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PROJECT TOPIC- MONEY DEMAND FUNCTION IN NIGERIA

PROJECT TOPIC- MONEY DEMAND FUNCTION IN NIGERIA

CHAPTER ONE

INTRODUCTION

  • 1 Background to the study

There is no gain saying the fact that a well specified money demand function is of great essence in the conduct of monetary policy. Goldfield (1994) asserts that a very important building block in macroeconomics is the relationship between demand for money and its determinants; hence it forms an important component in conducting monetary policy. Both developed and developing countries have paid utmost attention to money demand analysis, as it remains one of the central issues in macroeconomic literature which have attracted great attention. Money demand and its determinant have therefore formed the bases for macro-economic theory formulation and implementation.

It has performed very significant roles in the days of old, it’s still playing it now and it will continue to play it in years to come. Both developed and developing countries affirm that increase in national output (GDP) or what can be referred as economic growth cannot be possible without money (Abiola and Egbuwalo, 2012). Without money, nations of the world cannot achieve significant growth in national output.

Money demand function is therefore a measure of identification both as medium term growth for money supply and as a means of manipulating interest rate as well as reserve money with the aim of controlling total cash in the economy (money supply) and also in inflation control. Central bank of Nigeria (CBN) depends on the demand for money function in her implementations of monetary policies based on the assumption of stability in long run equilibrium relationship between money, real output, price level and other macroeconomic variables.

The importance attached to money demand has attracted the interest of a wide range of economists in the empirical determination of the determinants and stability of demand for money in Nigeria and other countries of the world. In transition economies, very few studies have been conducted with regards to demand for money function. In fact, Payne (2003) holds that the lack/inadequacy of empirical investigation of demand in transition countries is attributable partly to reliability, frequency and relative instability of time series data in those economies.  In the word of Essien, Onwioduokit and Osho (1996), a study of money demand is important given the fact that an efficient monetary policy framework depends on a stable money demand function and is essential for understanding of the behavior of important macroeconomic variables in the economy.

The study of demand for money raises the question on why individuals do prefers to hold cash instead of investing it. In the bid towards providing an answer to this question, the interest of various economists have been attracted ranging from Irving Fisher in the early 1900, Lord Maynard Keynes in the early 1936, Williams Baumol, James Tobin to Milton Friedman among others.

Keynes (1936) in his general theory of employment, interest and money introduced the liquidity preference concept which ushered in the development of modern macroeconomic theory, hence leading to development of the demand for money theory. In his word, individuals demand for money for three main reasons which are precautionary, transactionary or speculative motive. In Keynes tradition, according to Mai-Lafia (2002), money demand function was developed as if there were two aspects of money demanded separately. This stems from the disaggregation of money demand motives into transactionary, precautionary and speculative motives such that demand for money for both transactionary and precautionary motives depends on income while demand for money for speculative purposes depends on the prevailing rate of interest.

Many policies of Central Banks of most developing countries aimed at ensuring liberalization and deregulation of the economy beginning from the 1980s have shifted between economic tools of money, swapping policies that directly affect money supply with ones affecting bank rates. Case studies from a pool of developed countries indicate that financial reforms are the causes of money demand instability and hence prescribed interest rate targeting by the Central banks as a measure of stabilizing money demand (Maki and Kitasaka, 2006; Caporala and Gil-alana, 2006).

This same policy has been adopted by Central banks in various developing countries on the assumption that financial market reforms and liberalization have been the major contributors of instability of money demand functions in their home countries.  However, doubts have been raised through empirical studies with regards to the validity and strength of Apex banks’ policy of interest rate targeting and how it affects money demand function (Bahmani-oskooe and Rehman, 2005).

Given that it has been established that interest rate targeting as an instrument of monetary policy may lead to stability in money demand as opposed to financial market liberalization previously upheld by developed countries prior to the recent economic crises (meltdown), it becomes necessary to carry out a test of stability on demand for money function in less developed countries, for instance Nigeria.

However, few empirical studies have been carried out in Nigeria especially since the adoption of structural adjustment programme (SAP) in the late 1980s (Owoye and Onofoora, 2007). Among these studies, numerous variables were modeled of which most of them found a stable demand for money in Nigeria. However, in the course of their submission, none of them attempted to open up the Nigerian economy.

