ABSTRACT
This study examines the determinants of the broad money demand and its stability in Nigeria over the quarterly period 1991:Q1 to 2014:Q4. Most studies on the determinants and stability of the money demand function have been focused on the advanced economies. Only a few empirical studies are focused on the demand for money in Nigeria, differing by time period, monetary aggregate, data frequency and model specification. The specific objectives were to: (i) evaluate how income, interest rate, inflation rate, exchange rate and foreign interest rate affect the quantity of money demand in Nigeria, (ii) examine the money demand function and to understand its long-run cointegrating relationship with the selected macroeconomic variables and (iii) study the short-run dynamics of the money demand function in Nigeria so as to incorporate both short-term deviations and long-run expectations. The research utilizes secondary data sourced from the Central Bank of Nigeria’s statistical bulletin and the International Monetary Fund’s world economic outlook database and employs the ordinary least square regression technique, the autoregressive distributed lag modeling to cointegration and the error correction model in order to ascertain whether monetary targeting is still relevant in setting monetary policy framework in Nigeria. The findings of the study reveal that real income, domestic interest rate, inflation rate, exchange rate and foreign interest rate have a predictable impact on the quantity of money demand in Nigeria. Real income and exchange rate are positively related to the real broad money balances while domestic interest rate, inflation rate and foreign interest rate are inversely related to the demand for broad money. Also, the results indicate that a long-run relationship exists between the real broad money aggregate and its determinants. Furthermore, both the CUSUM and CUSUMSQ tests confirm that the short-run and long-run parameters of the real money demand function are robust and exhibit parameter constancy. The remarkable stability of the money demand function provides validity for the monetary authorities to target the broad money supply in its effort to achieve price and financial system stability in Nigeria.
Keywords: Broad money demand, autoregressive distributed lag, monetary policy, stability.
TABLE OF CONTENTS
Title                                                                                                       i
Certification                                                                                              ii
Approval                                                                                       iii
Dedication                                                                                     iv
Acknowledgements                                                               v
Abstract                                                                               vi
Table of Contents                                                                    vii
List of Tables                                                                                viii
List of Figures                                                                         ix
CHAPTER ONE: INTRODUCTION
- Background to the Study                                                1
- Statement of the Research Problem                                               2
- Objectives of the Study                                                          4
- Research Questions                                                                4
- Hypotheses of the Study                                                           4
- Scope of the Research                                                                    4
- Significance of the Study                                                   5
- Operational Definition of Terms
References
CHAPTER TWO: REVIEW OF RELATED LITERATURE
2.1      Conceptual Framework                          6
2.1.1   Variables in the Money Demand Function          6
2.2     Theoretical  Review                        8
2.2.1   Quantity Theory of Money              8
2.2.2    Keynes’s Liquidity Preference Theory     10
2.2.3      Further Developments in the Keynesian Approach 12
2.2.4      Friedman’s Modern Quantity Theory of Money      13
2.2.5      Distinction between the Friedman and Keynesian Theories   14
2.3         Empirical Review                                15
2.3.1      Review of International Empirical Studies            15
2.3.2      Review of National Empirical Studies                 20
2. 4        Summary of Empirical Review                     25
2.5         Knowledge Gap                                               38
2.6       Conceptual Model                             41
References
CHAPTER THREE: METHODOLOGY
3.1   Research Design                            39
3.2   Sampling Technique                               39
3.3   Specification of Models                                           39
3.4   Nature and Sources of Data                       44
3.5  Techniques of Analysis                                                44    Â
References
CHAPTER FOUR: DATA PRESENTATION AND ANALYSIS
-       Diagnostic Tests                                        46
4.1. 1  Multicollinearity Test                                   46
-   Heteroskedasticity Test                                     47
-  Autocorrelation Test                                                47
4.1.4    Stationarity Test                                                        48
-   Test of Hypothesis                                             49
-   Hypothesis One                                                            49
-   Hypothesis Two                                                                     51
-   Hypothesis Three                                                             53
-  Stability Test                                                       58
