Effects of Monetary Policy on Sectoral Output Growth in Nigeria

Effects of Monetary Policy

In the literature, macroeconomists have established the theoretical relationship between real output and monetary policy measures. To Keynesians, a discretionary change in money supply permanently influences real output by lowering the rate of interest and through the marginal efficiency of capital, stimulate investment and output growth (Molho, 1986; Athukorala, 1998). In contrast to Keynesian policy prescription, McKinnon (1973) and Shaw (1973) in advocating the financial liberalization hypothesis argued that a market force induced higher interest rate would enhance more investment by channelling savings to productive investment and stimulate real output growth. Based on these theoretical propositions, empirical questions have been raised on whether this consensus views on the effect of monetary policy on the real output holds for the different sectors of the economy.

Existing studies have shown that the effects of monetary policy on sectors output vary and such variation might arise because of the relative strength of a particular channel of monetary transmission mechanism on some sectors than for other sectors (Gruen and Shuctrim, 1994). Also, the possibility of a differential response between sectoral output and aggregate output to monetary policy measures has been investigated by Granley and Salmon (1997) for other countries.


In Nigeria, studies by Chimobi and Uche (2010) and Akinlo (2007) among other studies, who had investigated the relationship between monetary policy and real output growth, only concentrated on the aggregate output growth neglecting sector-specific analysis. The neglect of these important issues in the existing literature created an empirical gap and indeed might have undermined the policy relevance of inferences from the empirical evidence from such studies especially on Nigeria. Apart from the above reason, this study is distinct from the previous attempt at examining the effect of monetary policy on the real sector in several other ways. It used Autoregressive Distributed Lag (ARDL) model bound testing approach to carry-out co-integration or long- run relationship analysis among variable of interest. This approach has the advantage of detecting co-integration among variables even when the variables were not stationary in the same order.

Earlier studies adopted Engle-Granger (1987), Johansen (1988, 1991) or Johansen-Juselius (1990) to test for co-integration. This method has been criticized for its inability to be efficient when the variables were of different levels of integration (Harris, 1995; Pesaran and Shin, 1999). The aim of the paper is to examine the relative effects of monetary policy in stimulating the sectoral output growth in Nigeria.

Literature Review

The empirical evidence on monetary policy and economic growth nexus from Nigeria is not different from evidence from other developing countries. The results had been mixed without any consensus on the real effects of monetary policy. Ajayi (1974) pioneered the examination of this relationship in Nigeria. He tested the hypotheses that fiscal policy exerted a large influence on economic activity than monetary policy and that the response of economic activity to fiscal actions was more predictable than the monetary policy. The study concluded that monetary variable performed better than a fiscal variable in influencing activities in Nigeria. Ezeuduji (1994) also subjected similar hypothesis to test with larger sample data series and using different measures of monetary policy and measures of economic activities. The paper examined the implication of monetary policy on banking performance.

The study further observed that although monetary policy influence banks pattern and direction of credit, interest rate, asset structure and liquidity, among other things. The observed effects have often fallen below the desired target. Bogunjoko (1997) investigated the efficacy of monetary policy as a stabilization tool, using modified St. Louis model to take account of the peculiarity of the Nigeria economy. Using an error correction model and data covering the period 1970 to 1993; the study found that money matters in Nigeria economy and the appropriate monetary target is the domestic credit of the banking sector.

Ajisafe and Folorunso (2002) investigate the relative effectiveness of monetary and fiscal policy on economic activity in Nigeria using co-integration and error correction modelling techniques and annual series for the period 1970 to 1998. The study revealed that monetary rather than fiscal policy exerts a greater impact on economic activity in Nigeria and concluded that emphasis on fiscal action by the government has led to a greater distortion in the Nigerian economy.

Adebiyi (2006) investigated financial sector reforms, interest rate policy and the manufacturing sub-sector in Nigeria, using vector auto-regression and Error Correction Mechanism (ECM) technique with quarterly time series spanning 1986:1 to 2002:4. Unit root and Co-integration test were also performed. The study revealed that the real deposit rate and inflation rate are significant for the growth of the manufacturing sub-sector in Nigeria. In addition, the study revealed that the predominant sources of fluctuation in the index of manufacturing production are due largely to own shock and to a lesser extent, to real deposit rate. The study also showed that in the long run, the index of manufacturing production is insensitive to the inflation rate, commercial banks’ credit to the manufacturing sector, interest rate spread and exchange rate.

Folawemo and Osinubi (2006) examined the efficacy of monetary policy in controlling inflation rate and exchange instability. The analysis performed was based on a rational expectation framework that incorporates the fiscal role of the exchange rate. Using quarterly data spanning over 1980:1 to 2000:4 and applying times series test on the data used, the study showed that the effects of monetary policy at influencing the finance of government fiscal deficit through the determination of the inflation-tax rate affects both the rate of inflation and exchange rate, thereby causing volatility in their rates. The study revealed that inflation affects volatility in its own rate, as well as the rate of real exchange.

