On the relationship between monetary policy and inflation in Nigeria: a structural VAR approach

This paper examines the effect of monetary policy on inflation in Nigeria by employing the Structural Vector Autoregression Model and utilizing monthly data on the relevant variables for the period January 2008 to June 2016. The Augmented Dickey Fuller test for unit root was employed to test stationarity of the variables, the result shows all variables to be integrated of order one, implying that the variables only became stationary after taking their first difference. The Johansen Cointegration test was employed to test whether or not the variables have long run association. Findings of the Johansen test shows the presence of cointegration among the variables. Impulse Response Function result from the Structural VAR model shows the interest rate channel of monetary policy as having a contemporaneous short-lived negative effect on inflation after which a mild positive effect is noticed and far into time horizon, a long-lived negative effect sets in. Money supply channel was found to have no significant effect on inflation in the short run, but after some period time horizon, the effect was found to become negative and long-lasting period. Exchange rate channel was found to exhibit a mild negative effect on inflation at the outset, but after some time period horizon, the effect fizzles out and afterwards, a mild positive long lasting effect sets in. Credit channel of monetary policy was found to exert an almost no significant effect on inflation in Nigeria. The study indicates that interest rate is found to be the most effective channel of monetary policy that can be employed to curb inflation in the short run. Over the medium term, money supply was found to be effective in reducing inflation. The study stressed the note that the Nigerian inflation is more of supply side than demand side, hence more efforts should be directed towards reducing inflation, particularly from the supply angle.