ABSTRACT
This
study examines the determinants of the broad money demand and its stability in
Nigeria over the quarterly period 1991:Q1 to 2014:Q4. Most studies on the determinants
and stability of the money demand function have been focused on the advanced
economies. Only a few empirical studies are focused on the demand for money in
Nigeria, differing by time period, monetary aggregate, data frequency and model
specification. The specific objectives were to: (i) evaluate how income, interest rate,
inflation rate, exchange rate and foreign interest rate affect the quantity of
money demand in Nigeria, (ii) examine the money demand function and to
understand its long-run cointegrating relationship with the selected
macroeconomic variables and (iii) study the short-run dynamics of the money
demand function in Nigeria so as to incorporate both short-term deviations and
long-run expectations. The research utilizes secondary data sourced from the
Central Bank of Nigeria’s statistical bulletin and the International Monetary
Fund’s world economic outlook database and employs the ordinary least square
regression technique, the autoregressive distributed lag modeling to cointegration
and the error correction model in order to ascertain whether monetary targeting
is still relevant in setting monetary policy framework in Nigeria. The findings
of the study reveal that real income, domestic interest rate, inflation rate,
exchange rate and foreign interest rate have a predictable impact on the
quantity of money demand in Nigeria. Real income and exchange rate are
positively related to the real broad money balances while domestic interest
rate, inflation rate and foreign interest rate are inversely related to the
demand for broad money. Also, the results indicate that a long-run relationship
exists between the real broad money aggregate and its determinants.
Furthermore, both the CUSUM and CUSUMSQ tests confirm that the short-run and
long-run parameters of the real money demand function are robust and exhibit
parameter constancy. The remarkable stability of the money demand function
provides validity for the monetary authorities to target the broad money supply
in its effort to achieve price and financial system stability in Nigeria.
Keywords:
Broad money demand, autoregressive distributed lag, monetary policy, stability.
TABLE OF CONTENTS
Title i
Certification ii
Approval iii
Dedication iv
Acknowledgements v
Abstract vi
Table of Contents vii
List of Tables viii
List of Figures ix
CHAPTER ONE:
INTRODUCTION
- Background to the Study 1
- Statement of the Research Problem 2
- Objectives of the Study 4
- Research Questions 4
- Hypotheses of the Study 4
- Scope of the Research 4
- Significance of the Study 5
- Operational Definition of Terms
References
CHAPTER TWO: REVIEW OF
RELATED LITERATURE
2.1 Conceptual Framework 6
2.1.1 Variables in the Money Demand Function 6
2.2 Theoretical Review 8
2.2.1 Quantity Theory of Money 8
2.2.2 Keynes’s Liquidity Preference Theory 10
2.2.3 Further Developments in the Keynesian Approach 12
2.2.4 Friedman’s Modern Quantity Theory of Money 13
2.2.5 Distinction between the Friedman and Keynesian Theories 14
2.3 Empirical Review 15
2.3.1 Review of International Empirical Studies 15
2.3.2 Review of National Empirical Studies 20
2. 4 Summary of Empirical Review 25
2.5 Knowledge Gap 38
2.6 Conceptual Model 41
References
CHAPTER THREE:
METHODOLOGY
3.1 Research Design 39
3.2 Sampling Technique 39
3.3 Specification of Models 39
3.4 Nature and Sources of Data 44
3.5 Techniques of Analysis 44
References
CHAPTER FOUR: DATA
PRESENTATION AND ANALYSIS
4.1. 1 Multicollinearity Test 46
- Heteroskedasticity Test 47
4.1.4 Stationarity Test 48
- Test of Hypothesis 49
- Interpretation of Findings 59
CHAPTER FIVE: SUMMARY
OF FINDINGS, CONCLUSION AND RECOMMENDATIONS
5.1 Summary of Findings 63
5.2 Conclusion 63
5.3 Recommendations 64
5.4 Contribution to Knowledge 74
5.5 Suggestion for Further Research 64
Bibliography 65
Appendices
LIST
OF TABLES
Table 1.1: Review of International Empirical Studies 25
Table 1.2: Review of National Empirical Studies 32
Table 4.1: Correlation Matrix 46
Table 4.2: Heteroskedasticity Test for the first hypothesis 47
Table 4.3: Autocorrelation Test for the first hypothesis 47
Table 4.4 ADF Unit Root Test from M2 demand function 48
Table 4.5 Regression result of hypothesis one 50
Table 4.6: Wald Test for cointegration 52
Table 4.7: Error Correction Model result 54
Table 4.8: Lag selection result 57
LIST
OF FIGURES
Figure 2.1: Diagramatic Structure of the Determinants and Stability of Demand for Money in Nigeria 41
Figure 4.1: Plot of cumulative sum of recursive residuals 58
Figure 4.2: Plot of cumulative sum of squares of recursive residuals 59
CHAPTER
ONE
INTRODUCTION
1.1 Background to the Study
A
sound monetary policy formulation presupposes theoretically coherent and
empirically robust model of money demand. To monetary authorities, the
stability of the money demand function is necessary for understanding how the
formulation and implementation of an effective monetary policy is crucial in
offsetting the fluctuations that may arise from the real sector of the economy.
