Estimation of the Inflation Function under the Influence of Money Supply and the Monetary Reaction Function in Nigeria

Abstract

The need to control inflation has become one of the dominant objectives of the monetary authority in Nigeria. Therefore, the present study was aimed at investigating the inflation function under the influence of money supply and the monetary reaction function of the monetary authority. The study covered the period from 1996 to 2023. Moreover, annual time series data on inflation (proxied by the year on year CPI), monetary policy rate (MPR), money supply (proxied by M3/GDP), real gross domestic product (RGDP) and nominal exchange rate (NOMEXR) were obtained from the statistical bulletin of the Central Bank of Nigeria. The study adopted the ARDL approach in the estimation. The findings on the inflation function revealed that in the long run, money supply (M3/GDP) and nominal exchange rate (NOMEXR) exerted significant influence on inflation, but the magnitude of impact of the former on inflation was higher. The outcome also indicated that monetary policy rate (MPR) significantly influenced the rise of inflation in the short run. On the monetary reaction function, the outcome shows the stabilizing effect of output deviation, but the same could not be said of inflation deviation, which therefore implied that sustaining economic growth in the long run was prioritized by the monetary authority during the period under review. The study recommended that the monetary authority should be cautious of the growth of liquid liabilities in the economy and its influence on inflation. In addition, all relevant information on informal financial market activities should be taken into cognizance in the framing of inflation targets.