Analysis of the Impact of Monetary Policy Innovations in Nigeria

Abstract

This study examined the implications of monetary policy refinements on price stability and other key macroeconomic variables such as output gap, exchange rate, interest rate, and the Central Bank of Nigeria (CBN) operating target-reserve money. It estimated the traditional and innovation-induced- ‘elevated’ monetary policy rule for Nigeria using Markov-switching to track state-dependent variables in order to accommodate structural breaks or multiple-state phenomena. In addition, it employed a nonlinear autoregressive distributed lag (NARDL) model to estimate the asymmetric effects of monetary policy responses to both the traditional and ‘elevated’ monetary policy rule. The study found that conventional monetary policy (CMP) continues to be active in achieving price stability in the persistent state or the first phase of volatility transition in prices, implying that recalibrating monetary policy using unconventional monetary policy (UMP) instruments such as QE in this state renders it impotent and passive. In the moderate state, CMP is impotent and only UMP can reduce price volatility. Attempt to deploy CMP in the moderate state distorts the economy by increasing price volatility. The study found evidence of short and long run asymmetric effects in the monetary policy reaction function of the CBN, an indication that macroeconomic variables have a ‘ratchet-effect’ kind of behaviour, as such, monetary policy responses should be asymmetric in order to adequately track this dynamism. Finally, targeting a zero-level inflation regime would be both implicitly (output gap consequences) and explicitly (inflation consequences) expensive, implying that prioritizing inflation requires aggressive adjustments to the policy rate to moderate its indirect impact on the output gap and aggregate actual output in the economy. The study identified states within which a macroeconomic variable could pose either a moderate or persistent risk to the economy but did not provide the signals or characteristics it exhibits when it approaches any of the identified states, and we recommend this for future study.