JOURNAL OF ECONOMIC AND SOCIAL RESEARCH (JESR) VOL. 10 NO.

I, JUNE 2024

Monetary Policy Rate and Performance of the Nigerian

Economy: A Simulation Analysis
Hannah Ehi Onuh and Terwuah Simeon Asom
Department of Economics, Benue State University, Makurdi-Nigeria

Abstract
This study investigated the impact of monetary policy rate on the performance of the Nigerian economy by
focusing on the macroeconomic variables of aggregate demand, total output production and inflation. The
study used quarterly data on the Nigerian economy from 2006Q4 to 2022Q4. The study simulated the
impact of 5% increase and 5% decrease in the monetary policy rate on aggregate demand, total output
production and inflation. The study revealed that increasing the monetary policy rate was ineffective in
controlling inflation in Nigeria. An increase in the monetary policy rate caused an increase in the interest
rate, which in turn affected the supply of credit to the private sector. A reduction in the credit supply to the
private sector has adverse consequences for aggregate demand and total output production in the
economy. Also, the study concludes that decreasing the monetary policy rate in the country has the
propensity to increase the credit supply to the private sector, with a potential positive impact on aggregate
demand and total output production and, consequently, GDP growth in the economy. Therefore, the Central
Bank of Nigeria (CBN) should consider the option of lowering the monetary policy rate (MPR) to stimulate
economic and output growth. This would reduce interest rates, especially lending rates, and consequently
increase the credit supply to the private sector in the economy. It is also recommended that the CBN
continue to employ the monetary policy rate to effect changes in the credit supply and its accessibility to
the private real economy.
Keywords: Aggregate demand, inflation, macroeconomic performance, monetary policy, total output

1. Introduction
Monetary policy is a deliberate action of monetary authorities to influence the quantity, cost,
and availability of money credit to achieve the desired macroeconomic objectives of internal and
external balances (Central Bank of Nigeria, (CBN) 2021). According to Hassan and Oyedele (2022),
monetary policy is a policy framed and controlled by a central bank with the help of a monetary policy
committee through the monetary policy rate (MPR) to regulate the supply of money in an economy. The
MPR in Nigeria was introduced in 2006 to replace the minimum rediscount rate (MRR). There are two
types of monetary policy situations, namely, expansionary and contractionary monetary policy (CBN,
2021). Expansionary monetary policy helps in supplying money to the economy by reducing interest
rates when there is less liquidity. Hence, it is used during recessions. Contractionary monetary policy
helps reduce excess liquidity and inflation in the economy by increasing interest rates so that the money
supply will become limited and, automatically, inflation will decrease (Nikhil & Deene, 2021).
The MPR is an important monetary policy tool for influencing the performance of an economy
via inflation, output growth, aggregate demand, and exchange rate stability. The monetary policy rate
serves as the fundamental benchmark interest rate to which other rates are added (Obi, 2020). This
represents a short-term rate at which banks have the option to secure loans from monetary authority,
facilitating lending by deposit money banks to individuals, businesses, corporations, and the
government. When the monetary policy rate of the Central Bank of Nigeria increases, it becomes more
expensive for banks to borrow money from the central bank. As a result, commercial banks increase
their lending rates to consumers and businesses, which leads to higher borrowing costs. This can slow
economic growth, as businesses may reduce investments, and consumers may reduce spending due to
higher interest rates. Conversely, when the Central Bank lowers the monetary policy rate, borrowing
costs decrease, leading to increased investments and consumer spending. This can stimulate economic
growth and help boost employment levels in the country. However, if interest rates are lowered too
much, inflationary pressures can occur in the economy (CBN, 2021).

