Abstract:

The main responsibility of the Central Bank of Nigeria (CBN) is to formulate and implement monetary policy, with the primary objective of maintaining stable prices conducive to balanced and sustainable economic growth in Nigeria. It also aims to promote and preserve monetary and exchange rate stability as well as ensure a stable and sound financial system. Nigeria’s monetary policy is anchored on a monetary targeting framework, and price stability represents the overriding objective of monetary policy. The transmission mechanism needs to be continually strengthened. Consequently, there is need to fine-tune the monetary policy framework so that transmission can be more effective and clear and the economic agents can view monetary authority actions as credible. Understanding monetary authorities' behaviour is fundamental and often appears to be a daunting task. Nevertheless, the question on whether rules or discretion should be used to conduct the monetary policy is still unresolved. Thus, the objective of this paper is to estimate a monetary policy reaction function for the Central Bank of Nigeria (CBN) and examine the relevance of the Taylor’s rule in the management of interest rate and inflation for Nigeria. The data utilised spanned 2000:q1 to 2018:q4, sourced from the CBN database. The paper estimated two models of monetary policy reaction function (policy rate and monetary base) for Nigeria. After pre-estimation analysis, it adopted the technique of autoregressive distributed lag (ARDL) which captures the long-and short-run dynamics of the relationship among the variables. The findings indicated that the monetary authorities should constantly track the inflation gap, output gap as well as the divergence in exchange rate differentials between the official exchange rate, bureau de change (BDC) and the prime lending rate cum all-share index. This is critical, given that Nigeria is a major oil exporting country and the volatility in the international oil price is transmitted directly to the economy through its impact on exchange rates. Furthermore, the results indicate that the Bank reacts to a widening gap in the exchange rate premium, which implies that the Bank considers the exchange rate when designing monetary policy in order to avoid exchange rate misalignment and ensure stability of the currency.

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