Monetary Policy Strategy

2.1 INTRODUCTION
This chapter is a review of the concepts that make up the subject matter of the study. It reviews the work of authors on monetary policy strategy and economic development. It gives overview of all monetary tools used by the Central Bank of Nigeria.

2.2 CONCEPTUAL CLARIFICATION
Monetary Policy
The Central Bank of Nigeria defined monetary policy (MP) as specific actions taken by the Monetary Authority (CBN) to regulate the value, supply and cost of money in the economy with a view of achieving predetermined macroeconomics goals. The Decree 25 of 1991 CBN Act empowered it to formulate and implement monetary policy with consultation with the federal ministry of finance. This role has enhance the emergence of money market where treasury bills, a financial instrument used in open market operations and raising funds for government has grown in volume and value becoming a prominent earning asset for investors and source of balancing liquidity in the economy. There are varying policies of monetary policy in Nigeria. Sometimes, monetary policy is tight and other times it is loose. Monetary Policy is mostly used to stabilize prices.
Aaogu (1998) sees monetary policy as actions by monetary authorities to influence the national economic objectives by controlling or influencing the quantity and direction of money supply, credit and the cost of credit. This according to him is aimed at ensuring adequate supply of money to support financial accommodation for growth and development programmes for sustainable growth and development on one hand and stabilizing various sectors of the economy for sustainable growth and development on the other.
The root of monetary policy is the work of Irvin Fisher (Diamond, 2003) who lays the foundation of quantity theory of money through his equation of exchange. He states that money has no effect on economic aggregate but price. However, (Nouri, 2011) explained further that money supply exert strong influence on economic growth and activity in both developed and developing countries. They discussed the relationship between money supply and effectiveness of monetary policy on the economy. However, Onyido (1993) reviewed that the monetary policy is applied to influence the availability and cost of credit in order to control the money supply in the economy. From the above, it can be said that monetary policy are action undertaking by the regulatory authority in a country to manage the quantity of money in circulation in order to manage economic growth, price, inflation and other variables that can influence economic values.

2.3 MONETARY POLICY FRAMEWORK IN NIGERIA
In Nigeria, the monetary department of the CBN articulates the monetary policy framework and produce draft monetary programme which is considered by the monetary policy committee. The primary goal of monetary policy in Nigeria has been the maintenance of domestic price and exchange rate stability since it is critical for the attainment of sustainable economic growth and external sector viability (Sanusi, 2002). The objectives of the monetary policy of the CBN as mandated by legal act since its inception have been: Achieving domestic price and exchange rate stability; maintenance of a favourable balance of payment; promotion of a rapid and sustainable rate of economic growth and development; development of a sound financial system.
Monetary policy refers to the combination of measures designed to regulate the value and supply of cost of money in an economy in consonance with the expected level of economic activity. One of the principal functions of the Central Bank of Nigeria (CBN) is to formulate and execute monetary policy in order to promote monetary stability and a sound financial system. The CBN carried out this responsibility on behalf of the federal government through a process outlined in the Central Bank of Nigeria decree 24, 1991, the banks and other financial institution decree 25, 1991 as amended. In formulating and executing monetary policy, the governor of the CBN is required to make proposal to the president of the Federal Republic of Nigeria who has the power to accept or amend such proposals. Thereafter the CBN is obliged to implement the monetary policy approved by the president (CBN, 1996).

