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Monetary Policy Framework in Nigeria: Formulation and Implementation Challenges*
By
Central Bank of NigeriaCentral Bank of NigeriaCentral Bank of NigeriaCentral Bank of Nigeria
Ezema, Charles Chibundu, PhD
Monetary Policy Department,
Central Bank of Nigeria
African Institute of Applied Economics (AIAE): Monthly Seminar, August 2009
*The views expressed in this paper are entirely that of the author and do not in any way reflect the official position of the
Central Bank of Nigeria
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aOutline
� Introduction
� Monetary Policy Instruments
� Monetary Policy Framework
Monetary Policy Formulation
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� Monetary Policy Formulation
� Implementation Challenges
� Concluding Remarks
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aIntroduction
� Monetary Policy is the deliberate use of monetary instruments
(direct and indirect) at the disposal of monetary authorities such as
central bank in order to achieve macroeconomic stability
� Macroeconomic stability refers to achievement of internal and
external Balance
� Internal Balance here refers to:
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� price stability (Low inflation)
� Low unemployment
� High and stable Economic growth
� External balance
� Balance of payment equilibrium
� Exchange rate stability
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aIntroduction…cont.
� For most central banks, the objective of price stability is given priority
over others in the conduct of monetary policy
� In some instances, however, the laws establishing the central bank
impose dual mandate of low inflation and high growth…necessitating
the formulation of monetary policy that attempt to strike a balance
between the two goals
Mandates of CBN
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� Mandates of CBN
� The CBN Act. 2007, assigns the following mandates to CBN
� Ensure monetary and price stability
� Issue legal tender currency in Nigeria
� Maintain external reserves to safeguard the internationalvalue of the legal tender currency
� Promote sound financial system in Nigeria; and
� Act as banker and provide economic and financial advice theFederal Government
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aIntroduction…cont.
� The CBN is solely responsible for the conduct of monetary
policy in Nigeria
� The General Objectives of Monetary Policy
� Price stability
� High and sustainable economic growth
� (reducing the gap between actual and potential GDPin the short and medium-term)
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in the short and medium-term)
� Balance of payment equilibrium
� CBN monetary policy targets two major objectives
� Price stability
� Sustainable economic growth
� Monetary Policy is essentially the tool for executing the
mandate of monetary and price stability
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aInstitutional Framework for Monetary Policy Formulation in Nigeria
� Monetary Policy Committee (MPC): at the apex. Charged withthe responsibility for formulating monetary and credit policy
� Monetary Policy Technical Committee (MPTC): Providestechnical documents on issues of interest for MPC meetings
� Monetary Policy Implementation Committee (MPIC): Serves as
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� Monetary Policy Implementation Committee (MPIC): Serves asthe implementation arm of the MPC
� Liquidity Assessment Group (LAG): Assesses daily liquiditysituation and suggests policy actions
� Fiscal Liquidity Assessment Committee (FLAC): Providesinformation on the operations of the Treasury to assist LAG inforecasting the liquidity level
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Monetary Policy Instruments� Two types of instruments
� Direct and Indirect
� Direct monetary policy instruments is characterized by the use
of:
� Credit ceiling, Sectoral credit allocation, administrative control of
interest and exchange rates, Moral suasion, movements of
governments account in and out of the DMBs, issuance of stabilization
securities etc.
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� Indirect Monetary Policy Instruments are market-based
instruments and therefore, require a well developed and
functional financial market. These Instruments include
� Open Market Operations, Liquidity Ratios, Cash Reserve ratios, Discount
window operations, Expanded Discount Window operations (EDW) –
Dec 2008 – Jul. 2009, Minimum Rediscount Rate MRR- up to Dec. 2006,
Monetary Policy Rate – Dec 2006 to date 7
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aMonetary Policy Framework
� Monetary policy framework refers to thestrategy that the monetary authority adoptsin achieving its policy objectives
Exchange rate Targeting
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� Exchange rate Targeting
� Monetary Targeting
� Interest rate Targeting
� Inflation Targeting
� Nominal GDP Targeting
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aMonetary Policy Framework…cont.
� The Conduct of Monetary Policy in Nigeria
Exchange Rate Targeting
(1959-1973)
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Monetary Targeting
(1973-2009)
Indirect Control
(1993-Date)Direct Monetary Control
(1973-1993)
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aPolicy Framework: Transmission mechanism..cont
� Monetary policy actions affect the real economy through a
process generally referred to as the “transmission mechanism”
� It is complex, time consuming and therefore difficult to
manage (Lags)
� To achieve a goal that can not be directly measured requires
the employment of intermediate targets, or what is generally
referred to as the nominal anchor for monetary policy.
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referred to as the nominal anchor for monetary policy.
