The Effects of Nigeria Monetary and Firm Policies on Commercial Banks

 The Effects of Nigeria Monetary and Firm Policies on Commercial Banks

To be concise and explicit, the review in this study would be in this following order.

  1. An insight of the monetary, fiscal and other financial sector policies
  2. Monetary and fiscal polices
  3. Central bank and the Central of money
  4. The traditional theory of monetary policy

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  5. How monetary policy influence economic activities
  6. How monetary policy works to control spending
  7. Control of commercial banks by the central bank
  8. Fiscal policy – types
  9. Fiscal policy as a built stabilizer
  10. Fiscal policy and its economic influence
  11. Fiscal policy in practice
  12. The fiscal monetary mix
  13. Summary of related literature


An Insight of Monetary, Fiscal and Other Financial Sector Policies

According to Ojoh (2003:43) Nigeria economy

experienced a macro-economic stability between 1995 – 1997 this was a contract to the expansionary and unstable policy regimes of the 1998 – 2000.  remarkable success have been achieved in achieving the ultimate objectives of economics policy during the two years.  Inflation rate decelerated from an all time peak of 72.8% in 1998 to a single digit in 1997 and was not more than 9.0% in 1999.

The huge deficit in this balance of payment have substantially reduced.  External sector was strengthened and exchange rate stability was maintained.

The GDP rate grew to about 5.5%.  there was not more than 32.0% in aggregate bank credit to this domestic economy etc.

Naiyeju (1993:34), prior to 1999, particularly up to 1998, the economy was characterized by a number of socio-economic problem, notably high inflation rate, over dependency on a single economic product- oil, wreath industrial base and under capacity utilization to mention but a few.  In order to appreciate the specific and magnitude of the fiscal measures in 1999.

Monetary and Fiscal Policies

Definition: recording to Okeke (1985:143) monetary policy

is the control the activities of the commercial banks, while he sees fiscal policy as the aspect of the government policy dealing with obtaining taxation and deciding on how the revenue for government use mostly through taxation and deciding on how the revenue will be utilized.  It is concerned with the management of the nations economy by the government by varying the size and content of taxation and public expenditure.  This done with much regard to their impact on public debt.

Agu (1990:98) views fiscal policy as being concerned with the raising of government revenue through taxation and other means, and its expenditure.

According to Ejui (1991:134) monetary policy is the government instrument of financial administration and control. It is an instrument which attempts to influence the economy though the use of money supply and interest rate.  This government uses the policy stabilizer which the government was to direct and control economic activities.  It is a policy which uses the budget and taxation to influence aggregate demand and supply in the economy.  For instance, a down turn in economic activities can be revitalized through an increase in government expenditure and a  decrease in taxation.  The policy is also in use when the government decreases its expenditure and increases the rate of taxation.  So as to control inflationary trends in an economy.

According to CBN Brief (1996:1) monetary policy in general refers to the combination of design measures to regulate the value, supply and cost of money in an economy, in consumers with expected level of economic activities.  An excess supply of money will result in an access demand for goods and services which would cause rising price and or a decoration of the balance of payments position.

On the other hand, inadequate supply of money could be induce stagnation in the economy were by recording growth and development.  Consequently, the monetary authority must attempt to keep the money supply growing it an appropriate rate to ensure sustainable economic growth and maintain internal and external stability.  This discretionary control of the money stock by this monetary authority this involves the expansion and contraction of money, influence interest rate to make money cheaper or more expensive depending on the prevailing economic condition and thirst of policy are basically to control inflation, maintain a healing balance of payments position in order to safeguard  and sustainable level of economic growth and development.

According to Samulson (1978:298) every central bank has came prime function.  It operates to control this supply of high power reserves and thereby to control this economy supply of money and credit. Money won’t control itself.  If demand spending is excessive so that prices are being bid up in an inflation, this federal reserve board will want to clamp down on money supply’s growth.  If employment is high, the government would want to expend the money supply’s growth rate the central bank’s target as price stability and optioned real growth. It’s stubborn enemy is stagflation.

Fiscal policy expenditure in co-operation with stabilizing monetary policies, have for their goal a high employment and growing economy, but one without a demand pull inflation.

The fiscal and monetary authorities “loan against the economic winds that will be prevailing” thereby helping provide a favorable economic environment which they can have the widest opportunity for achievement.

Orjih (1997:69) says that the major function of money is its use as a medium of exchange, with this and other important functions, the supply and value of money becomes a very important factor in a nation’s economy.  It can influence the level of production and the distribution of creational income.

