Nigeria has adopted much policy strategy to combat inflation, prominent among those policies are the monetary and fiscal policies. Monetary policy has been seen as the use of some CBN monetary tools to influence the level of a aggregate credit so as to achieve some macroeconomic objectives of the economy. The primary objectives of this study is to assets the effectiveness of monetary in combating inflation in Nigeria and to trade the historical records of interest rate, exchange rate and money supply and their relationship with inflation rates covering the period of 1980 2010. For the course of this study, the following hypothesis were tested. Ho: Monetary policy variable interest rate, exchange rate and money supply have no significant impact on inflation. To derive and estimate the numerical values of the parameters, the linear regression applying the ordinary least square (OLS) technique was adopted. It was discovered that money supply has a negative relationship with inflation, while interest rate has a positive relationship with inflation. It was also discovered that monetary policy has no significant impact on controlling in Nigeria. It is therefore the recommendation of this paper that the Federal Government should increase the level of output so as to absorb the excess money in circulation and to combat imported inflation through the use of import tariffs.

TABLE OF CONTENTS

Title page i

Approval page ii

Dedication iii

Acknowledgement iv

Abstract vi

Table of contents vii

CHAPTER ONE

1.0 INTRODUCTION 1

1.1 Background of the Study 1

1.2 Statement of the Problem 5

1.3 Research Question 7

1.4 Objective of the Study 7

1.5 Hypothesis of the Study 8

1.6 Significance of the Study 9

1.7 Scope and Limitations of the Study 9

CHAPTER TWO

2.0 LITERATURE REVIEW 11

2.1 Theoretical Literature 11

2.1.1 Overview of Monetary Policy 11

2.1.2 Monetary Policy, Instruments, their application

and Effectiveness in Nigeria 19

2.1.3 Instruments of Monetary Policy, their

application and effectiveness in Nigeria 20

2.2 Empirical Literature 23

CHAPTER THREE

3.0 RESEARCH DESIGN AND METHODOLOGY 27

3.1 Methodology 27

3.2 Model Specification 28

3.3 Method of Evaluation 29

3.3.1 Statistical Test of Significance 29

3.3.2 Econometric Test of Significance 31

3.4 Data Required and Sources 32

CHAPTER FOUR

4.0 PRESENTATION AND ANALYSIS OF RESULTS 33

4.1 The Empirical Result 33

4.2 Examination of the Algebraic Signs of the

Parameter Estimates 35

4.3 Evaluation of the Working Hypotheses 36

4.4 Implications of the Results 38

CHAPTER FIVE

5.0 SUMMARY OF FINDINGS, CONCLUSION

AND RECOMMENDATIONS 40

5.1 Summary of Findings 40

5.2 Conclusion 41

5.3 Recommendations 42

References 44

CHAPTER ONE

6.0 INTRODUCTION

6.1 Background of the Study

Monetary policy has always been seen as a fundamental instrument over the years for the attainment of macroeconomic stability, often viewed as prerequisite to achieving sustainable output growth. Thus in the pursuit of macro-economic stability, the managers of monetary policy have often set targets on intermediate variable which include the short term interest rate growth of money supply and exchange rate. Among these intermediate variables of monetary policy, the exchange rate argued to have a greater influence on the economy through its effect on the value of domestic currency, domestic inflation, the external sector, macroeconomic credibility, capital flows and financial stability. Increased exchange rate directly affects the prices of imported commodities and an increase in the price of imported goods and services contributes directly to increase in inflation (CBN, 2008). The adverse consequence of inflationary pressure from exchange rate depreciation have been a serious concern for the monetary authorities, economists and policy analysts given that these variables (exchange rate and inflation) are the key barometers of economic performance.

Consequently assessing the nexus, among monetary policy, exchange rate and inflation rate is pertinent because understanding of the nexus between these variable in prerequisite for the successful conducting and adopting of inflation targeting, which the Nigerian government has also made prime objective in the attainment of its macroeconomic objective. Under inflation targeting, monetary policy stance (through changes short term interest) affects inflation through a large set of variables including exchange rate (Mukherjice, and Bhattacharya, 2011).

Over the years inflation has become a significant problem for Africa and particularly in Nigeria. Since the first oil shock n the mid 1970s, African inflation rates have averaged more than 15 percent a year (Barkky and Killian, 2004). For Sub0sahara countries (Africa), the average inflation rate has been closer to 20 percent a year. A few sub-Sahara countries have even experienced inflation rate of 50 percent or even more in a year (Batini, 2004). The emergency of substantial inflation in Nigeria has led to wide spread debate about its causes. Many economist that favour traditional adjustment strategies contend that monetary growth, arising particularly from the domestic bank financing of large budget deficits, is the major source of inflationary pressures. By contrast, some critics of the traditional approach, such as the United National’s Economic commission on Africa (UNECA) in its “African Alternative framework for structural Adjustment Programmes” UNECA, (1989) have identified exchange rate depreciations as a major factor. Controversy between these two viewpoints has led to differing prescriptions about the appropriate policy responses.

Those focusing on monetary factors have emphasized reducing government budget deficits and restraining credit to public enterprises, while advocating exchange rate depreciation to offset any over valuation resulting inflation and deteriorate in terms of trade. Those emphasizing the role of exchange rate depreciation, by comparison, have argued against further exchange rate adjustments preferring instead a combination of incomes policies, price controls and demand reduction measures. Despite its importance, there has been surprisingly little research on the control of inflation in African countries particularly in Nigeria. The few empirical studies on this issue have used traditional econometric techniques best suited to identifying whether individual variables are related to inflation. Thus, the relative importance of monetary policy in the control of inflation remains to be determined. It is on this back ground that this study would investigate the effectiveness of monetary policy in combating inflation in Nigeria.