� There are two kinds of nominal anchor:
� Quantity-based nominal anchor
� Price-based nominal anchor
� The quantity-based nominal anchor targets money stock while
the price-based nominal anchor targets exchange rate or
interest rate
� Currently, the CBN uses broad money supply (M2) as the
nominal anchor 10
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aPolicy Framework: Transmission mechanism..cont
� The final targets of monetary policy are macroeconomic
variables, normally, the inflation rate
� These targets are not directly affected by the central bank
policy tools
� The central bank chooses another set of variables called the
operating targets (base money, reserves etc) which are more
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responsive to its policy tools
� Operating and intermediate targets are used to direct the
monetary policy towards the achievement of its goals
� The criteria for choosing variable/targets include
� Measurability
� Controllability
� Ability to predictably affect goals in desired manner11
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Monetary Targeting
� The Bank’s current monetary policy framework is monetary
targeting with:
� Base (Reserve) money as operating target
� Broad money supply (M2) as intermediate target
� Inflation as the ultimate or final target
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� Both the operating target and intermediate target are
employed in determining the optimum level of money
stock/liquidity consistent with the assumed level of expected
output growth and inflation
� This process starts with the design of a short-term monetary
programme approved by MPC using the quantity theory of
money12
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aMonetary Policy Framework…cont.�� TheThe quantityquantity theorytheory ofof moneymoney isis illustratedillustrated inin anan equation,equation, asas::
�� MvMv == PÝPÝ ……………………………………………………………………………………....11WhereWhere MM == moneymoney stockstock // supplysupply
vv == velocityvelocity ofof moneymoney (the(the numbernumber ofof timestimes aa unitunit ofof currencycurrency changeschangeshands)hands)
PP == PricePrice ofof basketbasket ofof goodsgoods transactedtransacted
ÝÝ == thethe sizesize ofof basketbasket ofof goodsgoods transactedtransacted inin aa givengiven periodperiod..
AssumptionsAssumptions::
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�� AssumptionsAssumptions::�� vv andand YY areare constant,constant, inin thethe shortshort termterm..
�� QuantityQuantity ofof moneymoney determineddetermined byby outsideoutside forcesforces;; isis thethe mainmain influenceinfluence ofof economiceconomicactivityactivity inin aa societysociety..
�� TheThe economyeconomy isis operatingoperating inin fullfull employmentemployment equilibrium,equilibrium, andand ,,
� The optimum liquidity level and aggregate net credit to
the domestic economy are computed using the CBN
balance sheet and solving the following equation:13
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a� M2 = NDC + NFA + OAN…………………………….(2)
� Where
� M2 = Broad Money Supply
� NDC = Net Domestic Credit
� NFA =Net Foreign Assets
� OAN = Other Assets Net
� ∆M2 = ∆NDC + ∆NFA + ∆OAN…………………(3)
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� ∆M2 = ∆NDC + ∆NFA + ∆OAN…………………(3)
� Decomposing NDC into public and private
� ∆NDC = ∆NDCg + ∆NDCp…………………………(4)
� Where NDCg = Net Domestic Credit to the government
sector, and NDCp = Net Domestic Credit to the private sector
� ∆M2 = ∆NDCg + ∆NDCp + ∆OAN……………………(5)
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Monetary Policy Framework…cont.