A recent study by Chimobi and Uche (2010) examined the relationship between Money, Inflation and Output in Nigeria. The study adopted co-integration and Granger-causality test analysis. The co-integrating result of the study showed that the variables used in the model exhibited no long-run relationship among each other. Nevertheless, money supply was seen to Granger cause both output and inflation. The result of the study suggested that monetary stability can contribute towards price stability in the Nigerian economy since the variation in the price level is mainly caused by money supply and concluded that inflation in Nigeria is to an extent a monetary phenomenon.

Furthermore, the findings of the study support the money-prices-output hypothesis for the Nigerian economy. Obviously, the empirical studies on monetary policy and real output growth in Nigeria are still scanty. Apart from that, their methodologies, as well as the scope, are limited. For instance, the bulk of the studies failed to examine the disaggregate effect of monetary policy. Such neglect is surprising in view of the fact that there is a significant difference in the level of modernity and development of the sectors that make up Nigeria economy. Even if monetary policy is found to significant in stimulating aggregate output, it would difficult to conclude that such results could be extended to the various sectors of the economy. Therefore there is the need to examine the sectoral output response to monetary policy also. This is challenge taken up in the subsequent section of these studies.

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This study examines the effects of monetary policy on sectoral output growth in Nigeria over the period 1986:1 to 2008:4. The study utilized an Autoregressive Distributed Lag (ARDL) model and the findings showed that manufacturing sector is not sensitive to any of the monetary policy variables.

Before estimating ARDL model, this study tested for the presence of unit roots and co-integration among the variables, following standard econometric procedure. The unit root tests on all variables are carried out using the Augmented Dickey-Fuller (ADF) test and the Phillip-Perron (PP) with intercept only. The manufacturing sector output (man) and exchange rate (ext) are stationary at levels. That is, they are integrated of order zero while agricultural output (Agric); mining output (min); building and construction output (BCN); service output (ser); wholesale and retail output (wrt) are not stationary at their level forms. Other variables such as Asset Price (ASP), consumer price index (cpi), bank credit (psc) and interest rate (int)) are also non-stationary at levels. These non-stationary variables became stationary after first differencing. The PP unit root test results also confirmed results from ADF test.

Table 1: Effects of Monetary Policy on Real Output Growth in the Long Run










Exchange rate















Interest rate















Bank credit















Stock price















Inflation rate
















The values of the variables above the parenthesis are the regression coefficient while the values in the parenthesis are the probability values of the estimates. This study examines the effects of monetary policy on sectoral output growth in Nigeria. The findings showed that manufacturing sector is not sensitive to any of the monetary policy variables. In sharp contrast with the manufacturing sector, the agricultural sector is responsive to changes in interest rate only while service and wholesale/retail economic activities are responsive to exchange rate. Furthermore, interest rate and exchange rate are the major determinants of mining output growth while building/construction sector is more responsive to changes in exchange rate and bank credit. In general exchange rate is the most important and influential monetary policy measure in Nigeria. The study concludes that monetary policy will be more effective if the inherent differences in these sectors are factor in the design of policies in Nigeria.

Conclusion and Policy Recommendation

This study examined the effects of monetary policy on sectoral output growth in Nigeria and the findings of the study showed that, to a considerable extent, different policy variables influenced the output of the sectors differently, while sector like the manufacturing was non-responsive to all the explanatory variables in the model. This, therefore, suggested that the use of a one fit for all policy instruments in stimulating output growth across sectors rather than using sector-specific measures could also be attributed to the failure of monetary policy in Nigeria.

Based on the findings of this study, output growth in the agricultural, service, wholesale/retail and building/construction sector can also be enhanced through successful management of the domestic credit through a moderate reduction in the cost of borrowing in the financial market. More so, given the significant contribution of domestic credit in influencing the output growth of some sectors, there is the need for a monetary authority to reduce the extent of unproductive credit directed to the public authority. A greater proportion of the aggregate domestic credit should be directed to the private sector at a competitive rate with strict guidelines and monitoring. This guidelines and supervision would prevent diversion of the credits to unproductive usage. Prudent use of the credit would promote investment and consequently output growth across sectors of the economy.

The findings of this study also showed that the short-term interest rate is less significant in influencing output growth across sectors of the Nigerian economy in the long run. The insignificance of the interest rate might reflect the high cost of borrowing from the financial institution, which is a disincentive to the potential investors. Therefore, the interest rate should be moderately regulated downwards to a competitive level that would enhance investment in the sectors. Furthermore, the finding of the study showed that inflation is a major clog to the output growth of the various sectors.

Thus, there is the need for the monetary authority to maintain a low and steady inflation rate that would enhance investment in the various sectors of the Nigerian economy. Finally, improving monetary policy efficiency on sectors’ output will require further regulatory reforms and the strengthening of monetary policy implementation. Several measures could be implemented in the short term to strengthen the exchange rate channel and interest rate channel. The study concluded that the existence of disparity in the sectoral response to monetary policy underscored the difficulty of conducting uniform and economic wide monetary policy in Nigeria. Therefore, the best policy approach is to adopt a sector-specific policy based on their relative strength and significance in each sector of the economy within the overall monetary policy mechanism framework.

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