CHAPTER ONE
1.1. HISTORICAL BACKGROUND OF THE STUDY
The monetary approach to balance of
payments (MABP) has been a dominant view in the International Monetary
Economics, particularly; the theory is believed to' have a long
historical background. Which can be traced back to the writings of the
classical economists who conceived a system of integrated world capital
market and mobility? It is linked to the origin of balance of payments
theory in the work of David Hume, and more specifically, to this theory
of price-specie-flow mechanism (Johnson, 1976). While criticizing the
objective of mercantilism in accumulating precious metals, David Hume
pointed out that the amount of money in a country would be adjusted
automatically to the demand for it. In Hume's analysis, the process in
which this adjustment takes place is through surpluses and adjustment
deficits in the balance of payments brought about by changes in relative
national money price levels. However, while drawing heavily from Humes
theory of balance of payments, and this analysis of price-specie flow
mechanism, the monetary approach places emphasis' on monetary
considerations in the interpretation of external balance problems rather
than on changes in relative national price levels (Dornhusch and
Fischer, 1990, 764).
The balance of payments account in
Nigeria since political independence has undergone periods of boom and
doom at different stages. The period of boom has been short-lived and is
essentially attributed to the unprecedented increase in the oil price
of 1973 - 1974. Apart from this period, Nigeria has continued to
experience serious problems In the balance of payments position and the
problem became severe in the early 1980' s. From an overall surplus of
about N2A billion in 1980 in Nigeria's balance of payments, the country
recorded a persistent deficits of (N3 billion), (Nl.4billion) and
(0.3billion) in 1981, 1982 and 1983 respectively.
The internal factors that are
responsible for the adverse balance of payments position in Nigeria
include among other things, excessive demand for foreign products, heavy
reliance base, political instability and structural rigidities in the
domestic production process. The weaknesses, in the domestic
macroeconomic policies have tended to the problem. Moreover, the trade
and exchange rate policies pursued during the oil boom era of 1970s and
early 1980s failed to generate the required incentives for earning or
saving foreign exchange. Rather, they resulted in several macroeconomic
distortions and entrenched import-oriented consumption and production
patterns in Nigeria which widened the trade gap.
With respect to the monetary approach to
balance of payment under a fixed exchange rate regime, this studies
focused on the influence of changes or growth in determination of money
demand as well as domestic component of money supply in changes or
growth in external reserves.
The: results of these studies in most
cases support the propositions of the monetary approach. For instance,
Courechence and Youssefs (1967) study of the relative influence of
imports and money supply on the demand foreign exchange reserves for a
group of nine countries(Switzerland, Netherlands, Denmark, Sweden,
Germany, Belgium, Italy, Japan and Australia) indicates that money
supply is superior to the level of imports in determining the level of
foreign reserves. Their empirical 'results indicate that money supply
and long-term interest rate are
arguments in the demand function for individual country's foreign
exchanges reserves. From their study, Courchence and Youssef conclude
that "the application of the concepts of monetary theory to the field of
international payments can be very fruitful.
The basic concepts of the monetary
approach can be found in the works of Frenkel and Johnson (1976), Musa
(1974, 1976), Johnson (1958, 1972, 1976a, 1976b and 1977). Copppock
(1978), Melvin (1984) and Uddin (1985). Other contributions to the
development of the monetary approach to balance of payments (MABP)
theory include. Mundell (1968), Dornbusch (1971), Tsiang (1977) and
Bilson (1978). The central argument of the MABP is that external balance
problems are essentially (but not exclusively) Monetary in nature. As
such, the proponents of the monetary approach argue that the:
"Balance of payments problems in a monetary world should
be analysed by models that explicitly specify monetary behaviour
and integrate it with the real economy rather than by models
that concentrate on real relationships and real monetary behaviour as a residuance of real behaviour".
1.2 INTRODUCTION
Monetary approach exerts its influence
on the economy through changes in money supply and interest rates. These
variables also tend. to effect the position of the balance of payments
at any point in time. Monetary approach deals only with the ultimate
effect and not with the channels through which this effect occurs. Thus
monetary approach is essential for sensible discussion of the balance of
payments and that the money demand function and money supply process
should play a central role in the balance of payments analysis,
particularly for the long-run.
The monetary approach to the balance of
payments dates back to David Hume's refutation by use of the analysis of
the price-specie-flow mechanism of the mercantilist belief that a
country could achieve a persistent external surplus by
import-substitution and export promotion approach.