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Empirically, the relationship between the monetary policy and economic performance of
Nigeria was investigated by Acha and Enow (2023), Babatunde, and Olasunkanmi (2023), Ogar (2022)
and Nwobia, Ogbonnaya-Udo, and Ezu (2020); however, none of these studies examined the effect of
contractionary and expansionary monetary policy rates on the economic performance of the country.
Leaving a scholarly gap. Against this backdrop, this study investigated the effects of variations in the
monetary policy rate on aggregate demand, total output production, and inflation in Nigeria. By
employing simulation analysis, offers a comprehensive depiction of the impacts of contractionary and
expansionary MPR policies.
The remaining sections of the paper are structured as follows: Section 2 captured the literature
review, Section 3 comprise of the methodology, Section 4 contains results and findings, and lastly,
Section 5 comprise of the study's conclusions and recommendations.

2.0 Literature review

2.1 Theoretical framework
Hicks IS-LM Framework: The modern theory of interest rates, also known as the Hicks IS-LM curve,
posits that the real income and rate of interest are influenced by both goods market forces and money
market forces. This theory elucidates the interplay between the commodity market and the money
market, providing a comprehensive understanding of interest rate determination. It encompasses key
factors such as liquidity preference, investment, savings, and money supply in influencing the actual
income and interest rate. This determination is facilitated through the utilization of IS-LM curves. The
IS curve emerges from the interplay of savings and investment in the commodity market, signifying the
balance between the interest rate and income level in the goods market. Conversely, the LM curve arises
from the interaction of liquidity preference and money supply, representing the equilibrium in the
money market at various income levels. Consequently, the IS-LM curves collectively ascertain the
national income and interest rate in the short term when price levels remain fixed.
The influence of monetary policy changes on the interest rate, given a specific income level,
reveals that the equilibrium interest rate relies on the availability of real money balances. For example,
if the monetary authority decides to augment the money stock while holding real money balances
constant, it will lead to a decrease in the interest rate. This causes a downward movement in the LM
curve, ultimately achieving equilibrium in the money market at a lower interest rate. On the other hand,
if the money supply decreases, the interest rate will increase. This positive movement in the LM curve
results in a higher interest rate, leading to stability in the money market at an elevated interest rate.
Consequently, the LM curve demonstrates a positive association between income and the interest rate.
Monetarist theory: In response to the criticisms directed at Keynesian theory, Friedman (1956)
introduced the monetarist theory. However, Friedman (1968) contended that monetary policy should
solely focus on influencing the quantity, cost, and flow of money since inflation is inherently tied to
monetary factors across all contexts. He acknowledged that temporarily increasing the money supply
might lower unemployment, but it can also trigger inflation. As a result, monetary authorities should
exercise caution in their actions. Monetarist theorists relied on Fisher's equation of exchange to
demonstrate their arguments. Fisher's equation provided a framework for their thesis, and according
to this equation:

MV = PQ

where M denotes the money supply, V denotes the circulation velocity, P refers to the price level, and Q
is the output produced.
The significance of this equation lies in its implication that doubling the money stock within the
economy will lead to a corresponding doubling of the price. Furthermore, in the scenario where there
is a 10% increase in the money supply, the price level will correspondingly increase by 10%. Monetarist
economists, such as Friedman (1956; 1963), highlighted the crucial role of the money stock in the

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10 NO. S. Asom
JUNE 2024

overall well-being of the economy. They argued that rather than being subject to discretionary control
by the CBN, the money stock should expand at a consistent rate to promote stable growth. Additionally,
Friedman asserted that changes in the money supply directly and indirectly influence investment and
expenditure, as money serves as a substitute for various goods, services, and bonds. Monetarists firmly
believe that alterations in the supply of money have an immediate influence on the actual amount of
money in circulation. They maintain the perspective that the CBN has the capacity to influence the real
sector of the economy via open market operations.

