the caurse of poverty in nigeria

Topics: Inflation, Monetary policy, Foreign exchange market Pages: 30 (5614 words) Published: January 5, 2014
Applied Econometrics and International Development.

AEID.Vol. 5-2 (2005)

MONETARY POLICY AND MACROECONOMIC
INSTABILITY IN NIGERIA: A RATIONAL EXPECTATION
APPROACH
FERIDUN, Mete *
FOLAWEWO, Abiodun
OSINUBI, Tokunbo
Abstract
Generally, both fiscal and monetary policies seek at achieving relative macroeconomic stability. Based o countries’ experience on n
the role of monetary policy in controlling economics instability, this study examines the efficacy of monetary policy in controlling inflation rate and exchange rate instability. The analysis performed is based on a rational expectation framework that incorporates the fiscal role of exchange rate. Using quarterly data spanning over 1980: 1 to 2000: 4, and applying time series test on the data used, the paper shows that the effort of monetary policy at influencing the finance of government fiscal deficit through the determination of the inflationtax 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 in the rate of real exchange. The policy import of the paper is that monetary policy should be set in such a way that the objective it is to achieve is well defined.

Key words: Monetary Policy, Nigeria, exchange rate.
JEL codes: C5, E52, F33,

*

Mete Feridun Faculty of Economics and Administrative Studies. Cyprus International University Nicosia, Cyprus. E
-mail: mete.feridun@lycos.com.
Abiodun Oluwole Folawewo Department of Economics Olabisi Onabanjo University Ago-Iwoye, Ogun State, Nigeria. Tokunbo Simbowale Osinubi Department of Economics Faculty of the Social Sciences University of Lagos, Akoka, Yaba, Lagos, Nigeria E-mail: tokunbosinubi@yahoo.co.uk 69

Applied Econometrics and International Development.

AEID.Vol. 5-2 (2005)

1. Introduction
The primary goal of monetary policy is to maintain stable prices or low and stable inflation. Fluctuations in the exchange rate, in particular, may have a significant impact on the macroeconomic fundamentals such as interest rates, prices, wages, unemployment, and the level of output. This may ultimately result in a

macroeconomic disequilibrium that would lead to real exchange rate devaluation to correct for external imbalances (Parikh and Williams, 1998). Price stability and financial stability are viewed by Bernanke and Gertler (1999) as complementary and mutually consistent

objectives of monetary policy.
This argument stems from the notion that price stability tends to produce stable macroeconomic conditions and that higher inflation and surging asset prices are both counteracted by higher interest rates. Price stability and financial stability may also be conflicting goals of monetary policy as economic theory suggests that both price shocks and interest rate shocks are two fundamental forces that produce financial distress, (Bernanke and Gertler (1989), Mishkin (1998), and Allen and Gale (1999, 2000)). This study examines the efficacy of monetary policy in controlling inflation rate and exchange rate instability. As a means of achieving this, a simple monetary model with rational expectation that emphasizes the fiscal role of the real exchange rate is used.

The fiscal role of real exchange rate is particularly significant relevant to Nigeria since the bulk of government revenue is derived from foreign exchange earnings. In the theoretical model the links between high inflation and the joint volatility of the real exchange rate and inflation rate, and some aspects of government’s fiscal and exchange rate policies are illustrated in a rational expectation equilibrium framework. Consequently, inflation rate and the real exchange rates are jointly determined by the equilibrium of the model. This is derived from the sunspot equilibria theory in which Woodford (1986), Shigoka (1994) and Drugeon and Wignolle (1996) have demonstrated that macroeconomic instability is...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Gender and Poverty in Nigeria Research Paper
  • Poverty in Nigeria Essay
  • Poverty in Nigeria Essay
  • Nigeria Essay
  • Nigeria Essay
  • Nigeria Essay
  • Nigeria Essay
  • Nigeria Essay

Become a StudyMode Member

Sign Up - It's Free
Ch.43 : Sagiri-san Flips in the Cultural Festival (color) | #30 - Union 09-05-2017 | Cat's Eye