THE IMPACT OF FINANCIAL LIBERALIZATION ON MONETARY POLICY IN NIGERIA

CHAPTER ONE

1.1     BACKGROUND OF THE STUDY

Monetary policy in the current Nigerian context, encompasses actions of the Central Bank that affect the cost and availability of commercial and merchant bank's reserve balances and thereby the overall monetary and credit conditions In the economy (Akatu, 1993), The primary goal of such actions is to ensure that over time, the expansion in money and credit will be adequate for the long-run need of the growing economy at stable prices". The short-run objective of monetary policy however include, combating inflationary pressure, restoring a sustainable balance of payments, attainment of full employment level of productive resources, equitable distribution of income, and maintaining a stable exchange rate at internationally competitive level. Sometimes, changes in monetary policy are undertaken as part of concerted actions to remove obstacles to the growth of savings and efficient allocation of investment.

As is often the case, the pursuit of these short-term goals tends to conflict with the basic goalof stable, long-term growth. For example, a vigorous anti-inflationary stance would typically require the sacrifice of output growth in the short term. The same might be the case where priority is given to restoring a healthy balance of payments. Similarly, a stable exchange rate objective might call for a tighter control on aggregated demand which would in turn adversely impact output. Moreover, attaining the objective of exchange rate stability at internationally competitive level could require a significant depreciation of the local currency, with attendant cost push pressures on the price level. In sum, difficult trade-offs are inherent in the conduct of monetary policy, making the central bank, a frequent target of criticism and various kinds of pressures.

Over the years, the objectives of monetary policy have remained the attainment of internal and external balance. However, emphasis on techniques/instruments to achieve those objectives has changed over the years. There has been two major phases in the pursuit of monetary policy, namely, before 1986 and since 1986. The first phase placed emphasis .on direct monetary controls, while the second relies on market mechanisms.

The economic environment that guided monetary policy before 1986 was characterized by the dominance of the oil sector, the expanding role of the public sector in the economy and over­dependence 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 paint because of the underdeveloped nature of the financial markets and the deliberate restraint on interest rates.

However, as a result of the crash in international oil market in the 1980s and the resultant deteriorating economic conditions, the Structural Adjustment Programme (SAP) was adopted in this approach, the most popular instrument of 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 also stipulated for the banks in the mid-1970s on the basis of their total deposit liabilities.

As a result of the downturn of the international oil market in the 1980s, coupled with the inability of direct monetary policy to stimulated financial resources for investment, the Structural Adjustment Programme was embraced in 1986. In line with the general philosophy of economic management under SAP, monetary policy was aimed at inducing the emergence of a market-oriented financial system for effective mobilization of financial savings and efficient resource allocation. The main instrument of the market-based framework is the open market operations (OMO). This is complemented by reserve requirements and discount window operations.

With the adoption of financial liberalization programme under the auspices of SAP and the change from direct to indirect approach to monetary management, this study investigates the impact of this programme on monetary policy in Nigeria. Specifically, the basic question to be addressed in this study is: how effective is the conduct of monetary policy upon the liberalization of the financial sector in Nigeria? To what extent could monetary policy be relied upon for the achievement of macroeconomic objective in Nigeria?

These questions are very important because deregulation and changes in financial markets in recent years have had widespread implications for the conduct of monetary policy in several countries. Simple and well-behaved relationships between money and nominal income that existed under the regulated framework have apparently broken down in the changed financial environment. Indeed, Fama (1980) and Hall (1982) have argued that the more or less stable and predictable demand for money relationship estimated in earlier studies were themselves by-products of the system of financial regulation in force over the period examined.

Although these views reflect the outcomes of studies conducted in developed countries of the World especially in the United States, the test of this view has been validated in some observed Less Developed Countries. (LDCs).

With the liberalization of the financial sector in Nigeria, the assessment of its impact of this policy change on monetary policy becomes crucial. This is so because monetary policy is greatly relied upon for the achievement of macroeconomic objectives in Nigeria.

1.3    JUSTIFICATION FOR THE STUDY

According to Bogunjoko (1997) monetary policy remains one of the cornerstones of economic policy formulation and implementation. It is relevant irrespective of the economic framework in place. Monetary policy consists of discretionary measures designed by monetary authorities to regulate and influence the supply, cost and direction of money and credit provided to the economy. The measures are undertaken in such a way that monetary expansion is kept at a pace consistent with the level of economic activity and in consonance with general macroeconomic stability (Ojo, 1994).

In stressing further the importance of monetary policy, Montiel (1991) maintained that although both monetary and fiscal policies are both commonly accorded prominence in the pursuit of macroeconomic stabilization in developing countries. It is presumed that the authorities in such countries have access to macroeconomic policy instruments and can manipulate them to achieve desirable macroeconomic objectives.

In the light of the importance of monetary policy to developing countries, Nigeria inclusive, it becomes crucial to examine the impact of changes in the financial market on monetary policy in Nigeria. The main focus of this study therefore is to provide empirical evidence on the impact of financial liberalization on monetary policy in Nigeria. This study is crucial since it will provide an insight into the question of the effectiveness of monetary policy in Nigeria.

1.4    STUDY OBJECTIVES

The main objective of this study IS to conduct an empirical investigation of the impact of the adoption of financial liberalization programme on the conduct of monetary policy in Nigeria. This broad objective could however be decomposed into the following specific objectives:

1.       To conduct a comprehensive review of financial liberalization programme in Nigeria.

2.       To assess the performance of monetary policy prior to 1986 and since 1986 in Nigeria.

3.       To investigate the effectiveness of monetary policy under the financial liberalization programme in Nigeria.

4.       To provide an insight, based on the findings of this study, on measures to improve monetary control in Nigeria.

1.5    RESEARCH HYPOTHESIS

The main hypotheses to be tested in this study are:

Ho:    The adoption of financial liberalization programme In Nigeria has not actually improved the performance or effectiveness of monetary policy in Nigeria.

H1:   The adoption of financial liberalization programme In Nigeria has improved the performance or effectiveness of monetary policy in Nigeria.

Chapter three of this study deals with the structural composition of the study. This chapter considers the financial liberalization and monetary policy in Nigeria.

Chapter four, focuses on the research methodology and the empirical results and analysis of our estimated equation. Chapter five, on the other hand, deals with the summary, recommendations and conclusion drawn from this study.

1.8    THE CONTRIBUTION OF THE STUDY TO KNOWLEDGE

This study has contributed to knowledge in several ways. First, it has improved our understanding on the impact of financial liberalization on monetary policy in Nigeria. The study found that despite the adoption of financial liberation policy and the shift from direct to indirect monetary policy, the effectiveness of this stabilization tool has not improved. The study also revealed that the relationship between money demand and interest rate has not, been significant despite the liberalization measures adopted in the Nigerian economy.