2.2 Empirical Review

Acha and Enow (2023) examine the effect of indirect monetary policy on the performance of
the Nigerian economy from 1993 to 2020. The study revealed that the monetary policy rate and liquidity
ratio have detrimental effects on the performance of the Nigerian economy, while open market
operations and the cash reserve ratio have positive effects on the performance of the Nigerian economy.
The study concluded that indirect monetary policy contributed positively to the performance of the
Nigerian economy within the study period.
In a similar vein, Babatunde and Olasunkanmi (2023) examined the impact of monetary policy
on economic performance in sub-Saharan Africa from 2005 to 2019. This study employs the Blundell
and Bond system GMM technique for the estimation. This study revealed that monetary policy was an
important factor in the determination of economic performance in sub-Saharan African countries.
Furthermore, Ogar (2022) investigated the interplay among the monetary policy rate, inflation,
and economic growth in Nigeria from 2007Q1 to 2017Q4. Employing the SVAR methodology, the study
found that the monetary policy rate exerts a favourable and statistically substantial correlation with the
monetary policy rate. Additionally, the money supply spurs the level of output, whereas inflation
impedes economic growth in Nigeria.
The effects of monetary policy on selected macroeconomic variables in the Nigerian economy
from 1981 to 2019 were examined by Nwobia, Ogbonnaya-Udo, and Ezu (2020). Vector autoregressive
and least regression analysis techniques were used for the data analysis. The study results revealed that
monetary policy has a nonsignificant positive relationship with real gross domestic product but has a
significant positive effect on the inflation rate.

3.0 Methods
This research utilized an ex post facto research design to examine the influence of changes in
the monetary policy rate on various aspects of the Nigerian economy, including the interest rate
structure, aggregate demand, total output production, and inflation during the period from 2006Q4 to
2022Q4. The study included the following variables: monetary policy rate (MPR), prime lending rate,
interbank lending rate, private final consumption expenditure, credit to the private sector, inflation rate,
exchange rate, and real gross domestic product through the Central Bank of Nigeria (CBN) Statistical
Bulletin and reports from the National Bureau of Statistics.

3.1 Model Specification

The models for the study were built using the modelling procedure outlined by the CBN (2017)
and IS-LM framework. Thus, the study built three models to (i) examine the effect of MPR on aggregate
demand, (ii) examine the effect of MPR on total output production and (iii) examine the effect of MPR
on inflation. The models are specified below:

Model I: To capture the effect of the MPR on aggregate demand in Nigeria, the model is specified as:
PCE  f (CPS , DLR, MPR, INFL)
where PCE = Private final consumption expenditure, CPS = Credit to the private sector; DLR =
Differential between maximum and prime lending rates of deposit money banks; MPR = Monetary
Policy Rate; and INFL = Inflation Rate

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Model II: To capture the effect of the MPR on total output production in Nigeria, the model is specified
as follows:
TOP  f (CPS , MPR, INFL, EXCH )
where TOP = total output production, CPS = credit to the private sector, MPR = monetary policy rate,
INFL = inflation rate and EXCH = exchange rate.

Model II: To capture the effect of the MPR on inflation in Nigeria, the model is specified as:
INFL  f ( RGDP, MPR, EXCH , CPS )
where INFL = Inflation, RGDP = Real Gross Domestic Product, MPR = Monetary Policy Rate, EXCH =
Exchange Rate, and CPS = Credit to the private sector.

3.2 Method of Data Analysis

This study utilized both descriptive and analytical techniques to examine the data. Descriptive
statistics and graphical methods were employed to provide a comprehensive analysis of the variables
under investigation, presenting various properties and characteristics. Alongside descriptive statistics,
the Augmented Dickey Fuller and KPSS tests were utilized for the purpose of examining the data for
stationarity. Furthermore, the vector autoregressive (VAR) model was employed to estimate the models
that address the study’s objectives. To assess the effect of the set of scenarios, simulation experiments
were conducted within the framework of the VAR model. For the simulation experiments, the sample
period of 2006Q4-2018Q4 was utilized for within-sample simulations, while the out-of-sample
simulation period ranged from 2019Q1 to 2022Q4. A baseline simulation was compared against the
policy shocks introduced by the MPR adjustments, enabling an evaluation of the effects of the MPR on
aggregate demand, total output production, and inflation in Nigeria.

4. Results and Findings

Before the models in this study were estimated, the series used in the models were subjected to
descriptive statistical analysis and unit root tests.