If the relationship between the demand for money and its determinants shift
around unpredictably, the central bank loses the ability to derive results from
the implementation of its policies. In such a case, variations in the money
demand function is an independent source of disturbance to the economy.
(Bhatta, 2013,p.1).
The
identification of a stable relationship between the demand for money and its
determinants provides empirical evidence that monetary targeting is an appropriate framework
for economic stabilization policy (Rutayisire [as cited in Bhatta, 2013, p.1).
Monetary targeting is an attempt by central banks to describe or determine the
optimum money stock that will yield the desired macroeconomic objectives.
Theoretically, the choice of target is normally between the stock of monetary
aggregates and interest rates. Poole; and McCallum (as cited in Owoye and
Onafowara, 2007, p.1) expressed that whenever the money demand function is unstable,
interest rate is generally the preferred target, otherwise, the money stock
remains the appropriate target.
The
primary objective of the Central Bank of Nigeria (CBN), in its conduct of
monetary policy, is to maintain a stable price level that supports sustainable
economic growth and employment (Owoye and Onafowora, 2007,p.1). The CBN has
relied on setting predetermined growth rates for the broad money (M2) as a tool
for achieving price stability. This is based on the belief that inflation
cannot be sustained over the long-term, if it is not accommodated by excessive
growth in money supply (Doguwa, Olowofeso, Uyaebo, Adamu and Bada, 2014, p.16).
In the conduct and implementation of monetary policy, the assumption that the
money demand function is stable is very important, because, the money demand
function is used both as a means of identifying medium term growth targets for
money supply and as a way of manipulating the interest rate and reserve money
for the purpose of controlling both the inflation rate and the total liquidity
in the economy (Owoye and Onafowora, 2007, p.1).
Given
the importance attached to money demand in the success or failure of monetary
policy, it is not surprising that the demand for money is one of the most
controversial and heavily researched areas in macroeconomics. If the central
bank relies on control of monetary aggregates as its policy instruments,
Cameron (as cited in Bhatta, 2013), states that:
it must believe in a known and reliable connection between changes in that
aggregate and changes in the arguments of the money demand function in order
for its policy to have predictable effects on those arguments. If instead the
central bank relies on interest rates as targets and adjusts the monetary
aggregate through daily reserve management to whatever level is required to hit
them, instability of the demand for money could make the required reserve
changes both large and unpredictable. In such a case, disorderly financial
markets might well result. (p.2).
Laumas and Mehru (as cited in Ogunsakin and Awe, 2014, p.2) stipulated that the stability of money demand is crucial for the understanding of the monetary policy transmission mechanism. It is crucial because a stable money demand function means that the quantity of money is predictably related to a set of key variables that link money to the real sector of the economy. A stable money demand function always require appropriate instruments and intermediate targets of monetary policy. It enables a policy driven change in monetary aggregates so that the desired values of targeted macroeconomic variables such as fiscal policy, exchange rate, stock market, consumption expenditure, savings and investments, imports, exports, inflation and interest rates are ensured (Sober, 2013, p.32). Therefore, it is important to have knowledge of the determinants of money demand in order to ensure a stable relationship exists between these determinants and the money stock.
DETERMINANTS OF DEMAND FOR MONEY AND ITS STABILITY IN NIGERIA (1991-2014)