The CBN is also empowered by the two enabling laws, to direct the banks and other financial institutions to carry out certain duties in pursuit of the approved monetary policy. Usually, the monetary policy to be pursued is detailed out in the form of guidelines which are generally operated within a fiscal year but the elements could be amended in the course of those particular years. Penalties are normally prescribed for non- compliance with specific provisions in the guidelines.
The aims of monetary policy are basically to control inflation, maintain a healthy balance of payments position in order to safeguard the external value of the national currency and also to promote adequate and sustainable level of economic growth and development. The objectives of monetary policy in Nigeria are wide ranging; Reduction in the rates of inflation and unemployment, improvement in the balance of payments, accumulation of financial savings and external reserves as well as stability in the Naira exchange rate. The policy as well as instruments applied to attain these objectives have until recently been far from adequate with undue reliance placed on fiscal policy rather than monetary policy in Nigeria (Darrat, 1984).
As Kogar (1995) examined the relationship between financial innovations and monetary control, he concludes that in a changing financial structure, Central Banks cannot realize efficient monetary policy without setting new procedures and instruments in the long-run, because profit seeking financial institutions change or create new instruments in order to evade regulations or respond to the economic conditions in the economy. Examining the evolution of monetary policy in Nigeria in the past four decades, Nnanna (2001) observed that though the Monetary management in Nigeria has been relatively more successful during the period of financial sector reform which is characterized by the use of indirect rather than direct monetary policy tools, yet the effectiveness of monetary policy has been undermined by the effects of fiscal dominance, political interference and the legal environment in which the Central Bank operates. (Busari et-al., 2002) state that monetary policy stabilizes the economy better under a flexible exchange rate system than a fixed exchange rate system and it stimulates growth better under a flexible rate regime but is accompanied by severe depreciation, which could destabilize the economy meaning that monetary policy would better stabilize the economy if it is used to target inflation directly than be used to directly stimulate growth. They advised that other policy measures and instruments are needed to complement monetary policy in macroeconomic stabilization.
In the same stride, (Batini, 2004) stress that in the 1980s and 1990s monetary policy was often constrained by fiscal indiscipline, Monetary policies financed large fiscal deficit which averaged 5.6 percent of annual gross domestic product (GDP) and though the situation moderated in the later part of the 1990s it was short lived. As Batini described, the monetary policy subsequently was too loose which resulted to poor inflation and exchange rates record.
(Folawewo and Osinubi, 2006) investigates how monetary policy objective of controlling inflation rate and intervention in the financing of fiscal deficits affect the variability of inflation and real exchange rate. The analysis is done using a rational expectation framework that incorporates the fiscal role of exchange rate. The paper reflects that the effort of the monetary authority to influence the finance of government fiscal deficit through the determination of the inflation-tax rate affects both the rate of inflation and the real exchange rate, thereby causing volatility in their rates. The paper reveals that inflation affects volatility of its own rate as well as the rate of real exchange. The policy implication of the paper is that monetary policy should be set in such a way that the objective it is to achieve is well defined.
(Sanusi, 2002) says that the ability of the CBN to pursue an effective monetary policy in a globalised and rapidly integrated financial market environment depends on several factors which include, instituting appropriate legal framework, institutional structure and conducive political environment which allows the Bank to operate with reference to exercising its instrument and operational autonomy in decision- making, the degree of co-ordination between monetary and fiscal policies to ensure consistency and complimentarily, the overall macroeconomic environment, including the stage of development, depth and stability of the financial markets as well as the efficiency of the payments and settlement systems, the level and adequacy of information and communication facilities and the availability of consistent, adequate, reliable, high quality and timely information to Central Bank of Nigeria.

2.4 REVIEW OF TECHNIQUES OF MONETARY POLICY CONTROL
The CBN is mandated by the CBN act of 1958 to promote and maintain monetary stability and a sound financial system in Nigeria. The CBN has the 'target of achieving price stability and economic growth through the uses of monetary policy. Embedded in this twin objectives are (1) the attainment of full employment, (2) maintaining stability in the long-term interest rates and (3) pursuing optimal exchange rate targets. To achieve these multiplex objectives, the CBN operates through a system of targets. These are; the operational targets, the intermediate targets and the ultimate target (Ibeabuchi, 2007).
The monetary regulatory authority in Nigeria, the CBN uses different techniques in achieving its set objectives in maintaining economic growth through monetary policy. The techniques can be classified into two categories: the Market Control Approach and the Portfolio Control Approach. These can also be sub classified into direct or indirect approach of monetary control.