4.1 Descriptive Statistics

The descriptive properties of the series were computed, and the results are presented in the following
tables.

Table 1: Descriptive Statistics

RGDP(N) MPR (%) INTR (%) INFL (%) EXCH (N-$) CPS (N) PCE(N)
Mean 4.577402 11.01480 16.39449 11.94432 164.5371 9285.080 44501.56
Median 4.685442 9.916667 16.52000 12.15626 149.5891 8011.274 32940.02
Maximum 5.239369 14.00000 24.85000 18.87365 306.9400 22521.93 108468.2
Minimum 3.640928 6.000000 11.50000 5.388008 21.88610 200.1593 2405.094
Std. Dev. 0.513486 2.237821 3.187446 3.578147 78.11867 8515.284 38417.59
Skewness -0.476162 -0.309205 0.528463 0.070369 0.401142 0.340008 0.467263
Kurtosis 1.893764 2.573264 3.045650 2.152880 2.570890 1.503015 1.662621
Jarque-Bera 9.232941 2.446317 4.849762 3.195483 3.587104 11.71468 11.53500
Probability 0.009888 0.294299 0.088489 0.202353 0.166368 0.002859 0.003128
Observatio
ns 65 65 65 65 65 65 65
Source: Authors’ Computation using E-view 10

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Table 1 shows that between 2006Q4 and 2022Q4, RGDP, MPR, INTR, INFL, EXCH, CPS and PCE
averaged N4.58 billion, 11.01%, 16.39%, 11.94%, N164.54, N9,285.08 billion and N44,501.56 billion,
with peaks of N5.24 billion, 14.00%, 24.85%, 18.87%, N306.94, N22,521.93 billion and N108,468.20
billion, respectively. The corresponding minimum values of RGDP, MPR, INTR, INFL, EXCH, CPS and PCE
are N3.64 billion, 6.00%, 11.50%, 5.39%, N21.89, N200.16 billion and N2405.09 billion, respectively.
These results indicate that the series have moving trends, as their values vary with time. Furthermore,
RGDP and MPR are negatively skewed to the left, while INTR, INFL, EXCH, CPS and PCE are positively
skewed to the right. It was revealed that RGDP, MPR, INFL, EXCH, CPS AND PCE are platykurtic except
for the INTR, which is mesokurtic. The Jarque-Bera statistic indicated that the MPR, INTR, INFL, and
EXCH are normally distributed, while the RGDP, CPS and PCE are not normally distributed.

4.2 Unit Root Test Results

Second, to avoid spurious estimates, the series were subjected to unit root tests. In doing so, the
augmented Dickey-Fuller (ADF) test and Kwiatkowski-Philips-Schmidt-Shin (KPSS) test were used. The
results are presented in the following tables.

Table 2: Unit Root Tests Results

Variable ADF KPSS
At Levels P First Critical P- LM. Critical Order of
Values Difference Values Value Stat Values Integration
RGDP -1.99894 0.1384 -10.654 -2.8906 0.000 0.1275 0.1460 I(1)
MPR -2.60055 0.2811 -9.9841 -3.45447 0.000 0.0451 0.1460 I(1)
DLR -2.92793 0.314 -10.001 -2.89003 0.000 0.1900 0.4630 I(1)
INFL -3.24093 0.0824 -9.9575 -3.45447 0.000 0.0486 0.1460 I(1)
EXCH -2.42509 0.3646 -10.179 -3.45447 0.000 0.0913 0.1460 I(1)
CPS -2.63228 0.267 -9.9828 -3.45447 0.000 0.1520 0.4630 I(1)
CONS -2.34318 0.4070 -11.105 -3.45447 0.000 0.1140 0.1460 I(1)
Source: Author’s Computation from E-views 10

The results of the stationarity tests in Table 2 show that all variables were stationary at the first
difference, according to both the ADF and KPSS tests. This means that the series have a mean reverting
ability in the long run; the implication is that any shock to the series will taper off over time.

