Classical economic theory often ties inflation to the money supply, which has been the bedrock of monetary policy across several countries. In Nigeria, inflationary pressure has caused the Central Bank of Nigeria (CBN) to raise the monetary policy rate (MPR) to 27.25% in September 2024 from 26.75% in August 2024. Over the year, the CBN has raised the MPR by 850 basis points. This reveals the CBN's stance on inflation and its effort to control inflationary pressure.
Between February 2024 and September 2024, the CBN increased the cash reserve ratio (CRR) from 45% to 50%, reflecting a 5 percentage point rise. However, the liquidity ratio has remained unchanged at 30%. The rise in the CRR also underscores the bank's ongoing effort to tighten monetary fundamentals and manage inflationary pressure. However, the CBN has allowed merchant banks' CRR to remain at 16%, allowing merchant banks to support economic activities with lower interest rates.
Demand and Supply-side Inflation
One key assumption of classical economics is that inflation is demand-driven because there is too much money in circulation. This follows the inflation definition of too much money following too few goods. In such a scenario, implementing a contractionary monetary policy can effectively reduce the money supply, aggregate demand, and inflation.
However, it is also important to highlight the economy's supply side, which the CBN and the government ignore in the pursuit of disinflation. Supply-side inflation entails inflation that occurs when the supply of goods and services in an economy decreases, causing prices to rise. It is also closely related to cost-push inflation, which arises from the increase in the cost of production.
Supply-side inflation can be defined as too much money chasing too few goods. This definition shows that when inflation is demand-driven, the CBN should cut the money supply, and when inflation is a result of too few goods, the government must work to improve productivity in the economy.
Nigeria’s Inflation
A noticeable feature of the Nigerian inflationary problem is the significant supply-side factors that feed into it. The Nigerian economy's dependence on imports, combined with the devaluation and depreciation of the naira, has directly impacted both domestic consumer prices and producer goods, creating upward pressure on overall prices.
Beyond this, the consistent fall of the naira in the forex market and the removal of fuel and electricity subsidies have rapidly increased energy prices and the cost of doing business across all spectrums of the Nigerian economy, from MSMEs to large-scale firms. This has contributed significantly to inflation in the Nigerian economy.
Another exogenous shock feeding into the inflation dynamics in Nigeria has been the persistent security challenges clouding many agricultural-producing communities. Exogenous shocks such as insecurity are completely out of the reach of monetary policy tools and highlight the need for coordinated government policies to ensure optimal agricultural productivity.
Money Supply and the MPR
While the CBN has consistently insisted that raising the MPR is a crucial reason for reducing the money supply, data has shown that increasing the MPR is ineffective. Figure 3 shows the MPR and M3 money supply trend from January 2023 to September 2024. As revealed, there has been a persistence in money supply volume even when there has been a significant increase in MPR, indicating that a very weak link exists between the MPR and money supply. The lack of autonomy within the CBN is a key factor contributing to the weak relationship between monetary policy and its intended outcome. The CBN’s limited monetary policy credibility undermines its ability to achieve policy objectives. Despite efforts to curb the use of Ways and Means financing for short-term government obligations, this mechanism has consistently weakened the CBN’s attempts to reduce the money supply. Consequently, the strategy of raising the MPR has yielded little success. Instead, higher MPR levels have exacerbated the cost of doing business, further straining supply-side dynamics, limiting productivity, and adversely impacting GDP growth and unemployment rates.
Figure 3: Graph of Money Supply and MPR
Source: CBN and Veriv computation. Note: LM3 is the natural logarithm of M3 Money Supply.
It is also important to highlight that while money supply is a core determinant of inflation, the effect of money supply on inflation in Nigeria has been through the exchange rate channels. This is because of the rise in demand for the greenback by government officials and the subsequent pressure on the naira, causing increased import costs.
Curb the Rise of the Monetary Policy Rate
While the importance of monetary policy cannot be overstated, the CBN has rapidly increased rates in 2024. However, it has not transmitted a significant decline in inflation. This has largely been a result of the supply-side fundamentals that have influenced inflation in Nigeria. Therefore, it is essential for the CBN to reassess its approach to raising the MPR. Instead, collaborative, supply-side strategies that promote productivity should be prioritised. This approach avoids the trade-off between inflation and economic growth, aiming to control inflation sustainably while fostering growth and reducing unemployment.
The above is culled from the Veriv Africa Macroeconomic Outlook for 2025. Access our outlook here for an in-depth analysis of the Nigerian inflationary environment, economic landscape projections, and actionable strategies to better manage it in 2025.