The reveal of the monetary approach was
brought about through the growing reluctance of countries to resort to
either-devaluation or appreciation of their domestic currencies to
current external imbalance, together with the imposition of restraints
on the ability of countries to use exchange controls and trade
interventions respectively through the restoration of European currency
convertibility in 1958 and successive common markets among 'countries.
The restoration of the monetary-theoretic aspects of the balance of
payments and included in the work of Hahn (1959), Kemp (1970) and Khan
and Argy (1971).
With the continuous application of
monetary approach in Nigeria coupled with the other economic policies
aimed at solving the imbalance in the international trading and payments
position, Nigeria has not been able to achieve viability and precision
in its external reserve position. Among these studies are Gray (1963)
which examined the effects of credit creation for investment purposes on
the balance of payment for Nigeria's first- National Development Plan
Period, Olofin et al 1986 which examined the effects of devaluation on
the macro economy, Omobitan (1995), which concentrated on the study of
the trends, issues and determinants of the balance of payments.
1.3 STATEMENT OF THE PROBLEM
'The monetary
approach to the balance of payments has been related to the asset
market 'approach. This analysis changes in the balance of payments
position in terms of stock adjustments in the money market in which the
supply and demand for money balances are eventually willingly held.
Since the global economic crisis of the
1980s, many developing countries like Nigeria has been grappling with
numerous economic problems. Such problems include growing unemployment,
unsustainable fiscal deficits, high inflationary pressures, mounting
debt burden, adverse balance of payments, under-utilization of capacity
and exchange rate misalignment. In Nigeria, the adverse balance of
payments which could be attributed to a number of factor (both internal
and external), reflect the deep-seated problems in the economy.
Amount the external factors contributing
to the deterioration in the Nigeria's balance of payments are the
economic recession experimented by most industrialized countries
following the oil price shocks of 1973/74 and 1972/80. The rapid
increase in the price of crude oil during this period made these
industrialized countries adopt various energy conserving policies as
well as restrictive monetary and fiscal policy measures which all the
culminated the global economic recession and consequently- resulted in
the collapse of the world oil market in the early I 980s. Other external
factors include-the decline in capital flows, deterioration in
Nigeria's terms of trade and rising (but floating) rate. interests in
international capital and money markets, all of which worsened the
country's external debt burden,.
These internal and external factors are
however not mutually exclusive. They are in most cases, interrelated and
tend to reinforce one another. Most often, policies needed to maintain
external balance conflict within the required to restore internal
balance, thereby making the problem intractable. The huge external debt
burden and the dwindling foreign exchange reserves confronting most
development countries tend to constrain their efforts to respond
adequately to balance of payment shocks.
The empirical test of the monetary
approach to the balance of payment analysis on the Nigerian economy
which is the subject matter of this study shall provide precise solution
to the problem outline above.
1.4 RESEARCH OBJECTIVES
The broad objectives of this study is to
examine the relevance and applicability of the monetary approach to
balance of payments in Nigeria, with a view of determining the extent to
which the approach can serve as a useful framework for analyzing the
balance of payments problems in the country.
The specific objectives of this study are:
1. To test the propositions of the monetary approach to payments by way of analyzing the data from Nigeria.
2. To examine the impact of economic growth on the balance of payments' position in Nigeria.
3. Determine the nature and
stability of money demand function, and the relevance of other basic
assumptions of the monetary approach to balance of payments
determination in the Nigerian context.
1.5 RESEARCH QUESTIONS
I. Does monetary policy affect balance of payments in Nigeria?
2. What impact does economic growth has on the balance of payments' position in Nigeria?
3. The determination of the nature
and stability of money demand function have no effect on the balance of
payments determination in the Nigerian context.
1.6. RESEARCH· HYPOTHESIS
Ho: That monetary policy does not affect balance of payments in Nigeria
Ha: That monetary policy affects balance of payments in Nigeria
Ho: That economic growth does not have any impact on the balance of payments' position in Nigeria.
Ha: That economic growth has impact on the balance of payments' position in Nigeria
Ho: The determination of the nature
and stability of money demand function have no effect on the balance of
payments determination in the Nigerian context.
Ha: The determination of the nature
and stability of money demand function have a great effect on the
balance of payments determination in the Nigerian context.
