The core mandate of
Nigeria central bank is the regulation and maintenance of money supply and
monetary policy. The regulation and monetary implementation of monetary policy
is done by the CBN in line with the mandates as specified in the CBN Act of
1958. In addition to price stability, the promotion of growth and employment
are the secondary goals of monetary policy.
The monetary authorities’ strategy
for management is based on the view that inflation is essentially a monetary
phenomenon. Because targeting inflation in Nigeria economy, money supply
approach is considered the appropriate methods, the central bank of Nigeria
(CBN) chose a monetary targeting policy framework to achieve the objectives of
price stability. With the broad measure of money (M2) as the intermediate
target, and the monetary base as the monetary target of CBN and the instrument
to achieve the objectives.
These instruments
include reserve requirements, open market operations on Nigeria Treasury Bills
(NTBS), liquid asset ratios and the discount windows.
With these instruments, the CBN
hoped to direct the flow of loanable funds with a view to promoting rapid
economic development through the provision of finance to the preferred sectors
of the economy such as the agricultural sector, manufacturing and residential
housing. During the 1970s, the Nigeria economy experienced major structural
changes that made it increasingly difficult to achieve the aims of monetary
policy. The dominance of oil in the country’s export market began in the 1970s
for example, in 1970, the share of oil revenue in total export value was about
58 percents and this increased to over 95 percent during the 1980s. The increase
in Nigeria’s external reserve in the 1970s. Furthermore, the rapid monetization
of the increased crude oil receipts resulted in large injection of liquidity
into the economy, which induced rapid monetary growth. Infact, between 1970 and
1973, government spending averaged about 13 percent of gross domestic product
(GDP) and this increased to 25 percent between 1974 and 1980. This rapid growth
in government spending came not from increased tax revenues but the absorption
of oil earnings into the fiscal sector, which moved the fiscal balance from a
surplus to a deficit spending, led the government to borrow from the banking
system in order to finance the domestic deficits. At the same time the
government was saddled with foreign deficits, which had to be financed through
massive foreign borrowing and the drawing down of external reserves.
Giving the state of affair in the
economy at this period, government through its monetary authority strives to
reverse the deterioration macroeconomic imbalance; declining GDP, balance of
payment disequilibrium, high inflation rate, heavy debt burden, high rate of
unemployment, rising poverty level. Government embarked on austerity measures
in 1982 which successfully reduced the inflation rate and held to achieve a 9.5
percent growth in real GDP in 1985. Although, the achievement was transitory
since the economy did not establish a strong base for sustained economic
growth.
Government of Nigeria in her
attempts to achieve a sustained economic growth adopted the structural adjustment
program (SAP) sponsored by the international monetary fund (IMF) in June 1986.
The SAP was a structural and sectoral macroeconomic policy reform whose main
strategies were;
· The
liberalization of the external trade and payment systems
· The elimination
of price and interest rate control
· The adoption of
a market based exchange rate for the domestic currency (Naira).
· The reliance on
market forces as the major determinants of economic activity.
Infact, with the adoption of SAP in 1986, the CBN reached an important
milestone in 1986 when it decided to adopt M2 as an important and intermediate target for monetary
policy. While this choice raise a key question in terms of why the CBN
considered M2 as the
appropriate intermediate target instead of interest rate or nominal GDP or
inflation targeting. Given the fact that interest rate and prices were
controlled pre – SAP, it is not difficult to see why the CBN ruled out interest
rate targeting or inflation targeting as viable policy options. Furthermore,
the structure of the financial markets in less developed countries renders
interest rate targeting ineffective. As Taylor (2004) pointed out that “if
financial market are weak, the effectiveness of transmitting policy through
interest rate will be limited”. With these controls and the constraints due to
weak financial markets nominal GDP targeting may not have succeeded. As for the
commitment to rules, many countries apply rules because policy rules may aid in
focusing policy discussion in term or intermediate and operating targets. Over
the past decades, many countries adopted the Taylor rule, which Taylor (2004),
developed for the United States.
According to Taylor
(2004), these rules can be part of the monetary policy strategy in emerging
market economics. More recently, Batin (2004) argued that for Taylor rule to be
applicable to emerging market economy like Nigeria, modifications have to be
made because of the specific features of the emerging market economics. From
these analyses, the key issue to applying Taylor rule to monetary policy making
in Nigeria is commitment to target rules.