4.3 Simulating the Effects of Changes in MPR on the Performance of Nigerian Economy
4.3.1 Simulating the Effects of Changes in MPR on Aggregate Demand in Nigeria
To ascertain the impact of changes in MPR on aggregate demand, the study simulated 5%
increase and 5% decrease in MPR and the results of the experiments are presented in Table 3.

Table 3: Simulation Results of 5% Increase and 5% Decrease in MPR

5% Increase in MPR 5% Decrease in MPR
Variables Within Sample Out-of-sample Within sample Out-of-sample
PCE -0.004 -0.001 0.145 0.218
CPS -0.005 -0.018 0.019 0.023
DLR 0.370 0.481 0.002 0.004
INFL -0.014 -0.008 0.057 0.048
Source: Author’s Computations using E-views 10

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The result in Table 3 shows the simulated results for 5% increase in MPR and 5% decrease in
MPR. The table indicated that, a 5% increase in MPR would marginally reduce private consumption
expenditure by 0.004% for the within sample forecast and would marginally reduce private
consumption expenditure by 0.001% for out-of-sample forecast. This result suggests that increasing
MPR which represents a contractionary monetary policy stance would exert a detrimental effect on the
consumption patterns of households and firms in the economy. Also, the results showed that a 5%
increase in MPR would marginally reduce credit to the private sector both within and the out-of-sample
forecast. That is, 0.005% and 0.018%, respectively. This suggests that credit channel of the monetary
policy transmission in the country is weak.
Furthermore, the table indicated that increasing MPR by 5% would increase the differential or
the spread between the maximum lending rate and the prime lending rate by 0.37% for the within
sample forecast and 0.48% for the out-of-sample forecast. This suggests that the spread between the
maximum lending rate and the prime lending rate has relatively high interest rate elasticity. That is, it
is moderately variant to the official interest rate. Again, the results revealed that increasing MPR by 5%
would marginally reduce inflationary pressures by 0.14% for the within sample forecast and 0.008%
for the out-sample forecast. The implication of this outcome is that incremental changes in the MPR are
propitious in influencing inflationary pressures in the country. Though, the response is very low to
notice the impact.
On the other hand, by decreasing the MPR by 5%, aggregate private consumption increased by
0.145% for the within sample forecast and 0.218% for the out-of-sample forecast. This suggests that
private consumption appears to be more responsive to decrease in MPR than increases to MPR in the
country. For credit to the private sector, a 5% reduction in the MPR has increased the credit to private
sector by 0.019% for the within sample forecast and 0.023% for the out-of-sample forecast. This
scenario also indicates that the credit channel is weak in transmitting monetary policy; however, the
elasticity appears to increase with increasing MPR.
For the spread between the maximum lending rate and the prime lending rate, increasing the
MPR by 5% marginally increased it by 0.002% for the within-sample forecast and 0.004% for the out-
of-sample forecast. This suggests that the spread between the maximum lending rate and the prime
lending rate is more sensitive to increases in the official interest rate than to decreases in the official
interest rate in the country. Finally, reducing the MPR by 5% marginally increased inflation by 0.057%
for the within-sample forecast and 0.048% for the out-of-sample forecast. This suggests that inflation is
more elastic to the expansionary monetary stance than to the contractionary monetary policy stance in
the country.
Furthermore, the actual and simulated graphs for the five endogenous variables were plotted
together to examine their turning points, and the graphs presented in Figure 1.

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PCE
150,000.00

100,000.00
Values

50,000.00

0.00
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
Years

Actual Baseline

DLR
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INFL
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Figure 1: Baseline Simulation of the Endogenous Variables

A critical examination of the graphs shows that for all the graphs, the simulated could replicate the
critical turning points of the actual data, implying that the model is appropriate for policy analysis and
projection of the monetary and other macroeconomic variables in the Nigerian economy.