-      Interpretation of Findings                                         59
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS
5.1    Summary of Findings                                                  63
5.2    Conclusion                                                                       63
5.3   Recommendations                                                         64
5.4   Contribution to Knowledge                                     74
5.5   Suggestion for Further Research                          64
Bibliography                                                                65
Appendices
LIST OF TABLES
Table 1.1:        Review of International Empirical Studies   25
Table 1.2:       Review of National Empirical Studies        32
Table 4.1:       Correlation Matrix                                     46
Table 4.2:       Heteroskedasticity Test for the first hypothesis  47
Table 4.3:       Autocorrelation Test for the first hypothesis   47
Table 4.4        ADF Unit Root Test from M2 demand function         48
Table 4.5        Regression result of hypothesis one              50
Table 4.6:       Wald Test for cointegration             52
Table 4.7:       Error Correction Model result       54
Table 4.8:       Lag selection result                       57
LIST OF FIGURES
Figure 2.1:   Diagramatic Structure of the Determinants and Stability of Demand for Money in Nigeria                41
Figure 4.1:      Plot of cumulative sum of recursive residuals 58
Figure 4.2:Â Â Â Â Â Â Plot of cumulative sum of squares of recursive residuals 59
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
A sound monetary policy formulation presupposes theoretically coherent and empirically robust model of money demand. To monetary authorities, the stability of the money demand function is necessary for understanding how the formulation and implementation of an effective monetary policy is crucial in offsetting the fluctuations that may arise from the real sector of the economy. If the relationship between the demand for money and its determinants shift around unpredictably, the central bank loses the ability to derive results from the implementation of its policies. In such a case, variations in the money demand function is an independent source of disturbance to the economy. (Bhatta, 2013,p.1).
The identification of a stable relationship between the demand for money and its determinants provides empirical evidence that monetary targeting is an appropriate framework for economic stabilization policy (Rutayisire [as cited in Bhatta, 2013, p.1). Monetary targeting is an attempt by central banks to describe or determine the optimum money stock that will yield the desired macroeconomic objectives. Theoretically, the choice of target is normally between the stock of monetary aggregates and interest rates. Poole; and McCallum (as cited in Owoye and Onafowara, 2007, p.1) expressed that whenever the money demand function is unstable, interest rate is generally the preferred target, otherwise, the money stock remains the appropriate target.
The primary objective of the Central Bank of Nigeria (CBN), in its conduct of monetary policy, is to maintain a stable price level that supports sustainable economic growth and employment (Owoye and Onafowora, 2007,p.1). The CBN has relied on setting predetermined growth rates for the broad money (M2) as a tool for achieving price stability. This is based on the belief that inflation cannot be sustained over the long-term, if it is not accommodated by excessive growth in money supply (Doguwa, Olowofeso, Uyaebo, Adamu and Bada, 2014, p.16). In the conduct and implementation of monetary policy, the assumption that the money demand function is stable is very important, because, the money demand function is used both as a means of identifying medium term growth targets for money supply and as a way of manipulating the interest rate and reserve money for the purpose of controlling both the inflation rate and the total liquidity in the economy (Owoye and Onafowora, 2007, p.1).
Given the importance attached to money demand in the success or failure of monetary policy, it is not surprising that the demand for money is one of the most controversial and heavily researched areas in macroeconomics. If the central bank relies on control of monetary aggregates as its policy instruments, Cameron (as cited in Bhatta, 2013), states that:
it must believe in a known and reliable connection between changes in that aggregate and changes in the arguments of the money demand function in order for its policy to have predictable effects on those arguments. If instead the central bank relies on interest rates as targets and adjusts the monetary aggregate through daily reserve management to whatever level is required to hit them, instability of the demand for money could make the required reserve changes both large and unpredictable. In such a case, disorderly financial markets might well result. (p.2).
Laumas and Mehru (as cited in Ogunsakin and Awe, 2014, p.2) stipulated that the stability of money demand is crucial for the understanding of the monetary policy transmission mechanism. It is crucial because a stable money demand function means that the quantity of money is predictably related to a set of key variables that link money to the real sector of the economy. A stable money demand function always require appropriate instruments and intermediate targets of monetary policy. It enables a policy driven change in monetary aggregates so that the desired values of targeted macroeconomic variables such as fiscal policy, exchange rate, stock market, consumption expenditure, savings and investments, imports, exports, inflation and interest rates are ensured (Sober, 2013, p.32). Therefore, it is important to have knowledge of the determinants of money demand in order to ensure a stable relationship exists between these determinants and the money stock.
