Monetary policy transmission mechanism in Nigeria: A vecm approach

Abstract

In Nigeria, the financially repressive policies that preceded the adjustment era of the late l9S0s seem to have made the understanding of the channels of monetary transmission more difficult due to interest rate stickiness. This study analyses the role of bank credit and credit rationing in the monetary transmission mechanism in Nigeria. Tlie Granger Causality tests on the variables of the cointegrating vector atitoregressive (VAR) model indicated that one-way relationships existed between bank credit and real GDP, money supply and prices and investment and real GDP with the causation running from credit to output, from money supply to real GDP and from investment to real GDP. The impulse response analysis showed that an unexpected shock to interest rate caused a significant decline in the level of real GDP and real GDP also responded significantly to bank credit innovations. The variance decomposition of the estimated cointegrating VAR model revealed that shocks to output and investment were found to be significant in explaining variability in real investment, accounting for 35 and 54 per cent respectively of one year forecast variance in investment. Shocks to investment and the price level accounted for the highest proportion in price forecast variance. Drawing from the findings of this study, it was inferred that the two broad channels of monetary transmission mechanism - the interest rate and the credit channels, played significant roles in the transmission of monetary impulse to the real sector in Nigeria.