1.7 MODEL SPECIFICATION
GDP = F (ms, md, bop) under the hypothesis that
Ho = Bo = B1= B2=B3= 0
Ha ?Bo?B1 B2?B3?0
From the above, the null hypothesis (Ho)
states' that the values of the estimated parameters are not
significantly different from zero, while the alternative hypothesis (Ha)
states that the values of the estimated parameters are significantly
not equal to zero, which is our theoretical expectation.
ECONOMETRIC MODELSPECIFATION
This study will use a multi-regression analysis to investigate that:
GDP = Bo + B1MS + B2 BOP + B3MD + U
This win be regressed following a list wise regression in the following ways
MODEL 1
GDP=Bo+B1MS+U
Where GDP = Growth of the Gross Domestic Product
Bo = intercept or constant term of the relationship
Bl= coefficient of MS
The model is to test the single impact of rate of growth of money supply on Gross Domestic Product
Hypothesis of the Model
Ho = That monetary policy does not affect balance of payments in Nigeria
Ha = That monetary policy affects balance of payments in Nigeria
MODEL2
GDP =Bo + B1MS + B2 BOP + U
Where B2 = Coefficient of BOP
The model is to test the impact of money supply and balance of payments Gross Domestic Product
Hypothesis of the model
Ho = That economic growth does not have any impact on the balance of payment in Nigeria.
Ha = That economic growth have impact on the balance of payments' position in Nigeria.
MODEL 3
GDP= Bo+BlMS+B2BOP+B3MD+U
Where B3 = coefficient of Md
The model is an improved fashion of (1 and 2) as it now involves money demand and money supply.
Hypothesis of the model
Ho = The determination of the
nature and stability of money demand function have no effect on the
balance of payments determination in the Nigerian context.
Ha = The determination of the
nature and stability of money demand function have a great effect on the
balance of payments determination in the Nigerian context.
1.8. SIGNIFICANCE OF THE STUDY
The need for this study arises from the
inability of the Nigerian economy at experiencing a favourable balance
of payment position for most parts of the period since independence.
Fundamental surpluses are only recorded in 1974· and 1990 in Nigeria 's
balance of payments when N3, 102.2 billion and N 18? 498.2 million
overall balances are recorded respectively. For most of the other
periods, surpluses have been insignificant and for only few periods,
deficits have been the order.
The structural adjustment programmes
embarked upon by most developing countries including Nigeria, since the
1980s device their basic analytical framework largely from the financial
programming model of the International Monetary Fund (IMF).Though the
adjustment programmes are complex package of policy measures aimed at a
number of objectives including the attainment of a viable balance of
payments, satisfactory long-term growth performance and low inflation
(Khan, 1990: 95) the immediate objective of the IMF's financial
programming model is the attainment of a viable balance of payment
position. According to Khar, Monthel and Haque (1986), the model is
essentially a monetary model, built on the framework that links the
financial sector with the balance of payments.
From the foregoing, it is evident that
the theoretical basis of the -IMF's approach to economic stabilization
and adjustment is the monetary approach to balance of payments which
views external imbalance as emanating essentially from monetary
disequilibrium. This has accounted for the extensive use of the monetary
approach in analyzing, and designing economic policies for countries in
balance of payments trouble (Dornbusch and Fischer, 1990. 764). Thus,
the need to examine the theoretical basis and empirical relevance of the
monetary approach to balance of payments determination in the Nigerian
context cannot be disputed at this period of economic reform, programme
in the proponents of the monetary approach suggest that the
effectiveness of various policy reform measure in the place to address
the balance of payments problems in the economy would depend mainly on
how their monetary implications are taken into consideration and on the
ability of the monetary authorities to control money supply and credit
creation.
1.9 SCOPEANDLIMITATIONOFTHESTUDY
The study covers two distinct periods of
exchange rate arrangement in post independence Nigeria. The first
period (1960 - 198$) covers the regime of -relatively fixed exchange
rates, while. the second period (1986 -1997) covers the regime of
floating exchange rate. The influence of the, determinants of money
supply and money demand on the balance of payments (as measured by
external reserve flows) is examined in the first period, while the
influence of' the determinants of money supply and money demand on
exchange rate changes is examined in the second period.
Annual data are used for the first
period, while quarterly data are employed in the second period because
of the short period of flexible 'exchange rate system in Nigeria (i.e,
between 1986 - 1997).
The major constraints of this study are the inaccurate data; the cost and time requires carrying out this research.