2.4.1 Market Control Approach
This is a traditional or indirect approach of monetary control. This includes the manipulation of the Open Market Operations and Discount Rate.

Open Market Operations

This is the flexible and important technique used by CBN to control money in circulation. The CBN goes to the public through an open market to buy and sell government securities depending on the aim ' either to reduce or increase the deposit with commercial banks (Chuku, 2009). Increase in the commercial banks deposit implies an increase in the money supply, thus is the Central Bank wish to reduce the total value of money in the economy in order to reduce inflation, it sells government securities in open market (primary and secondary) for which the public pays through commercial banks with their deposit. This will reduce the bank's balance with the Central Bank. Conversely, in times of depression, the Central Bank buys securities thereby increasing the reserve base of the commercial banks and hence their loanable funds.

The Discount Rate
Chowdhry (1986) states that this rate measures the price changed by the CBN for financial loans made available to the commercial banks in the events of perceived shortage of liquidity in the economy. This is the interest rate charge by the Central Bank on funds lent to Commercial Banks to meet short term facility. The term also applies to the CBN activity of discounting bills when commercial banks buy discounting bills, such as treasury bills, treasury certificates, commercial bills and promissory notes of short term durations. The manipulations of discount rates help the CBN in controlling the money in circulation. For example, if the economy experiences inflationary pressure, CBN will raise the rate at which commercial banks borrow from it, thereby increasing the lending interest rate commercial banks gives to borrower, thus make borrowing unattractive. This will make investment to shrink, and employment, income and the general price level will fall.

2.4.2 The Portfolio Control Approach
The portfolio control approach is a direct or non-traditional approach of monetary control use by the Central Bank. The instruments used in this approach are: (1) Reserve Requirement. (2) Selective credit controls. (3) Moral Suasion. (4) Special deposits with Central Bank.

a) Reserve Requirement
By law commercial banks are required to keep some fund reserves with the Central Bank. By increasing or decreasing the banks' reserve requirement, the Central Bank affects the banks' ability to lend. When the Central Bank increases the reserve requirements of commercial banks, that is, to hold more liquid assets in reserve, fewer assets will be left for them to lend to the general public. On the other hand, reduction in reserve requirement will give the commercial banks capacity to lend more to the public as loans thus controlling the cash in circulation.
b) Selective Credit Control
This measure of monetary control is used to control the flow of bank credits to different sectors of the economy. The Central Bank may instruct the bank sector to give more loans to the preferred sector of the economy- the productive sector while extending little or no credit to the less preferred sectors- the service or consumption sector of the economy. By using this method of monetary policy, the Central Bank is able to influence the liquidity in circulation and the allocation of resources.

c) Moral Suasion
This entails the use of issuing persuasive instructions by the Central Bank to the commercial banks to control the flow of credits to the economy. The instruction is issued at a periodic monetary policy meeting by the monetary committee or the Bankers' committee meetings. This is used to solicit the commercial banks support in helping to control the inflationary pressure in the economy through the use of credit or loans to general public.

d) Special Deposits with the Central Bank
Unlike the reserve requirement, this is additional deposits over and above the minimum legal reserve requirement that the commercial banks are made to deposit with the Central Bank. This is mandatory special deposits that are used in reducing the deposits available funds for banks to lend to their customers. The deposit is still part of the bank's assets on the balance sheet, but cannot be used as part of the reserve base.