� Under the monetary targeting framework in an
indirect approach, the liquidity level that is consistent
with macroeconomic objectives is determined using
� Base Money (BM) as the operating target,
� M2 as the intermediate target while inflation is the
ultimate target
� Conventionally, Base Money is made up of currency
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� Conventionally, Base Money is made up of currency
with the non-bank public, (C) and reserves of DMBs,
(R), while
� R = CRR + OR …………………………………………………(6)
� where, CRR = cash reserve Requirement and
� OR = Other reserves
� i.e. C + DMBs deposits at CBN
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aMonetary Policy Framework…cont
� The main sources of base money in Nigeria:
� Net Central Bank Claim on Government (NCBCg)
� Net Foreign Assets of the Central Bank (NFACB)
� Other Assets Net of the Central Bank (OACB)
� The balance sheet identity of the Central
Bank can be written as:
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Bank can be written as:
� NCBCg +NFACB + OACB = C + R = BM………………..(6)
� The process of money creation derives from banks
expanding money supply by a multiple of reserves
� To influence money supply, OMO is applied among
other instruments
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aMonetary Policy Framework…cont
� M2 = C + D…………………………………..(7)
� BM = C + R…………………………………..(8)
� M2 = 1 + c……………………………………(9)
� BM = c + r……………………………………(10)
� M2/BM = K = (1+c)/(c+r); 0 < r, c < 1…..(11)
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� M2 = KBM = [(1+c)/(c+r)BM…………(12)
� Where:
� k = multiplier
� R = DMBs’ Reserve with the Central Bank
� C = Currency outside banks
� c = currency/deposit ratio
� r = reserve/deposit ratio17
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Monetary Policy Framework…cont
� Equation (12) can be used to estimate money supply
(M2) arising from a given Base Money (BM) and the
multiplier (k) through change in bank reserve (R) and
currency outside bank (C) as shown above
� Although the currency/deposit ratio (c ) is a function of
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Although the currency/deposit ratio (c ) is a function of
the cash preferences of the economic agents, it may be
sensitive to interest rate movements,
� Bank reserves/deposit ratio (r) may be influenced by
CBN through the use of reserve requirements
� The Central Bank can also influence the multiplier (k) in
the desired direction 18
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aShort-Term Monetary Policy Framework in Nigeria
� Before 2002, the Central Bank of Nigeria had
designed monetary policy in line with fiscal duration
of one year
� Monetary policy had always faced the problem of
non-committal to both intermediate and ultimate
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non-committal to both intermediate and ultimate
targets
� The optimal long-term policy was not consistent
with both the short-term objectives of government
and the events that emerged over time – time
inconsistency problem19
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aKey Policy Targets and Outcomes (%)
Targets Outcomes Targets Outcomes Targets Outcomes
M2 10 31.4 14.6 48.1 12.2 27
M1 4.1 19.9 9.8 62.2 4.3 28.1
Agg.
1999 2000 2001
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Agg.
Credit to
the
Economy 18.3 35.5 27.8 -23.1 15.8 74.8
Net Credit
to Govt. 10.2 57.1 37.8 -162.3 2.6 -94.6
Net Credit
to Private
Sector 19.9 27.3 21.9 30.9 22.8 43.5
Inflation 9 6.6 9 6.9 7 16.5
Real GDP
Growth 3 2.7 3 3.8 5 4.620
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aMedium-Term Monetary Policy Framework
� With effect from January 2002, the CBN adopted the
medium-term perspective in monetary policy
formulation
� The medium-term framework gives the Bank the
opportunity to set targets on a two yearly basis
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opportunity to set targets on a two yearly basis
rather than on annual basis
� However, in the course of the implementation,
reviews could be made to reflect current economic
developments
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aMedium-Term Monetary Policy Framework
� Rationale:
� This shift was necessitated by the fact that
monetary policy actions affects the ultimate
target with substantial lags
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� The shift freed monetary policy implementation
from the problem of time inconsistency and
minimized overreaction to some temporary
shocks
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aKey Policy Targets and Outcomes
Targets Outcomes Targets Outcomes Targets Outcomes Targets Outcomes Target Outcome
M2 15.3 21.55 15 24.11 15 14.02 15 16.07 27.8 30.55
2002 2003 2004 2005 2006
Table 2: Key Policy Targets and Outcomes (% except otherw ise stated)
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M1 12.4 15.9 13.8 29.5 10.8 8.6 11.4 14.53 16.7 20.34
Agg. Credit
to the
Economy 57.9 56.59 25.7 58.44 24.5 11.99 23.4 16.29 22.5 -67.12
Net Credit to
Govt. 96.6 -6,316.31 -150.3 26.8 29.9 -17.95 -14.4 -30.44 23.5 -692.1
Net Credit to
Private
Sector 34.9 11.79 32.3 24.11 30 26.61 35.3 31.08 30 27.82
Inflation 9.3 12.2 9 23.8 12 10 9.5 11.9 9 8.5
Real GDP
Grow th 5 3.48 5 10.24 5 6.1 6 6.23 7 5.6323
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aNew Monetary Policy Implementation Framework
� With effect from December 2006, the Bank
introduced a new monetary policy implementation
framework with the aim of:
� Reducing interest rate volatility to ensure that money
market rates especially the overnight interbank rates are
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market rates especially the overnight interbank rates are
more responsive to policy rates
� Preparatory steps towards transiting to full fledged
inflation targeting
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aNew Monetary Policy Implementation Framework
� Main features of the framework
� A new monetary policy rate (MPR) replaces the minimum
rediscount rate (MRR) as anchor for monetary policy
� The operating target is the overnight interbank interest