4.3.2 Simulating the Effects of Changes in MPR on Total Output Production in Nigeria
To examine the impact of changes in MPR on total output production in Nigeria, the study
simulated 5% increase and 5% decrease in MPR and the results of the experiments are presented in
Table 4.

Table 4: Simulation Results of 5% Increase and 5% Decrease in MPR

5% Increase in MPR 5% Decrease in MPR
Variables Within Sample Out-of-sample Within sample Out-of-sample
TOP -0.043 -0.038 0.035 0.067
CPS -0.028 -0.032 0.021 0.026
INFL -0.001 -0.051 0.052 0.049
EXCH -0.037 -0.039 0.471 0.433
Source: Author’s Computations using E-views 10

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Table 4 shows the simulated results for 5% increase in MPR and 5% decrease in MPR. The table
indicated that, a 5% increase in MPR would marginally reduce total output production by 0.043% for
the within sample forecast and would marginally reduce total output production by 0.038% for out-of-
sample forecast. This result suggests that increasing MPR which is a contractionary monetary policy
stance would the funds available for production in the economy. Again, the results indicated that, a 5%
increase in MPR would marginally reduce credit to the private sector by 0.028% for the within sample
forecast and by 0.032% for the out-of-sample forecast. This suggests that credit channel of the monetary
policy transmission in the country is not strong enough.
Furthermore, the results revealed that increasing MPR by 5% would marginally reduce
inflationary pressures by 0.001% for the within sample forecast and 0.051% for the out-sample
forecast. The implication of this result is that incremental changes in the MPR are propitious in
influencing inflationary pressures in the country. Though, the response is very low to feel the impact in
the contemporary Nigerian economy. Again, the table shows that, a 5% increase in the MPR marginally
reduces the exchange rate by 0.037% for the within-sample forecast and marginally reduces total
output production by 0.039% for the out-of-sample forecast.
On the other hand, by decreasing the MPR by 5%, the total output production increased by
0.035% for the within-sample forecast and 0.067% for the out-of-sample forecast. This suggests that
total output production is more responsive to decreases in the MPR than to increases in the MPR in the
country. Additionally, a 5% reduction in the MPR increases the credit to the private sector by 0.021%
for the within-sample forecast and 0.026% for the out-of-sample forecast. In this case, the credit channel
is weak in transmitting monetary policy in the economy. Furthermore, by decreasing the MPR by 5%,
inflation marginally increased by 0.052% for the within-sample forecast and 0.047% for the out-of-
sample forecast. This suggests that inflation is more elastic to the expansionary monetary stance than
to the contractionary monetary policy stance in the country. Finally, reducing the MPR by 5% increased
the exchange rate by 0.471% for the within-sample forecast and 0.433% for the out-of-sample forecast.
Furthermore, the actual and simulated graphs for the five endogenous variables were plotted
together to examine their turning points, and the graphs are presented in Figure 2.

CPS
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JOURNAL OF ECONOMIC AND SOCIAL RESEARCH (JESR)

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VOL. 10 NO. I, JUNE 2024
MONETARY POLICY
JOURNAL OF RATE AND
ECONOMIC ANDPERFORMANCE OF THE(JESR)
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E. Onuh andI, T.
10 NO. S. Asom
JUNE 2024

TOP
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Figure 2: Baseline Simulation of the Endogenous Variables

A close look at the graphs reveals that the simulated values could replicate the critical turning
points of the actual data for all the graphs. This implies that the model is appropriate for policy analysis
and the projection of monetary and other macroeconomic variables in the Nigerian economy.

4.3.3 Simulating the Effects of Changes in MPR on Inflation in Nigeria

To examine the impact of changes in MPR on inflation in Nigeria, the study simulated 5% increase and
5% decrease in MPR and the results of the experiments are presented in Table 5.