2.5 EVOLUTION OF MONETARY POLICY IN NIGERIA
The CBN has been implementing monetary policy using various combinations of the above techniques with more or less emphasis on one. Depending on the technique used by the CBN, the monetary policy evolution in Nigeria can be classified into two phases: (1) Direct Control period (1959 ' 1986) and (2) Market-based period (1986 ' date).
The direct control phase sees a lot of remarkable changes in monetary policy management in Nigeria, the CBN focuses on the structural changes in the economy; the focus shift from agricultural base to crude, the civil war, the oil boom and its crash in 1970s and the introduction of structural adjustment programme (SAP). During this period the CBN's monetary policies focuses on interest rate as well as the exchange rate. The CBN uses the selective credit control, moral suasion of the commercial banks and manipulations of the discount rate. Due to the CBN's lack of autonomy in regulating the economy, the monetary policy was ineffective (Omotor, 2007).
Omotor (2007) observed that economy was heavily influenced by the political atmosphere conveyed by the ministry of finance (a representative of the federal government in the monetary policy committee).
The commencement of the Structural Adjustment Programmed in 1986 ushered in different approach to the monetary policy management. The use of market friendly approach or market based approach techniques increase the CBN autonomy in setting and implementing monetary policy that favoured the economy.

2.5.1 Monetary Policy Transition Mechanism
The primary goal of monetary policy in Nigeria has been the maintenance of domestic price and exchange rate stability since it is critical for the attainment of sustainable economic growth and external sector viability (Sanusi 2002: 1)

(Adefeso and Mobolaji, 2010) employed Jahansen maximum likelihood co-integration procedure to show that there is a long run relationship between economic growth, degree of openness, government expenditure and M2. (Ajisafe and Folunso 2002) observe that that monetary policy exerts significant impact on economic activity in
Nigeria.

2.5.2 The Exchange Rate Targeting Regime (1959-1973)

During the period of 1959 ' 1973 was tagged colonial period rule, the monetary policy was influenced greatly by the colonial master (Britain). The economic developments in Britain influence tools used in managing the monetary policy; and which is the exchange rate and is at par with what was obtainable in Britain. Ezinne (2012) noted that the exchange rate was a convenient way of effective managing money supply and a good mechanism for the maintenance of balance of payment and controlling inflation in the colony. The fixing of exchange rate was stopped in 1967, when the British pound was devalued leaving the Nigerian pound untouched due to the civil unrest at the time.

Major reasons accounted for this: (1) considerable proportion of the Nigerian naira would only raise the domestic price of imports without any appreciable impact on exports, which were largely the primary products. (2) large amount of the country's resources was used to finance the civil war during the period. The monetary authorities decided to peg the Nigerian currency to the US-dollars; this is done not to worsen the unfavourable balance of payments position but rather, the monetary authority imposed severe restrictions on imports via strict administrative controls on foreign exchange.

In the 1970's, a global crisis erupted which led to the devaluation of the US dollar. Nigeria had its own national currency (the Naira), pegged to the US dollar in line with the emergence of the Bretton Woods System of adjustable pegs. Due to the downside risks of pegging to a particular currency, the authority in 1978 decided to peg the Naira to a basket of 12 currencies of the major trading partners (Nnanna, 2001). With those developments, the severe drawbacks in pegging the Nigerian naira to a single currency became obvious. A clear case was that the naira had to undergo a 'de facto' devaluation in sympathy with the dollar when the economic fundamentals dictated otherwise in 1973 and 1975 respectively. It was against this backdrop that the need to independently manage the exchange rate of the naira became very imperative and was firmly established (Ezinne, 2012)
The Nigerian economy witnessed significant structural changes in the 1970s that greatly affected the conduct of monetary policy. The discovery of oil exerted significant impact on exports. Oil constituted about 57.6 per cent of total exports in 1970 and grew to 96 per cent in 1980, while non-oil exports, mostly agricultural produce, declined rapidly from 42.4 per cent in 1970 to 4 per cent in 1980. Following the increased revenue accruing to Government from oil, Nigeria's external reserves rose sharply. The favourable terms of trade at the time led to considerable growth in public expenditure and thus, intensified inflationary pressures. Consequently, the authorities adopted a new monetary policy framework; Monetary Targeting. (CBN Monetary Framework: 23)

2.5.3 Monetary Targeting Regime 1974 to date

This is a direct approach or market-based approach to management of monetary policy.
This development marked the beginning of monetary targeting in Nigeria, which involved the use of market (indirect) and non-market (direct) instruments. As stated by Ezinne, 2012, the major focus of monetary policy was predicted on controlling the monetary aggregates, a policy stance which was largely based on the belief that inflation is essentially a monetary phenomenon. The internal balance condition is imposed by setting the inflation and output growth rates at targets that are consistent with the expansion in aggregate demand.

