Monetary Policy Under Inflationary Pressure: Causal and Long-Run Evidence from Nigeria

The paper examines how monetary policy and inflation have interacted and how this interaction pattern has changed between 1990 and 2023 in Nigeria. It also analyses the change of both variables over-time by evaluating the degree to which the monetary policy affects inflation, as well as examining whether there is a causal relationship between monetary policy action and inflationary results during the study period. In an effort to achieve these goals, the research uses yearly time-series data of money supply, interest rate, gross domestic product (GDP), exchange rate and inflation, which were extracted from World Development Indicators (WDI) database. To address the second objective, the study utilise the Dynamic Ordinary Least Squares (DOLS) technique to provide an evaluation of the long-run relationship between the variables and to overcome the endogeneity problems that may arise. In the third objective, causal linkages were tested using the Toda-Yamamoto causality framework. Before model estimation, a sequence of preliminary statistical tests was performed in order to get to know the characteristics of the data. These are descriptive statistics, correlation analysis, unit root test, as well as selection of lag length and Johansen cointegration test. The findings demonstrate that there is long run positive statistical significance between money supply and inflation with coefficient of money supply being 0.756 (t-statistic ≈ 4.89, p ≈ 0.01). On the other hand, the interest rates show zero but statistically significant negative correlation with inflation rate with a coefficient of -0.234 (t-statistic ≈ -2.17, p < 0.05). The DOLS model is associated with a good level of explanatory power, showing a value of 0.78 adjusted R-squared, and thus implying that monetary policy variables are associated with a large part of long-run inflation trends in Nigeria. Nevertheless, Toda-Yamamoto causality results fail to support the short-run causality between money supply or interest rates and inflation. Interestingly, the marginal evidence (p ≈ 0.08) is that inflation can Granger-cause money supply changes, and this denotes the reactive monetary policy framework in Nigeria. Overall, the results indicate that the monetary policy of Nigeria is largely reactive, where inflation has a greater impact on liquidity changes compared to proactive monetary policy countering the effects of inflation. By employing econometric techniques such as DOLS and the Toda-Yamamoto causality framework, this study enriches the empirical literature on inflation management in developing economies and provides valuable insights for designing more forward-looking and effective monetary policy strategies in Nigeria.