Another main function of the government is the stabilization of the economy through fiscal policy, it involves the rise of government spending, that is budgeting and taxation in the regulation of money supply.  By this, the budget has become an instrument of economy policy.

Central Bank and the Control of Money

Okabi (1979:100) writes that the part of the primary

function of the central bank often contain in the statue books, is its responsibility to ensure monetary stability.  This is often constructed to practical terms to include the controlling of monetary aggregates, mainly the stock of money.  In interventional justification assigning this role to a central bank was often been based on a purported theory of money which requires that its supply be determine independently of the demand for it.

Johnson (1981:92) very little explicit acknowledgement may be made of fact that the simplifying assumptions which often underlies abstractions from reality.

Under the topic of discussion, effort will be made to point out the major but falls in the scheme of thought which reactively assigns the control of stock of money to the monetary authority, effort will also be made to provide experience of Nigeria in recent years.

A central argument in this submission is that this traditional roles of a central bank is at test on up hill task if not actually achievable only by a fluence this is especially so in the circumstance of economic and social under development in which the parameters of the system are little known, especially where public deficit is significant.  This discussion here is done in three phases.

Firstly, the traditional theory is summarized and examined, notably, a realistic modification of the scheme of though is discussed.


Traditional Theory of Monetary Policy

Most economic model treat money supply as a policy

variable that is, fixed unless changed by the government policy. Sometimes, the impression is created as if this changing of the level of money supply is analogues to the changing of a year models actually abstract from a range of behavioural relationships which exist on the real world.

Fro example, a simple presentation of this traditional theory of money typilary relates growth in the stock of money, on to change in given high powered money.


The relationship are defined as:

M      =       CM + (1 – c)m

A       =       CM + r (1 – c)m

Where C is the ratio of money held by the public to the quantity of money and r is the ratio of reserves to deposited of commercial banks. From the above relationship, a money multiplier, M is derived as

M      =       M/H = 1/C + r (1 – c).

The above equation explain the effect of changes in it or M through the process of credit multiplication by the banks which operations on fractional reserve principle.  This principle actors in this simple model are the commercial banks their capacities are circumscribed by both the private sectors preference for currency deposit mix and the monetary authorities control of the reserve/deposit ratio, these are given by the parameters or respectively.

This simple money multiplier model assumes that the bank stays leaned up thus abstracting from the degree of freedom which they have hold excess reserves or to borrow through the discount window in response to persevered trends in financial conditions if this behaviour of the commercial bank is realistically taken unto account and if one takes the interest rate as an indicator or financial condition in a free market, then money supply will become responsive to the level prevailing interest rate thus qualifying the assumptions of the exigency of money supply.

Tegen C. (1965:55) in this approach to the measurement of the interest rate elasticity of money divides the stock of money into two components, one mainly determine by the monetary authorities and the other by the banks.

Even if one does not accept a strike economy between these components, on the argument of interaction through the public preference for currency which can be influenced by the monetary authorities open market operation this approach dimos attention to the fact but the control of money supply usually involves much more than a mechanical “fixing” of the level of high powered money by the central authorities.

It is plausible to argue that, because high powered money in many countries usually is made of monetary liabilities of the central bank currency in circulation and bank deposit.  It would appear that control of stock of money through adjustments in the central bank’s portfolio should be easy, especially as the currency, deposit and reserve, Cayer (1965:50) therefore central bank, has argued that this assumption of a given level of high-powered money obstruction from the main operation problem facing the authorities in achieving any desires level for this monetary base.

Lipsey Richard G., says that at its simplest level traditional view of monetary policy consist in manipulating nominal money supply so as to shift the C. curve and thus to shift the aggregate demand curve the nominal quality of money and aggregate demand being positively associated with each occur, centers paribus.

An important variable in the monetary abase equation is the public sector deficit (PSD) which the monetary authorities must accept as given, as it result from fiscal operation.  The PSD is given as

PSD  =       OMO + NMO + ECE + DH

In typical flow of funds, analytical frame work in which the sum of all the financial sumplasses and deficits of all the institution sectors as equal to zero of funds from other sectors necessary constraints the monetary authorities management of their financial liabilities form their balance sheet point of view change in thigh powered money is given as:

Dh = PSD – OMO – NMD + MAT = ECF(s)

The PSD, apart from being the function of current fiscal measures, is not unreacted to past budget decision with the result that its effects on monetary flows cannot be intravenous between the need to actor the level of monetary base in response to monetary flows requirements and the frequency of budgetary decision.