2.5.4 Direct Control, 1974 ' 1992

The major objective of monetary policy during this period was to promote rapid and sustainable economic growth. Consequently, the monetary authority imposed quantitative interest rate and presented sectored credit allocation to the various sectors of the economy. Overall, the 'preferred' sectors, such as agriculture, manufacturing and construction were singled out for the most favored treatment, in terms of generous credit allocation and a below market lending rate.
The most important instrument of monetary control that the CBN relied upon was the setting of targets for aggregate credit to the domestic economy and the prescription of low interest rates. With these instruments, the monetary authority hoped to direct the flow of loan able funds with a view to promoting rapid development through the provision of finance to the preferred sectors of the economy. The level and structured of interest rates were administratively determined by the CBN. Both deposit and lending rates were fixed in order to achieve social optimum in resource allocation, promote the orderly grow of the financial market, curtail inflation and lessen the burdens of internal and international debt servicing of the government. In implementing the policy, the sectors were classified into three categories: (1) 'preferred' agriculture, manufacturing and residential housing, (2) 'less preferred' imports and general commerce; and (3) 'others'. This classification enabled the monetary authorities to direct financial resources at concessionary rates to sectors considered as priority areas. These rates were typically below the CBN.
Determined minimum rediscount rate (MRR) which itself was low and not determined by market forces. Empirical evidence during the control regime era revealed that the flow of credit to the prior sectors did not meet the prescribed targets and failed to impact positively on investment, output and domestic price level. Overall, banks tended to practice adverse selection in their credit allocation. The major factor which impaired the effectiveness of monetary policy during the era of control regime was the lack of instrument autonomy by the Central Bank.
During this period, monetary policies were dictated by the Ministry of Finance and as such, were influenced by short-term political considerations. Beginning from mid-1981, crude oil prices to a downturn as prices fell from the peak of US & 40 per barrel to US & 14.85 in 1986. This led to severe external sector imbalance. The emerging economic development made Nigeria adopt the Structural Adjustment Programmer (SAP) under General Ibrahim Babangida as the Military Head of State, as a policy option to put the economy back on the path of sustainable growth. In broad terms, the SAP strategy involved both structural and sectoral policy reforms. The reforms included the deregulation of the financial system to accomplish a market-oriented financial system that would support efficient financial intermediation. The programme entailed reforming and dismantling the control regime which was characterized by a system of fixed credit allocations, a subsidized and regulated interest rate regime, exchange controls and import licensing. The emergence of SAP ushered-in a regime of financial sector reforms characterized by the free entry and free exit and the use of indirect instruments for monetary controls.

2.6 MONETARY POLICY AS A TOOL FOR ECONOMIC GROWTH
As discussed above, different tools are used in monetary policy for economic growth. This monetary policy must be consistent and is usually a set of demand management measures intended to remove some macroeconomic imbalances, which if allowed to persist, could be inimical to long-term growth.
Anyanwu (2003), countries seeking for sustainable economic growth after a period of macroeconomic imbalances must first get stabilized. In Nigeria, monetary policy effectively implemented is a veritable tool for stable economic growth. Efforts for sustainable growth began in Nigeria in the early 1980's in response to the emergence and persistence of unstable macroeconomic developments. There was need to address basic elements of economic instability such as the expended government spending which resulted in large deficits. In 2011, the CBN Governor, Mallam Sanusi Lamido Sanusi, started a different approach of reform to stabilize the economic growth, the reform which includes: capitalization and consolidation of commercial banks; increase in the deposit money banks' capital base to N25b; Introduction of risk base supervision and so on. The following variables were needed to stabilize in order to enhance the growth of the economy: excessive government borrowing; rapid monetary expansion; inflation; reduced export competitiveness.
2.6.1 FACTORS INFLUENCING MONETARY POLICY
Anyanwu (2003) listed a number of variables that have tendencies of influencing the monetary policy. The following variables are listed below:

Economic Stability
In order to get the full implementation of monetary policy, there should be macroeconomic stability in order to have distortions and lapses that will make the CBN monetary targets unrealizable.

