The Central Bank of Nigeria (CBN) plays a crucial role in shaping the Nigerian economy through its monetary policy framework. Established under Section 2 of the CBN Act of 2007, the CBN is mandated to maintain monetary and price stability while safeguarding the financial system and the value of the naira. Over the years, the CBN has introduced various monetary policies aimed at boosting economic growth and fostering a conducive investment environment. In this article, we will be answering frequently asked questions on these monetary policy tools used by the CBN in Nigeria.
What is a Monetary Policy?
Monetary policy refers to the actions and strategies implemented by the CBN to regulate the supply of money, interest rates, and credit in the economy. The goal of monetary policy is to achieve stable prices, control inflation, and foster economic growth.
What are the main Objectives of CBN's Monetary Policy?
The primary objectives of CBN's monetary policy are:
Maintaining price stability (controlling inflation); promoting sustainable economic growth; ensuring stability in the financial system; managing exchange rate stability; and facilitating employment generation
What are the Types of Monetary Policies?
CBN's monetary policy can either be:
- Expansionary Policy: This is used to stimulate economic growth by increasing money supply and making borrowing cheaper. It encourages investment and consumption.
- Contractionary Policy: This is used to combat inflation by reducing the money supply and raising interest rates, thus slowing down economic activity.
What are the CBN's Key Monetary Policy Tools?
These are the various monetary policy tools utilised by the MPC. They include:
Monetary Policy Rate (MPR); Liquidity Ratio (LR); Open Market Operations (OMO); Cash Reserve Ratio (CRR); Standing Facilities (SF) and Asymmetric Corridor (AC); and Loan-to-Deposit Ratio
What is the Monetary Policy Rate (MPR)?
The MPR is the benchmark interest rate set by the CBN, which influences the cost of borrowing in the country. Simply put, the MPR is the rate at which the CBN lends money to commercial banks. By adjusting the MPR, inflation will drop and this in turn help the economy to grow. By making borrowing more expensive, consumer spending and investment level is regulated.
How does the MPR Influence Inflation and Economic Growth?
The CBN may raise the MPR to make borrowing more expensive, which reduces the money supply and dampens inflationary pressures. If the economy is sluggish, the CBN may lower the MPR to make borrowing cheaper, encouraging investment and consumption.
What is Nigeria's Current MPR?
Nigeria's MPR was currently increased by the MPC by 50 basis points (0.5%) to 26.75 per cent from 26.25 per cent in July 2024.
What is a Liquidity Ratio (LR)?
LR is the ability of a bank to pay off its short-term debt obligations. Simply put, LR is the percentage of money a bank is to have in reserve in relation to the deposits made into the bank. Adjusting the ratio determines how much left the bank has available to lend. Thus, the higher the liquidity ratio, the less available amount to lend and the more available sum to meet customers' withdrawal needs, while the lesser the liquidity ratio, the more available amount to lend.
If the CBN wants banks to lend less (which can help control inflation), it increases the ratio, making banks keep more money in liquid form. If it wants to encourage more lending to help the economy grow, it lowers the ratio. The CBN has maintained the liquidity ratio at 30% for over the last 10 years, this was also retained at the last MPC meeting in July 2024.
What is Open Market Operations (OMO)?
Open Market Operations (OMO) are one of the primary tools used by the CBN to control liquidity in the financial system. OMO refers to the buying and selling of government securities, such as Treasury Bills, in the open market. The CBN uses this tool to either increase or decrease the amount of money available in the banking system, thereby influencing interest rates and overall economic activity. When the CBN sells government securities to banks and other investors, the buyers pay cash in exchange for these securities. This transaction effectively removes money from circulation, reducing the liquidity (the amount of money) in the financial system. As a result, banks have less money to lend, interest rates may rise, and borrowing becomes more expensive. This approach is often used to combat inflation when there is too much money chasing too few goods and driving up prices. When the CBN buys government securities from banks or investors, the sellers receive cash, which increases the liquidity in the financial system. With more money available, banks can lend more easily, interest rates may fall, and borrowing becomes cheaper. This encourages spending and investment, stimulating economic growth, especially when the economy is sluggish. The CBN carefully calibrates OMO to ensure that there's neither too much money causing inflation nor too little money stifling growth. It is one of the most flexible tools available to manage short-term economic conditions.
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