A rather disturbing phenomenon from the point of view of controlling the money supply, is that foreign capital flows and non marketable debt tends to respond perversely to interest rate change.  Thus, of high interest rates, the increase the monetary base. In addition there could be some decline in the bank’s excess reserve ratio as interest rates on earning assets rise relatively to rates on reserves.

Against the background of change constraints, the monetary authorities will have to seek to achieve this hopefully, money supply by trying to off exogenous variable through open market operations.

How Monetary Policy Works to Control Spending

There are five steps by which banking authorities effect the

general spending o commercial banks or member banks. These banks must have reserve to support their assets ad deposit.

  • The first step of the fed, therefore, when it wants to put on economy brakes as to act to cut down on the reserves available to the commercial banks.
  • Each naira contraction in the bank reserves forces about N10 contraction in total bank money i.e. in total demand deposits.
  • The contraction in total money tends at first to make credit severally “tight” but is both clear and less available.
  • With credit expensive and hard to get and with wealth of people and firms down, private and public investment will lend to fall why do and the schedule shift towards? It come because people’s decision as to whether it is profitable to built a new hence or hold more investment spending if a high interest rate is involved, they often scale down their investment plan.
  • The same holds for stated and local government.
  • Finally, the present on credit and on investment spending will through, the down ward shift in the  1 + G schedule have down ward effect on income spending prices and jobs.

How Does Monetary Policy Influence Economic Activities

There are various views among economists to the exact mechanism by which monetary policy affects the economy.  Nevertheless, liquidity, interest rates, credit and exchange rate channels have been generally accepted as avenues for the influence of monetary policy under the liquidity channel of monetary transmission. Change in money supply, initiated by the various techniques of monetary policy, influence interest rates (short and long term) in this way, the initial monetary impulse is transmitted to economic activities (consumption, investment etc. though are effects of change in interest rates on cost of capital.  The credit channel work mainly by portfolio adjustments in banks, hence hold and firms balance sheet in favour of assets that have higher returns during period of monetary fluctuation.  Under normal circumstance, assets of higher demand would be produced more and hence economy stimulates.  A special case of bank loan on which credit squeeze forces banks to ratio customer who depends on banks loan, will crowed the loan market;

consequently, economic activities would be curtailed.  Basically, the excrescence of interest and exchange rate differentives, resulting from monetary policy measures induce substitution domestic and foreign assets (foreign currencies, bonds, records) as well as domestic and foreign goods and services.  Their various channel to not work in isolation but when enforce on another in promoting the objective of monetary policy.

Control of Commercial Banks by the Policy

There are various mechanism which the Central Bank employ in order to carry out its monetary policy and thus be able to regulate and control the supply of money.  The services are instruments of control of the Commercial Bank that force that to dance to the time of the central bank so that the objective of economic stability can be achieved, the weapons aim as follows:

(1)     Open Market Operation:       The Central Bank controls.  The activities of the commercial banks through the open market operations.  This involves the central bank in the money market.  If the objectives as to control the money in circulation, the central bank sells the government securities (bills and bond) to the commercial bank this will invariably reduce their capacity to give loan and expand credit.

On the other hand, if the central bank wishes to expand the supply of money it buys security form the market.  The payment to the bills and bonds will increase the quality of money available for the commercial banks.  Uncurbed increasing over capacity to give loan and expand create this will increase the volume of money in circulation.

(II)    Open market Operation Measures in 1999 and 2001

          In 1999 and 2001, open market operation was concluded mainly in government securities open market operation was equally conducted in secondary market for creasing bills and complemented by the use of reserve requirement and discount window.  Operation including repurchase agreements (report).  This report was extended to not only commercial but merchant banks.  The discount houses act as the principal dealers in the conduct of Omo intervention by the CBN in co-operation with banks and own market participants.

(III)   Interest rate ceiling:      The regulation of interest rate through their instruments is a regular feature in government monetary policies.  How and, government can also regulate interest rate by directly imposing ceiling on the interest rates which commercial banks can pay or various deposit in order to regulate their amount of money in circulation.

In 1999 and 2000, the administrative control on interest rate was removed.  The CBN has continued to influence interest rate through intervention with market instruments.  Meanwhile, the minimum rediscount rate IRR, was maintained at 13-5% and treasury bill rate retained at 12.0% for tune to time in time with preventing monetary condition.

