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Title: Analysis of the Effects of Changes in Money Supply on Output and Price Level –
A Macro Econometric Model and A Simulation Analysis for Nigeria
Aim of the Project: The broad aim of the project is policy analysis. Utilization of the
tool of an aggregative, structural, macro econometric model to analyze the
macroeconomic effects of changes in select money supply for Nigeria can serve the
above aim.
Statement of the Problem: The problem is to strike a balance between the two
polarized approaches of the classicists and the Keynesians. While classicists profess
the dichotomy between nominal variables like money supply and prices on the one
hand and real variables like output on the other, Keynesians proclaim a positive
relationship between money supply and real output in a situation of less than full
employment. Considering that the reality remains somewhere in between these two
extreme, the model tries to capture the effects of changes in money supply on both
of price and output.
Conceptual Framework: The project work would strive to outline the framework of
a model of the Nigerian Economy that emphasizes the broad interrelationships
among money, output and prices and should be useful for policy analysis and short
term forecasting. The main linkages in the model are as follows: the stock of money
varies endogenously through the feedback from reserve money, which changes to
accommodate fiscal deficits. The price level is determined by money supply and
output. The government budget is affected by the price level and output. The latter is
influenced, among others, by changes in real money supply acting as a proxy for real
credit. While ways and means advances by/from CBN to finance public sector
investment leads to monetary expansion, the investment itself will sooner or later
lead to higher output. The fiscal stimulus to growth operates through capital
expenditures adding to the real capital stock as a factor of production and directly
affects the level of output. Another feature of the model is the endeavor to link credit
and output by introducing real money/credit as an additional variable in the
production function besides capital stock. Both variables are expected to affect
output with a lag of one year. Together with money supply and output price behavior
is the third economic indicator endogenous to the model. The forces interacting
within the economy cause changes in the behavior of prices. In this model an
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increase in credit is reflected by monetary expansion. The inflationary impact of
monetary expansion will be neutralized only to the extent of the additional output
that credit expansion would help generate. The transmission mechanism of the
monetary and output impulses works simultaneously to determine the price level
with partial adjustments over time. The extent of inflation will depend on various
elasticities quantifying the relationships among money, output and prices. To capture
their interactions, the entire process would be built into a dynamic process. In
addition the external sector consisting of export supply and export demand, import
demand and balance of payments identity is incorporated within the model. The
model would specify the supply and demand functions and try to capture the
influence of the world economy on the Nigerian economy.
Research Methodology
(a) Coverage
For all the Macroeconomic variables like GDP and real capital stock in the real
sector and money (broad as well as narrow) and prices in the monetary sector,
the values they took with respect to the Nigerian economy would be the
universe. Since statistical analysis needs enough degrees of freedom monthly
data may be needed for a sufficiently large size of sample for the period in the
21st century especially after liberalization of foreign investment and shift from
a protectionist paradigm to a liberal paradigm. While quarterly data covering
two or three decades prior to 2000 would suffice for moderately long term
analysis, monthly data would give better insight regarding the short term
behavior of the variables.
(b) Data Collection
The data are secondary in nature and to be collected from CBN statistics on
the Nigerian economy.
(c) Data Analysis
Time series econometric techniques like simultaneous equations system
involving non-stationary variables, co-integration and error correction
mechanism would be used in data processing. Eviews package can be used for
data analysis.
Implications: Since monetary policy is a key tool in achieving the twin objectives –
(i) the internal balance between inflation and unemployment; and (ii) the stability of
the exchange rate and a strong balance of payment position, inclusion of the external
sector in the model where demand for import is determined by, inter alia, real
income level and foreign exchange reserve of the country, would help ascertaining
how and whether the above tool works successfully.
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Select References
Cagan P. (1965): Determinants and Effects of the Changes in the Stock of Money
1875-1960, NBER, New York, Chapter 6
Enders W. (1995): Applied Econometric Time Series, John Wiley and Sons, New York,
Cahpters 4-6