Table 5: Simulation Results of 5% Increase and 5% Decrease in MPR

5% Increase in MPR 5% Decrease in MPR
Variables Within Sample Out-of-sample Within sample Out-of-sample
INFL -0.007 -0.009 0.022 0.031
RGDP -0.016 -0.021 0.047 0.038
EXCH -0.011 -0.023 0.019 0.029
CPS -0.026 -0.029 0.671 0.589
Source: Author’s Computations using E-views 10

The Table 4 shows the simulated results for 5% increase in MPR and 5% decrease in MPR. The
table indicated that, a 5% increase in MPR would marginally reduce total output production by 0.043%
for the within sample forecast and would marginally reduce total output production by 0.038% for out-
of-sample forecast. This result suggests that increasing MPR which is a contractionary monetary policy
stance would the funds available for production in the economy. Again, the results indicated that, a 5%
increase in MPR would marginally reduce credit to the private sector by 0.028% for the within sample
forecast and by 0.032% for the out-of-sample forecast. This suggests that credit channel of the monetary
policy transmission in the country is not strong enough.
Furthermore, the results revealed that increasing MPR by 5% would marginally reduce
inflationary pressures by 0.001% for the within sample forecast and 0.051% for the out-sample
forecast. The implication of this result is that incremental changes in the MPR are propitious in
influencing inflationary pressures in the country. Though, the response is very low to feel the impact in
the contemporary Nigerian economy. Again, the table shows that, a 5% increase in MPR would
marginally reduce exchange rate by 0.037% for the within sample forecast and would marginally reduce
total output production by 0.039% for out-of-sample forecast.

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On the other hand, by decreasing the MPR by 5%, total output production increased by 0.035%
for the within sample forecast and 0.067% for the out-of-sample forecast. This suggests that total output
production is more responsive to decreases in MPR than increases in MPR in the country. Also, a 5%
reduction in the MPR has increased the credit to private sector by 0.021% for the within sample forecast
and 0.026% for the out-of-sample forecast. In this case too, the credit channel is weak in transmitting
the monetary policy transmission in the economy. Furthermore, by decreasing the MPR by 5%, inflation
has marginally increased by 0.052% for the within sample forecast and 0.047% for the out-of-sample
forecast. This suggests that inflation is more elastic to expansionary monetary stance than
contractionary monetary policy stance in the country. Finally, by reducing the MPR by 5% has increased
exchange rate by 0.471% for the within sample forecast and 0.433% for the out-of-sample forecast.
Furthermore, the actual and simulated graphs for the five endogenous variables were plotted
together to examine their turning points and the graphs presented in Figure 3.

CPS
25000
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INFL
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10
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EXCH
400
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values

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0

2014
2015
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Years Baseline

EXCH
400
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values

200
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RGDP
6

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0
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2017
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Actuals Baseline

Figure 3: Baseline Simulation of the Endogenous Variables

A critical look at Figure 3 reveals that, the simulated values could replicate the critical turning
points of the actual data for all the graphs. This implies that, the model is appropriate for policy analysis
and projection of the monetary and other macroeconomic variables in the Nigerian economy.