rate
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� The transmission mechanism is largely through the term
structure of interest rates
� The intermediate target include the prime lending rates
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aNew Monetary Policy Implementation Framework
� An interest rate corridor was introduces with the
upper band representing the CBN overnight lending
rate to the DMBs under Standing Lending Facility
(SLF)
� The lower band represents the overnight deposit rate
at which the CBN accept deposits from DMBs under
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at which the CBN accept deposits from DMBs under
(SDF)
� Provision of Standing Facility limited by collaterals
� Standing Lending Facility is a window that provides
overnight lending to DMBs at a fixed rate above MPR
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aAppraisal of the Current Monetary Policy Framework
Period MRR/MPR CRR OMO
sales(N’b)
SLF (N’b) SDF (N’b) Forex
Swap
(N’b)
2000 13.5 9.8 318.1 N/A N/A N/A
2001 13.5 10.8 386.9 N/A N/A N/A
2002 16.5 10.6 591.95 N/A N/A N/A
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2002 16.5 10.6 591.95 N/A N/A N/A
2003 15 12.5 794.5 N/A N/A N/A
2004 15.0 11.0 1099.5 N/A N/A N/A
2005 13.0 5.0 989.9 N/A N/A N/A
2006 14.0 5.0 1808.4 1350.46 82.44 N/A
2007 9.5 3.0 3582.60 3430.69 15359.49 116.44
2008 9.75 2.0 2331.34 29644.04 0 122.80
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aAppraisal: Volatility in OBB Rates Before (2005/06) and After (2007/08) Current MP
10.00
15.00
20.00
25.00 per cent
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0.00
5.00
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
per cent
Yr 2007/08 Yr 2005/06
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aAPPRAISAL: Uncollaterized Call Rates Before (2005/06) and After (2007/08) Current MP
15
20
25
30
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0
5
10
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sept
Oct
Nov
Dec
Yr 2007/08 Yr 2005/06
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Appraisal of the Current Monetary Policy Framework …
25
30
35
40
Interest rates (Prime) 1981-2008)
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0
5
10
15
20%
30
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Appraisal of the Current Monetary Policy Framework …
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50
60
70
Per cent (%)
Growth in M2: 1995 - 2008
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0
10
20
30
40
19951996199719981999200020012002200320042005200620072008
Per cent (%)
Growth in M2 (%) outcomes
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Appraisal of the Current Monetary Policy Framework …
50
60
70
80
Inflation rate 1981-2008
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1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
inf rate 21.4 7.2 23.2 40.7 4.7 5.4 10.2 56 50.5 7.5 12.9 44.5 57.3 57 73.1 29.1 8.5 10 6 6.9 18.9 12.9 14 15 11.6 8.5 6.6 15.1
0
10
20
30
40
50
%
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aAppraisal of the Current Monetary Policy Framework …
�� TheThe useuse ofof MPRMPR providesprovides betterbetter signalsignal ofof
monetarymonetary policypolicy stancestance thanthan whenwhen thethe MRRMRR waswas
usedused..
�� InterInter--bankbank ratesrates areare stabilizingstabilizing
�� DeviationDeviation fromfrom MM22 targettarget inin thethe lastlast fivefive yearsyears
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�� DeviationDeviation fromfrom MM22 targettarget inin thethe lastlast fivefive yearsyears
havehave moderatedmoderated..
�� InflationInflation ratesrates havehave moderatedmoderated significantlysignificantly inin
relativerelative termsterms
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aKey Challenges of Monetary Policy in Nigeria
� Fiscal Dominance
� Relative volatility of the inter-bank rates
� Low Level of Inter-bank Trading and
� Inadequate Infrastructure
Banking Habit is low
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� Banking Habit is low
� Cost of Liquidity Management
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4
6
8
10
12
Per Cent
OBB rates 5-days before and after FAACC
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Mar AprMay
Jun Jul AugSept.
Before FAAC 10.52 9.84 7.24 10.07 10.08 10.73 10.54
After FAAC 7.23 7.38 8.29 7.93 6.82 10.09 9.1
0
2
4
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aLow Level of Inter-bank Trading
Individual Share /Total Securities of the industry
15.00
20.00
25.00
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0.00
5.00
10.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
per cent
Share /Total
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aGoing Forward….
� Need for policy harmonization between
monetary and fiscal authorities
� Development of the Financial Infrastructure is
fundamental to efficient and effective monetary
policy
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policy
� Strengthening of the legal framework
� Enhance Central Bank Independence
� Need to broaden and strengthen regulation and
supervision
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aGoing Forward…
� Inflation Targeting……?
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Concluding Remarks� This paper presents an overview of monetary policy
framework in Nigeria
� The challenge of monetary policy management rest wholly
on monetary authorities which has over the years been
committed to its effective control
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� The performance of monetary policy has improved greatly in
recent times- inflation has remained at moderate levels
accompanied by high growth of domestic output
� To sustain the efforts, there is need for appropriate
collaboration with the fiscal authorities as well as the
development of confidence in inter-bank market and the
necessary financial market infrastructure is still relevant 39
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aThanks for Listening
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40