**Abstract**

*In the past decade, significant changes in the design and conduct of monetary policy have occurred around the world. Many developing countries, including Nigeria have adopted various policy measures to achieve targeted objectives. The monetary policy is essential to achieve desired objectives which traditionally include promoting price stability. The estimated results revealed that the first lag of price gap, current money supply gap, first lag of money supply gap, current real output gap and first lag of real output gap exert positive influence on current price gap in Nigeria between the inception of a decade after independence and 2011 fiscal year and it was only the effect of real output gap that does not conform with the theoretical expectation. While, second lag of price gap exerts negative effects on inflationary pressure in Nigeria during the review periods and this does not conform to the apriori expectations based on sign. Also, the Johansen cointegration test result indicated evidence of long-run relationship. The study recommends that the monetary authority should endeavour to strengthen the effectiveness of the major instruments of controlling money supply in order to decelerate its effect in influencing inflation pressure in Nigeria.*

**Keywords:**Price stability, monetary aggregate, output growth rate, macroeconomic policy gap, Nigeria

*Journal of African Macroeconomic Review Vol. 4, No. 1 (2013-2014)***I. Introduction**

**II. Literature Review**

*d(GDP)*and

*d(M2)*, is estimated by OLS. Based on the research, they conclude that lagged changes in GDP play a significant role in estimating the change in M2, and they also predict the estimated change of M2 in 2011Q1 and the corresponding M2 at the end of the first quarter of 2011 through the estimated equation. However, among the empirical evidence documented for Nigeria includes Asogu (1998) examined the influence of money supply and government expenditure on Gross Domestic Product. He adopted the St Louis model on annual and quarterly time series data rom 1960 -1995. He finds money supply and export as being significant. This finding according to Asogu corroborates the earlier work of Ajayi (1974) Nwaobi (1999) while examining the interaction between money and output in Nigeria between the periods 1960- 1995. The model assumed the irrelevance of anticipated monetary policy for short run deviations of domestic output from its natural level. The result indicated that unanticipated growth in money supply would have positive effect on output. A clear examination of the above shows that there is no general agreement on the determinant of economic growth in the Nigerian economy. In Nigeria, Nwaobi (1999) following the earlier work of Ajayi (1974) and Asogu (1998) examined the interaction between money and output between 1960 and 1995. His findings indicated that unanticipated growth in money supply has positive effect on output. Although, the findings of Iyoha (1969, 1976) and Taiwo (1990) show that there is a clear relationship between money and economic growth. In a broader scope, Omoke and Ugwuanyi (2010) examined the causality between money, price and output in Nigeria between 1970 and 2005, and employed cointegration and granger-causality test analysis. Their analysis revealed that no existence of a cointegrating vector in the series used. Money supply was seen to Granger cause both output and inflation. The result suggest that monetary stability can contribute towards price stability in the Nigerian economy since the variation in price level is mainly caused by money supply and they conclude that inflation in Nigeria is to an extent a monetary phenomenon. Ogunmuyiwa and Ekone (2010) investigated the impact of money supply on economic growth in Nigeria between 1980 and 2006, applying ordinary least square equation, causality, and error correction model to the considered time series. The results revealed that although money supply is positively related to growth but the result is however insignificant in the case of GDP growth rates on the choice between contractionary and expansionary money supply. Omanukwue (2010) examined the modern quantity theory of money using quarterly time series data from Nigeria for the period 1990:1-2008:4. The study uses the Engle-Granger two –stage test for cointegration to examine the long-run relationship between money, prices, output and interest rate and ratio of demand deposits/time deposits (proxy for financial development) and finds convincing evidence of a long-run relationship in line with the quantity theory of money. Restrictions imposed by the quantity theory of money on real output and money supply do not hold in an absolute sense. The granger causality is also used to examine the causality between money and prices. The study establishes the existence of “weakening” uni-directional causality from money supply to core consumer prices in Nigeria. In all, the result indicates that monetary aggregates still contain significant, albeit weakening, information about developments in core prices in Nigeria. Also, the study finds that inflationary pressures are dampened by improvements in real output and financial sector development. Adesoye (2012) examined the examined the cointegration and causality between price, monetary aggregate and real output in Nigeria from the period1970 to 2009 using the inflationary gap model that emanates from the quantity theory of money. The study test of stationary revealed that money and price gaps are stationary at level, while real output is found stationary at first difference. The Johansen cointegration test revealed presence of one cointegrating vector and causality is found to significantly run from money supply to price. Also, his econometric findings suggest that inflation is amonetary phenomenon and previous price and output gap are strong indicators of controlling monetary aggregate in Nigeria. The impulse response function analysis indicated that price is more responsive to one squared variance of its own shocks, monetary and output shocks as the horizon prolonged. Also, Akinbobola (2012) provides quantitative analysis of the dynamics of money supply, exchange rate and inflation in Nigeria. The study utilizes secondary data that were obtained from the International Financial Statistics (IFS), of all variables investigated in the model. The sample covers quarterly data from 1986:01 to 2008:04. The model was estimated using Vector Error Correction Mechanism (VECM). The empirical results confirms that in the long run, money supply and exchange rate have significant inverse effects on inflationary pressure, while real output growth and foreign price changes have direct effects on inflationary pressure. Empirical deductions also signify the presence of significant feedback from the long run to short run disequilibrium. However, there exists a causal linkage between inflation, money supply and exchange rate in Nigeria.