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4.4 Discussion of Findings

The study used two simulation experiments by increasing the MPR by 5% and decreasing the
MPR by 5% to ascertain the impact of changes in MPR on aggregate demand, total output production
and inflation in the Nigerian economy. The study found that, by increasing the MPR by 5% tends to
increase the spread between the maximum lending rate and prime lending rate in the country. The
increase in this spread between the two rates in turn reduces credit accessibility to the private sector.
The reduction in credit supply to the private sector due to the hike in interest rate exerts negative
impact on the aggregate demand defined in this study as the private final consumption expenditure.
These findings are in line with the findings of Bianco (2021), Breitulechner and Scharler (2021),
Benehon and Fantino (2021) and Olofinlade and Azeez (2021), who found in different economies that
an increase in the interest rate affects the credit channel of the monetary policy transmission
mechanism.
The study also found that reducing the MPR by 5% marginally increased the spread between
the maximum lending rate and the prime lending rate; however, the impact is insignificant; as such, the
supply of credit to the private sector has increased, leading to an increase in private final consumption
expenditures. The implication of this finding is that an expansionary monetary policy stance enhances
the credit supply in the economy. This finding agrees with the findings of Yunusa et al. (2020), Ahmed
(2020), Mukolu and Adeleke (2020), and Olofinalade, Oloyede and Oke (2020), who concluded that a
reduction in the bank lending rate positively impacts other monetary and macroeconomic variables in
an economy.
Furthermore, the study revealed that increasing the MPR by 5%, which is a contractionary
monetary policy, reduces the supply of credit to the private sector due to hikes in interest rates. This in
turn exerts a detrimental effect on the total output production in the country since investors do not have
enough capital to carry out investment activities. This finding corroborates the findings of Afolabi,
Adeyemi, Salawudeen and Fagbemi (2018), Anwar and Nguyen (2018) and Vithessonthi, Schwaninger
and Muller (2017), who, in their different studies in different economies, concluded that bank loan
availability exerts substantial influence on firms’ investment decisions.
Again, the findings of the study showed that reducing the MPR by 5% increased the availability
of bank loans to private investments, which translates to an increase in total output production in the
economy. The implication of this is that the expansionary monetary policy stance of the monetary
authorities reduces the lending rate, thereby making borrowing for investment profitable to investors.
These findings are in line with the findings of Chaiporn, Markus and Mathias (2017) and Chukwu and
Ogbonnaya-Udo (2020), who found that low lending rates stimulate investment and output growth in
an economy.
Finally, the study revealed that increasing the MPR by 5%, which is a contractionary monetary
policy, has an insignificant impact on reducing inflationary pressures in the economy, while decreasing
the MPR, which is an expansionary monetary policy stance, appears to have exerted a more noticeable
incremental impact on inflation in Nigeria. This finding agrees with the findings of Olofinlade, Oloyede
and Oke (2020) and Ogar (2022), who found that MPR is not effective in curtailing inflationary
pressures in the Nigerian economy.

5. Conclusion and Recommendations

Based on the findings of this study, it is concluded that increasing the monetary policy rate is
ineffective in controlling inflation in Nigeria. Increasing monetary policy in Nigeria, as a contractionary
monetary policy stance, has caused an increase in the interest rate, which in turn affects the supply of
credit to the private sector. A reduction in the credit supply to the private sector has adverse
consequences for aggregate demand and total output production in the economy. Additionally, the
study concludes that decreasing the monetary policy rate in the country as an expansionary monetary
policy stance has the potential to increase the credit supply to the private sector, with a potential

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positive impact on aggregate demand and total output production and, consequently, GDP growth in the
economy. The study recommended the following:
i. The Central Bank of Nigeria (CBN) should consider the option of lowering the monetary policy rate
(MPR) to stimulate economic and output growth. This would reduce interest rates, especially lending
rates, and consequently increase the credit supply to the private sector in the economy.
ii. It is also recommended that the CBN continue to employ changes in its monetary policy rate as a
monetary policy trigger to effect changes in credit supply and accessibility to the private real
economy. Through such measures, there would be changes in credit market expectations and, hence,
the behaviour of credit institutions. It is through such a mechanism that the interest rate and credit
effects positively impact other financial institutions in their financial intermediation operations, as
well as the foreign exchange market and exchange rate pass-through in the economy.
iii. The CBN and financial institutions should design appropriate credit structural facilities within the
framework of the financial institutions, especially money deposit banks and other banking
institutions, to provide special credit windows for low-creditworthiness and vulnerability
enterprises in the real sector with the aim of enhancing the potency of the credit channel of monetary
policy transmission, which was found to be weak in the economy.
iv. To effectively control inflationary pressure in the Nigerian economy, which could arise not
necessarily from interest rate changes but from other production costs, especially from a
depreciated exchange rate, cost-push dynamics, the mark-up pricing mechanism in the production
process, and the phenomenon of imported inflation, a robust monetary-fiscal policy mix is
imperative. Thus, government fiscal operations and instruments are needed to have a proper
handshake with monetary policies, and such an optimal policy mix would help to attain
noninflationary output growth in the economy.

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