Empirical Analysis of the Links Between Money Market Activities and Economic Growth in Nigeria

Topics: Economics, Money market, Financial markets Pages: 42 (12148 words) Published: August 3, 2012

CHAPTER ONE

INTRODUCTION

1.1Background to the Study

The Financial system is one of the most important creations of modern society. Its primary task is to move funds from surplus economic units to deficit economic units spenders to produce goods and services and to make investments in new equipments and facilities so as to facilitate the growth of the economy and improve the standard of living of its citizens. It is generally recognized that a financial system and its components play a catalytic role in the process of economic development. As the economy grows, the financial system becomes increasingly more complex and its structure more sophisticated (Ochejele, 1999). The financial system of any nation is a function of the size of its economy. A growing economy places more responsibilities on the financial sector to mobilize the needed capital to facilitate production, generate employment and income. An economy that does not experience growth on sustained basis is likely to have a very passive financial sector as there are no incentives for investment. Through the process of growth, financial system offers a wide range of portfolio options for savers and issuable instruments for investors, a function often referred to as financial intermediation (Oke, 1989).

The Nigerian financial system comprises of various institutions, financial markets and operations that are in the business of providing financial services. There are various financial markets, which are institutional arrangements that facilitate the intermediation of funds in an economy. The financial market is segmented into two: one is the money market, which deals in short term funds and the other, the capital market that is for long–term dealings in loanable funds (Anyanwu, 1996). The basis of distinction between the money market and the capital market lies in the degree of liquidity of instruments bought and sold in each of the market, which can be further sub-divided into the primary and secondary markets. While primary market is concerned with the raising of new funds, the secondary market exists for the sale and purchasing of existing securities that are already in people’s hands, thus, enabling savers who purchased securities when they had surplus funds to recover their money when they are in need of cash (Afolabi, 1991).

Money markets play a key role in banks’ liquidity management and the transmission of monetary policy. In normal times, money markets are among the most liquid in the financial sector. By providing the appropriate instruments and partners for liquidity trading, the money market allows the refinancing of short and medium-term positions and facilitates the mitigation of business’ liquidity risk. The banking system and the money market represent the exclusive setting in which monetary policy operates in. A developed, active and efficient interbank market enhances the efficiency of central bank’s monetary policy, transmitting its impulses into the economy best. Thus, the development of the money market ensures the smooth progress of financial intermediation and boosts lending to economy, hence improving the country’s economic and social welfare. Therefore, the development of the money market is in all stakeholders’ interests: the banking system itself, the Central Bank and the economy on the whole.

No money market existed in Nigeria before the establishment of the Central Bank of Nigeria. This is however not to say that a market for short-term funds did not exist before then. Before the advent of commercials banking, there existed some elements of short-term lending and borrowing based of commercial paper. The market was an integral part of the London money market. It worked by moving funds from London to Nigeria during the season in order to finance the export of produce. At the end of the season, the funds were moved back to London, when there was all-season money-market activity. The establishment of...

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