Monetary Policy, Price Stability and Economic Growth in Nigeria

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WP/04/97

Achieving and Maintaining Price Stability in Nigeria
Nicoletta Batini

© 2004 International Monetary Fund

WP/04/97

IMF Working Paper Research Department Achieving and Maintaining Price Stability in Nigeria Prepared by Nicoletta Batini1 Authorized for distribution by James Morsink June 2004 Abstract This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

This paper reviews the historical performance of monetary policy in Nigeria and discusses the relative merits of alternative monetary policy strategies that Nigeria could adopt in the future, once the many operational issues that today obstruct the conduct of monetary policy have been addressed. An analysis of external and fiscal dominance in Nigeria reveals that none of the candidate strategies is particularly appealing although, on various grounds, a long-run target for inflation combined with a free float seems to be the ultimate option. The paper shows how to design and operationalize such a regime in Nigeria when account is taken for the emerging market features of the economy. JEL Classification Numbers: O23, O24, O55 Keywords: inflation targeting, dollarization, fiscal dominance, Nigeria Author’s E-Mail Address: nbatini@imf.org

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I would like to thank Bill Allen, Menachem Katz, Jeanne Helen Gobat, Edward Nelson, Steve Nickell, and Geoffrey Wood, and participants at the 2nd Annual Conference on Financial Stability of the Money Market Association of Nigeria, held in Abuja, Nigeria, on May 1–15, 2003, for useful comments on an earlier draft. I am grateful to Stuart Lee and Imran Contractor for excellent research assistance. All errors and omissions are mine.

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Contents

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I. Introduction ............................................................................................................................4 II. A Brief History of Inflation in Nigeria: 1980–2003 .............................................................4 A. Recent Inflation Performance in Nigeria ..................................................................4 B. Viable Monetary Policy Strategies for Nigeria .........................................................7 III. Stylized Facts on Nigeria’s External Dominance and Monetary Transmission ..................9 A. Volatility of Selected Variables ................................................................................9 B. Openness .................................................................................................................12 C. Exchange Rate Pass-Through..................................................................................13 D. Commodity-Price Sensitivity..................................................................................15 E. Fiscal Sustainability and Risk Premia on Sovereign Debt ......................................16 IV. A Way Ahead for Monetary Policy in Nigeria? ................................................................18 V. Opting for Price Stability in Nigeria ...................................................................................22 A. Which Stable Prices/Free Float Regime for Nigeria?.............................................22 B. A Target for Stable Prices in Nigeria ......................................................................24 VI. Operationalizing Price Stability in Nigeria via a Simple Plan ..........................................26 A. How Should Taylor Rules be Used in Emerging Market Economies?...................28 VII. The Historical Taylor-Rule-Implied Path for Nigeria......................................................30 A. Taylor Rules for Nigeria...
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