Nigeria's Monetary Conditions Index

Abstract

The paper aims to construct a monetary conditions index (MCI) for Nigeria to aid the evaluation of the stance of monetary policy. Quarterly data for 91-day treasury bill rate (TBR), real exchange rate (RER), inflation rate (INF), real private sector credit (RCP), and real gross domestic product (RGDP), covering the period 2000Q1 to 2014Q1, were utilised. The period coincided with key reforms in the money and foreign exchange markets, culminating in the adoption of a new monetary policy framework in 2006. Following some econometric diagnostic tests, an aggregate demand function was estimated using the Johansen co-integration technique. The resultant long-run coefficients were applied to the deviations of the MCI component variables to derive the monetary conditions indices. The narrow and broad MCIs suggested a relatively tight monetary environment with the broad MCI being more volatile, compared with the narrow MCI due to the inclusion of the credit component, which reflects the continual swings in banking system liquidity. Our findings revealed that the exchange rate is a strong channel of monetary policy transmission mechanism in Nigeria, and thus very crucial in the conduct of monetary policy.