(IV)   Reserve Requirement:  Reserve requirement is an instrument used by the central bank whereby the commercial banks are required to maintain a percentage of over deposit in grantly in the form of cash in hand.  It is a very powerfully policy instrument.

In practice, the CBN can change reserve requirement if it wants to change financial conditions.  By rasing the case reserve, the CBN can make money right work on the reversal, credit can be made ease. Reserve requirement, house cash reserve and liquiding ratio.

In 1999 and 2000, commercial banks were made to observed that cash reserve requirements of 8.0% while the cash ratio shall remain at its 1998 level.

Liquiditng ratio is defined as the ratio of liquiding reserve to total deposit liabilities.  The gratutory liquidity ratio for both years are fixed at 30%.

(V)    Discount Rate:     The use of discount rate is also a major features of monetary policy when the discount rate raised, borrowing becomes more expensive and demand for loan will be reduced.  This is a deflationary measure as it will bring down the purchasing power of the people and leading to fall in price.  An increase in discount rates checks outflows of foreign found.  A reduction of discount rate produces the reverse.

(VI)   Special Deposit:   The government equally requires the commercial banks to deposit with the central bank of Nigeria.  An increase or decrease in special deposits will produce the same effect as reserve requirements.

(VII)  Moral Session:     Here the central banks instruction is optimal to the commercial banks.  The apex bank may such instruction on certain issues but the commercial banks are not legally bound to follow the instruction.

In 1999 and 2000, the CBN continued to engage in moral session through regular dialogue with commercial banks in order to enhance the efficiency of the financial system

(VIII)          Special Directors:          The CBN equal exercise control over the commercial banks by giving them directive on certain issues the apex bank may advice than to give credit facilities for agricultural and industrial development purposes.  In some cases, it gives them direct instruction with regards to the volume of loan which they can give and the sector of the economic which receive the loan.

Fiscal Policy Types

Basically were two types of fiscal policies namely:

i.        Expansionary fiscal policy:   In order to immolate recovery from an economic recession government can either reduce or increase its expenditure.  This will basically increase the amount money in circulation.

ii.       Concretionary fiscal policy:   This involves the use of budgeting to check inflation of advise balancing of payment in order to achieve budget sum plus, government can decrease its expenditures.

However, care must be taken in apply this instrument because it could sometimes produce negative effectives.

Fiscal Policy as A Built In Stabilizer

          Fiscal policy has a great inherent automatic stabilizing properties.  Whether the resident is there or not, fiscal policy helps to stabilize the economy these mysterious stabilizers are:

i.        Automatic changes in the receipts:  It means that as soon as income begins to full of and even before tax authority makes and changes in tax, the receipts of the government also fall off.  Unemployment compensation and other welfare transfers:

In the developing countries in the years back, if employees are laid off, they begin to receive payments from unemployment ceases.  Tax collected to finance unemployment compensation rise when employment as high.  During boom years, unemployment reserve fund grants and exerts stabilizing pressure against much spending while the reserve fund is use to pay out income if employment stocks.  Other welfare programmes public service employment and family relief payments shows a stabilizing behaviour.

ii.       Operative savings and family savings:     Not all the appraises go to the governments our private institution also have a built in stabilizer.

Fiscal Policy and Its Economic Influence:

The fiscal policies applied in recent year have been yielding positive results the port reform, the deliberate tax regime adopted and sluft of emphasis in taxation from high income tax to the consumption tax of VAT have led to positive results in terms of revenuer to government.  All the laws inputting the economic liberalization and opening up the entire economy for investment opportunities have been reviewed. The tax laws as well as custom and exercise duties/tariffs an constantly reviewed to align them with economic growth.

Fiscal Policy in Practice

Keynesian economic in general and fiscal policy in particular has recently come under very severe criticism. It is not uncommon to hear it said that the Keynesian model is totally misleading.  Suffice to say that the view that the basic theory of income determination is misguided is difficult to sustain.  The circular flow of income concept long bredutes keyness almost every econometric model in existence today uses it.

The Fiscal Monetary Mix

           The fiscal monetary mix is the mixture of both fiscal and monetary policies to achieve the desired aim of economic jubilization of GBP.  This is done by verify the mixture taxes spending and monetary supply in which case, government can change the fraction of pollution output devoted to investment, consumption and government purchases.

Care should be taken to lean against prevailing economic wine. This implies that the prevailing economic situation should be studied critically and the trend will understood before any policy is adopted.

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