1.10 METHOD OF DATA COLLECTION
This study will make use of econometrics
modeling coupled with an indepth descriptive analysis of the relevant
macro-economic . variables that have direct or indirect. The necessary
diagnostic 'and significant test will be conducted on the estimated
equations.
This study will make use of secondary data and the main source of these data will be from:
- The International Financial Statistics Year Book of the International
Monetary Fund (IMF) for several years.
- Annual Reports and Statement of Accounts for Central Bank of Nigeria
between 1960 and 1994.
- The CBN Economic and Financial Review for the periods 1970-1994.
- The CBN Statistical Bulletin-December 1994.
1.11. LITERATURE REVIEW
The monetary approach to balance of
payments could be regarded as an extension of the rudiments of monetary
theory to the area of the balance of payments. Three-main factors could
be attributed to the renewed interest in the approach in the post-world
war II. The first factor was the re-birth of academic interest in
monetary problems as spearch headed by Milton Friedman and others from
the University of Chicago. The second factors emanated from the search
by the International Monetary Fund (IMF) for a monetary framework within
which the balance of payments policies could be evaluated.
The monetary approach to balance of
payments (MABP) has been a dominant view in. the International Monetary
Economics, particularly; the theory is believed to have a long
historical background, Which can be traced back to the writings of the
classical economists who conceived a system of integrated world capital
market and mobility? It is linked to the origin of balance of payments
theory in the work of David Hume, and more specifically, to this theory
of price-specie-flow mechanism (Johnson, 1976). While criticizing the
objective of mercantilism in accumulating precious metals, David Hume
pointed out that the amount of money in a country would be adjusted
automatically to the demand for it. In Hume's analysis, the process in
which this adjustment takes place is through surpluses and adjustment
deficits in the balance of payments brought about by changes in relative
national money price levels. However, while drawing heavily from Hume's
theory of balance of payments, and this analysis of price-specie-flow
mechanism, the monetary approach places emphasis on monetary
considerations in the' interpretation of external balance problems
rather than on changes in relative national price levels (Dromhusch and
Fischer, 1990, 764).
The difficulties in applying the
conventional elasticity/absorption approaches to external balance on the
developing economies prompted the search. Thirdly, it was then the view
that the monetary approach might provide a better 'framework within
which the balance of payments policies could be easily applied and
evaluated, given the reliance of majority of the developing economies on
monetary policies which operated in conjuction with relatively to the
financial markets.
1.12 ORGANISATION OF THE STUDY
In chapter one, we have presented a
general introduction -of this study. Also, the objectives, scope of the
study as well as the need for the study are also stated in this chapter.
In chapter two, relevant literatures
will be reviewed. Specifically, literatures and empirical works directed
at testing the monetary approach to the balance of payments will be
reviewed. The theoretical framework governing the monetary theory of
balance of payments analysis will be presented in chapter two as well.
The operations of monetary policies under various exchange rate regimes
will be discussed.
In chapter three of this study over view
of balance of payment in Nigeria. This talk about the balance of
payment related with Nigeria. The administration of monetary approach
coupled with the study of the trends issues and factor affecting
Nigeria's balance of payments will also be discussed in chapter three.
Chapter four will be centered on an
empirical and descriptive analysis of relevant data. The basic feature
and assumptions as well as some of the existing empirical finding on the
monetary approach to balance of payments are reviewed, while the
methodology, model specification and estimation techniques as well as
data description.
Finally, in chapter five, we present a
summary of findings of the study, on the basis of which some policy
conclusions are drawn. The limitations of the study and areas for
further study are also highlighted in this chapter.
1.13 CONTRIBUTION TO KNOWLEDGE
With respect to the monetary approach to
balance. of payment under a fixed exchange rate regime, this .studies
focused on the influence of changes or growth indetermination of money
demand as well as domestic component of money supply in changes or
growth in external reserves.
The results of these studies in most
cases support the propositions of the monetary approach. For Instance,
Courechence and Youssefs (1967) study of the relative influence of
imports and money supply on the demand foreign exchange reserves for a
group of nine countries (Switzerland, Netherlands, Denmark, Sweden,
Germany; Belgium, Italy, Japan and Australia) indicates that 'money
supply is superior to the level of imports in determining the level of
foreign reserves. Their empirical results indicate that money supply and
long-term interest rate are arguments in the demand function for
individual country's foreign exchanges reserves. From their study,
Courchence and Youssef conclude that "the application of the concepts of
monetary theory to the field of international payments can be very
fruitful.