**III. Methodology**

**3.1 Theoretical Framework and Model Specification†**

*P** is defined as the price level which is consistent with current money supply and equilibrium in goods and financial markets. As the gap between the actual price level (P) and P* is zero in equilibrium, deviations of P from P* indicate the amount of price adjustment which has not yet materialized and can help predict future movements in the price level (Peter and Pierre, 1991).

*MV*=

*PQ*(1)

*Q*

*P*Âº

*M*´

*V*(2)

*Q**

*P*Âº

*M*´

*V*(3)

*Q*

*P M V*

*Q*

*P M V*

*p** -

*p*Âº (

*m** -

*m*) + (

*q*-

*q**) (5)

*p** -

*p*, the P* model predicts the direction of movement of the price level: it will rise, fall or remain unchanged as the actual price level is below, above or at equilibrium level. The price gap, however, does not contain information about the dynamics of adjustment of

*P*to

*P**.

*255***Model Specification**

*p*= log of CPI;

*m*= log of broad money supply;

*q*= log of real output;

*m**is trend or equilibrium monetary aggregate measure as

*m m c m** = l = - Ë† ;

*q** is trend or equilibrium real output measure as

*q q c q** = l = - Ë† ; D

*p*is change in price level; ( ) Y

*t t GAP t m m m m*1

*t t GAP t q q**

*q q*

*t t m m*is the previous changes in

*t j t j q*-

*q*- D - D is the

*t u*is the stochastic error term.

*256***3.2 Research Hypothesis**

**H0:**Monetary aggregate and Output growth rate have no significant effect on price stability in Nigeria.

**Hi:**Monetary aggregate and Output growth rate have significant effect on price stability in Nigeria.

**3.3 Estimation Techniques**

**3.4 Stationarity Test**

*t*n as time and residual respectively. The equation (10) and (11) are the test model with intercept only, and linear trend respectively.

**3.5 Cointegration Test**

*no at least one cointegrating vector*”. The rejection of this hypothesis indicates dynamic longrun relationship or cointegrating vector.

**3.6 Scope, Data Description and Sources**

**IV. Results and Discussion**

**4.1 Unit Root Test Results**

*pt*) and output gap ( D

*q*Y ) were found to reject the null hypothesis “

*no stationary*” at level. This indicates that the first difference or gap of price level and real output growth have no unit-root or are stationary at level. This implies that these series are mean reverting and convergences towards their long-run equilibrium at the level which they are incorporated in the regression analysis. The other incorporated time series, monetary policy gap (D

*m*Y ) proxied by first difference of broad money supply was found not to reject the null hypothesis “

*no stationary*” at level but after several iterations based on the number of lag length and differencing, the series are found to reject the null hypothesis at another differencing level. This indicates that the second-difference of money gap is integrated of order one.

**4.2 Cointegration Results**

**4.3 Long-Run Estimates**

*p-values*are less than 0.05 and the second previous price gap was statistically significant at 10% significance level. While, the parameters for current money supply gap, first lag of money supply gap, current real output gap and first lag of real output gap were found insignificant at both 5% and 10%critical level. Although, the F-statistic result shows that all the incorporated gap indicators are simultaneously significant at 5% critical level. While, the R-squared result reveals that 87.4% of the total variation in inflationary pressure is accounted by changes in the first-two previous price gap, current money supply gap, first lag of money supply gap, current real output gap and first lag of real output gap during the review period. The Durbin- Watson test result reveals that there is presence of weak positive serial correlation among the residuals, because of the d-value (1.7874)is far from zero but closer to two.

**V. Conclusion and Recommendations**

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