The Effects of Money Supply on Interest Rate in Nigeria (1988 – 2010).
ABSTRACT
This thesis work examines the effects of money supply on interest rates in Nigeria from 1988 – 2010, by applying the vector Auto-regression approach. The choice of this period is to enable us focus strictly on the era of market-based monetary regime in Nigeria. The results confirm a negative effect of money supply on interest rates. This result relies on the liquidity frame theory. While, fiscal deficits indicated a positive relation with interest rate.
The granger causality indicated a bilateral relation between money supply and interest rate. It is recommended that for government to stimulate investment for economic growth, they should reduce interest rate by expanding money supply. The government should also discourage unnecessary spending to bring down interest rate. Moreover, where deficit financing is inevitable, it should be put into productive activities in order to create more employment opportunities, raise national output, and increase the living standard of the people.
TABLE OF CONTENTS
Declaration ———————————————————————————— ii
Certification ———————————————————————————– iii
Dedication ————————————————————————————- iv
Acknowledgement ————————————————————————— v
Abstract —————————————————————————————-vii
List of figures ———————————————————————————viii
List of tables ———————————————————————————–ix
List of Appendices —————————————————————————-x
Table of contents —————————————————————————–xi
CHAPTER ONE
1.1 Introduction ————————————————————————————- 1
1.2 Statement of the Problem ——————————————————————— 2
1.3 Research Questions —————————————————————————- 3
1.4 Objectives of the Study ———————————————————————— 3
1.5 Hypothesis Testing —————————————————————————– 3
1.6 Justification for the Study ——————————————————————— 3
1.7 Scope and Limitation of the Study ———————————————————– 5
1.8 Organisation of the Study ——————————————————————— 5
CHAPTER TWO
2.0 Literature Review —————————————————————————— 6
2.1 Concept Definition —————————————————————————– 6
2.2 Theoretical Frameworks ———————————————————————– 6
2.2.1 The Quantity Theory of Money ———————————————————— 7
2.2.2 Theories of Interest Rate ——————————————————————– 9
2.2.3 Liquidity Trap ——————————————————————————- 10
2.2.4 Money Supply ——————————————————————————- 11
2.2.5 The Determinants of the Level of Interest Rates ————————————— 13
2.2.6 How the Central Bank of Nigeria influences Interest Rate ————————— 15
2.2.7 Money Supply and Inflation ————————————————————– 19
2.2.8 Money Supply and Interest Rate ——————————————————— 19
2.2.9 The Liquidity Preference Framework—————————————————- 22
2.3 Monetary Policy in Nigeria —————————————————————— 23
2.3.1 Trends of Money Supply and Interest Rate in Nigeria ——————————– 27
2.4 Empirical Literatures ————————————————————————- 31
CHAPTER THREE
3.0 Research Methodology ———————————————————————– 37
3.1 Introduction ———————————————————————————— 37
3.2 Empirical Framework of the Model ——————————————————– 37
3.3 Impulse Response Function —————————————————————– 39
3.4 Variance Decomposition ——————————————————————— 40
3.5 Estimation Techniques ———————————————————————– 40
3.6 Unit Root Test ——————————————————————————— 40
3.7 The Cointegration Test ———————————————————————– 41
3.8 Granger Causality Test ———————————————————————– 42
CHAPTER FOUR
4.0 Presentation, Analysis and Interpretation of Results ————————————- 44
4.1 Unit Root Test Result————————————————————————- 44
4.2 Cointegration Test Result——————————————————————– 46
4.3 Vector Auto-Regression Estimation ——————————————————– 47
4.4 Estimated Effects of Money Supply on Interest Rate ———————————— 48
4.5 Variance Decomposition Results ———————————————————– 50
4.6 VAR Granger Causality Test —————————————————————- 51
CHAPTER FIVE
5.0 Summary, Conclusion and Recommendation ——————————————— 52
References —————————————————————————————— 55
Appendices —————————————————————————————– 60
INTRODUCTION
The ultimate effect of money on the real economy has always been of great concern to economists and monetary policymakers. The Classical and New Classical Economics, namely the traditional approach proposes that money supply has no significant effect on interest rates. This approach completely relies on The Quantity Theory of Money and assumes a dichotomy between monetary and real sectors, known as classical dichotomy.
Its main hypothesis is that the real money demand of people is fixed, so that there is a direct relation between money supply (Ms) and price level (P). (Mishkin-1989). A change in money supply induces price level to change through the same direction and by the same proportion. The traditional approach hypothesizes that the interest rate is determined in the real sector by investment demands and loanable funds.
The causality is from quantity of investment demands and loanable funds to interest rates. Thus, this framework excludes interest rates from monetary analysis. But the Liquidity Preference framework refuses the classical dichotomy and implicates an inverse relation between money supply and interest rates. The Keynesian economics implicates an indirect relation between money supply and price level.
This indirect relation is determined by interest rates and unemployment. However, Monetarists argue that the liquidity effect is not the ‘whole story’ (Mishkin-1989/129): Money supply will have other effects on the economy that may make interest rates rise, such as income effect, price level effect and expected inflation effect. Whether monetary authorities could or not affect interest rates by determining money supply variables depends on these factors.
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StudentsandScholarship Team.
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