aimed at influencing the direction of bank advances and the amount that go into any particular sector of the economy. CBN (1993) has it that the economic environment that guided monetary policy before 1986 characterized by the growing importance of the oil sector, the ending role of the public sector in the economy and over-dependence on the external sector. The economic environment, which guided monetary policy in the SAP era, could be termed the period of boom and burst. In order to maintain price stability and a healthy balance of payment position, monetary manage-ment depended on the use of direct monetary instrument such as credit ceilings, selective it controls, administered interest exchange rates as well as the prescription of reserve requirement and special and deposit. The use of market-based instruments was not feasible at that point because of the underdeveloped nature of financial markets and the deliberate restraint on interest rates. From the mid-1970, it became increasingly difficult to achieve the aims of monetary policy. Generally, monetary Akanbi and Ajagbe 12039 aggregates, government fiscal deficits, GDP growth with rate, inflation rate and the balance of payments position moved in undesirable positions/directions. As Ajayi and Ojo (1979) observed, a review of major developments in the Nigerian economy showed that the inflationary trend in country started its upward turn at the end of the civil war in 1970. Contributory factors responsible for the inflationary trend include disruptions of production by civil war and the unrealistic wage increases awarded by the Adebo and Udoji. Throughout the early 1980’s, the Nigerian economy continued to experience the problem of low domestic output, high rate of inflation, unemployment, huge public debt and balance of payment disequilibrium. In 1984, domestic output dropped by 5.5%. The problem of inflation still persisted. The rate of inflation was 9.9% in 1980. But by 1984, it had jumped to 39.6%. There was also the problem of inadequate foreign exchange earnings. It was thus visible that institutional economic reforms must take place in order to correct the imbalances e.g. several austerity measures was adopted by Shagari Administration during the period 1980 to 1993. As noted by Ojo (1993) such measure was the Economic Stabilization act, which was passed in 1982. The act stipulates that a package of fiscal, exchange control and monetary measures was adopted with the aim of conserving the country’s foreign exchange, and measures were also aimed at stimulating local manu-facturing in order to restrict imports and smuggling. Commercial and Merchant banks were also directed to grant more loans and advances to the preferred sectors of the economy.




The objectives of monetary policy may vary according to the level of development of the economy involved, but invariably; they include the attainment of price stability, maintenance of external payments equilibrium, as well as promotion of employment and output growth, and sustainable economic development. Irrespective of the type of economy, these objectives are critical for the attainment of internal and external balance and ultimately the promotion of long-run economic growth. Where the stability of the financial system is threatened, these short and long term objectives could be subordinated to the overriding objective of achieving financial stability.


In pursuit of the provisions of the CBN Act 2007, the primary objective of monetary policy has remained the maintenance of monetary and price stability. Generally, the monetary policy of the CBN is anchored on four main pillars:


(i) Inflation as a monetary phenomenon;


(ii) The public‘s expectation of future inflation (this is crucial in the setting of current wages and prices). A corollary to this is that there is no long-run trade-off between unemployment and inflation; to anchor expectations;


(iii) Proactive and rule based monetary policy (for instance, under the Taylor rule, for monetary policy to stabilize prices, the nominal interest rate must be raised by more than the level of inflation); and


(iv) The need for monetary policy to be undertaken outside the control of the political authorities i.e. independence of the central bank to conduct monetary policy.




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