According to Carpenter and Lange (2002), anxiety over the stability of money demand function has led to continuous and unabated search for it and this has been compounded by the recent break-down hitherto stable relationships which gave rise to re-specification and remodeling of money demand function during the war period. The earliest attempt at investigating the money demand function stability and determinants as well can be traced to the study in 1972 by Tomori (Sani, Olorunsola, Uyabo and Abiodun, 2014).

The findings from his study led to the controversial debate known as “tattoo debate” (Sani et al, 2014).  According to Cziraky and Gilman (2006), stability of money demand function ensures better and more accurate prediction of how monetary policy affects macroeconomic targets like interest rate, productivity and price stability and hence brings about a reduction in the likelihood of inflation bias. Therefore, money stability entails that given a small set of variables which connects the monetary sector with the real sector in the economy, it is possible to make prediction on available quantity of money.

In the course of this study, further empirical evidence on money demand is provided by modeling broad money demand against income, interest rate and inflation in Nigeria between 1980 and 2014.

PROJECT TOPIC- MONEY DEMAND FUNCTION IN NIGERIA

1.2 Statement of the Problem

Enormous academic interests have been drawn as regards money demand level and stability based on the assumption that a good knowledge of causes and effects of money demand instability can be very useful in monetary policy formulation. Carpenter and Lange (2002) cited in Aiyedogbon, Ibeh Edafe and Ohwofasa (2013) holds the view that a stable money demand function has attracted wide attention because it is very useful in the explanation and prediction of the behavior of other segments of the aggregate economy.

They went further to opine that demand for money depends on scale variables such as nominal gross domestic products, and the cost of holding money in its liquid form (interest rate). According to them, if it could be easy to know the interest elasticity of money as well as the income elasticity of money together with their stability status, then it would be easy to predict nominal output observed at a lower frequency from the observation of money data observed from a higher frequency while both of these conditions are important, they uphold that the second is most important.

The structural adjustment programme (SAP) was instituted in Nigeria in the late 1980s with the objective of reducing drastically Nigeria’s foreign debt and setting the overall economy on the right growth path, a policy which was sadly jettisoned in 1988. Such structural changes in the political economy of the country had significance impact in a wide range of economic relationship, some which includes high rate of inflation, high rate of unemployment and reduced productivity coupled with high rate of interest.

It is noteworthy that interest rate has been on the increasing path currently and as a result both medium and small scale enterprises are finding it difficult to access loan from financial institutions thereby bringing about decline in economic activities in the face of rising prices. This has led to the closure of many businesses and underutilization of capacity to mention but a few.  These challenges are attributable to poor monetary policy management, recklessness on the part of one leaders coupled with large scale corruption in existence in the country.

The distance between policy formulation and policy implementation has equally been on the increase while transparency and accountability in the use of public resources have been lacking. There are equally serious resource constraints and uncertainties as well as policy implementation delay. These problems have made the prediction and targeting of demand for money very hard for the monetary authorities in Nigeria. Similarly, governments’ imprudence with regards to fiscal policy has equally resulted in unguided deficit financing giving rise to inflation which contradicts one of the major macroeconomic objective of price stability. All these are potential destabilizes of macroeconomic productivity and development making it difficult to conduct monetary and fiscal policies in a regulated environment.

The major problem of money demand in Nigeria is therefore the problem of persistent inflationary pressure, unemployment, increased money reserve ratio and interest rate in spite of monetary policy me assures adopted and applied over the years. There is equally the problem of general feeling that a continuous decrease in rate of interest will have adverse consequence on demand for money which will lead to inflation, denying the intended benefit of monetary policy use. It is therefore important to carry out an investigation on the stability of money demand function since it will enable policy makers select and adopt the correct monetary policy instruments in the pursuit of various macroeconomic goals.

  • 2 Research Questions

In the course of this work, the following questions will provide a lead:

  • 1) Does Keynes liquidity preference theory hold in Nigeria?
  • 2) Is the demand for money stable in Nigeria?

1.4 Research Objectives

The central objective of this research is the examination of money demand function in Nigeria. However, the following specific objectives would equally be achieved:

  • 1) To determine whether Keynes liquidity preference theory hold in Nigeria.
  • 2) To determine whether there is stability money demand function in Nigeria.

1.5 Research Hypotheses

PROJECT TOPIC- MONEY DEMAND FUNCTION IN NIGERIA

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