Financial Market Efficiency
A special ingredient for the monetary policy effectiveness is the money market segment. Inflation: The scope or magnitude of the inflationary trends in the economy goes a long way to influence the monetary policy. With high inflation any, rate the price stability exchange rate stability and balance of payments position, will not be fully realized.
2.6.2 Monetary Policy in a Regulated Financial System Environment
Anyanwu (2003), emphasized that if an economy with financial regulation starts to observe a fairly steady upward trend in the velocity of the monetary base M1 and M3 without a corresponding growth in the gross domestic product (GDP) the ultimate economic monetary policy would be in addition to informing the commercial banks of this view by way of consultations to increase the interest rate, raise the special reserve deposits ratio and thus force the bank to reduce their asset base. Because of the existence of controls, changes in the reserve ratio have a direct impact on banks' lending.
Under the tap system of selling government securities whereby the price (and not the quality) of these securities was fixed, there was very little risk of capital losses. Although most nations apply market operations to affect their liquidity condition, they are not the primary instrument of monetary policy. Indeed, it mounts pressure on the primary market, therefore, discouraging the development of the secondary market; impairing true portfolio adjustment is by holders of government debt as well as the government ability to conduct open market operations.
2.7 MONETARY POLICY IN DEREGULATED FINANCIAL SYSTEM
The system of regulatory measures constructed to protect investors and to maintain confidence in the stability of financial market and institutions failed to achieve the set objective as financial institutions devised other names of operations than their compliance to the regulatory body controls. As observed by Anyanwu (2003), the regulations had allowed the banks to emerge as highly profitable institution but with a declining market share and at a high cost to depositors. Several developments, according to her, rendered the impact of regulations of financial institutions a weak tool. One of such developments is the upsurge of and increase variability in inflation. Inflation has the potentials of increasing the opportunity cost of holding moneys balances. Investors tend to prefer short dated claims over longer dated claims. Maturity controls imposed on the banks restricted their ability to meet this demand. The limited flexibility of banks in the face of high and variable inflation rates afforded an opportunity for non-bank financial intermediaries to expand consequently, money Market Corporation, building society and credit Unions, experience rapid growth. Other development is the progressive increase in the size of government budget deficits. The effect of this rapid growth places considered pressure on the existing methods for the sales of public securities.
Osuber (2006) had maintained that monetary authorities could switch to financial de-regulation to set in motion changes in both manner in which monetary policy is transmitted to the real economy and the stability and interest rate elasticity of the demand for money. Thus the introduction of tender system of selling government securities and the move to a floating exchange rate regime increasing the monetary authorities potential control over injections of liquidity into the domestic monetary system thus, enhancing their ability to use open market operations to influence domestic monetary condition.
Osuber (2006) noted that monetary policy in a deregulated financial system strengthens the role of market force in determining operations, and the real economy through changes in interest rates. With greater competitions therefore, financial sector, changes in interest rate, tend to spread quickly through the whole range of financial assets and liabilities. Specifically, in the deregulated financial environment, the value of deposit is determined by both demand and supply consequently, any tightening of monetary policy by the monetary authority will induce a rise in deposit rate resulting in an increase in the supply of deposits and offsetting to some extend the authorities effort to reduce the growth of money. Thus, financial institutions particularly banks are now better able to protect their deposit base and to sustain their lending than they had been in the regulated frame work in which the volume of deposit was primarily determined.
The demand for credit may also have become less sensitive to interest rate in the deregulated system. For example, increased use of floating interest rates and moral suasion and flexible loan packages may result in less discouragement to marginal borrowers as rate rises.

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