The transmission of monetary policy in Nigeria

Abstract

This paper investigates the transmission channels and mechanisms through which monetary policy affect economic activities with particular focus on the Nigerian economy. Even though there is no consensus on how monetary policy affects the economy, the liquidity or interest rate, credit (including bank loan) and exchange rate channels of monetary transmissions were identified in the literature. The propagation of monetary policy through the various channels were explained broadly under the monetarist and Keynesian theoretical frameworks. The monetarist transmission mechanism relies mainly on portfolio adjustment of the assets and liabilities in the balance sheets of banks, firms and households for the transmission of monetary policy changes to the rest of the economy, while the keynesian transmission mechanism is centered on the ability of changes in money supply to affect the cost of capital (through interest rate movements). The various channels and mechanisms reinforce each other but may vary in importance from country to country and over time; and are applicable in the Nigerian case. In addition, the informal credit market forms an important avenue for the transmission of monetary policy in Nigeria. In order to establish the existence of the credit channel, the composition of manufacturing firms' sources of finance data from Central Bank of Nigeria Annual Business Survey was analyzed. The results indicated that the portion of the firms' financing from banks was responsive to the stance of monetary policy during the review period. A further examination of the Lagos area component of the data revealed that banks lend more to larger manufacturing firms than to smaller ones in conformity with the generally held views on the subject and results of previous studies. The smaller firms, unlike their larger counterparts, relied more on their internal funds for fixed investment than from other sources. The transmission of monetary policy in Nigeria could be further improved if capital flows are liberalised; open market operation (OMO) instruments are made more attractive; and the activities in the informal financial market are better understood.