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PROJECT TOPIC: FINANCIAL DEREGULATION, STOCK PRICE VOLATILITY AND MONETARY POLICY IN NIGERIA

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CHAPTER ONE

 

1.0  GENERAL DESCRIPTION OF STUDY

Germane to every monetary policy is the goal of achieving price stability. The objective of price stability essentially encapsulates the need to eliminate price expectations to zero and to eliminate the long run uncertainty about the price level. The trend is interesting and indeed focused within the purview of two monetary frameworks – inflation targeting and monetary targeting extremes. The Nigerian CBN has been on both sides of this divide. In between this divide is found the income targeting frameworks and the Friedman-type policy rule which itself has been criticized for reasons of perceived instability in the demand for real money balances by monetary targeting advocates. Proponents of inflation targeting on the other hand are quick to point to the fact that monetary targeting is an ineffective strategy, because of the underlying core inflation, which accommodates persistent inflationary pressures, which are transmitted into inflation expectations. While inflating expectation and long-run price volatility keeps generating interest, little in terms of studies and policy focus has been on these in Nigeria.    So far the studies on Nigeria’s inflation have been able to tell us that expectations in the price level have been tested under adaptive expectations whereas the assumptions for rational expectations of prices are considered to be too strong for prices. It is imperative therefore, to examine the ability of monetary policy at reducing forward-looking expectations to tolerable levels that are consistent with desired level of prices.  And more so, the concentration has been on the causes of inflation in Nigeria, where as the role of monetary in the context of Nigeria’s current framework is not shown to be capable of circumventing or eliminating distortions in the price level occasioned by uncertainty and forward-looking expectations. The recent opening in emerging financial markets has generated a large literature, with many commentators predicting that such liberalization will increase the inflow of foreign capital, leading to greater financial development and economic growth. In principle, some models maintain that a market opening should decrease the variability of asset prices. The more able investors are to adjust the quality of their portfolios in response to shocks, the less impact there should be on prices, and hence the volatility of returns should fall (Reinhart 1998). However, the tumultuous events in developing countries over the last few years have led some practitioners and policy makers to question whether opening may in fact substantially raise the volatility of asset prices. Moreover, several papers examining the behaviour of recently liberalized stock exchanges (Borenzstein and Gelos 2000), Froot, O’Connell and Seasholes 1999, and Kaminsky, Lyons and Schmukler 1999 have found strong evidence of herding, momentum trading, and trend chasing, all of which can substantially increase, rather than decrease the volatility of share prices. There have been previous studies which have examined the effect of liberalization on stock volatility (Bekaert and Harvey 1997, Desantis and Imorohoroglu 1997), (Inclan, Aggarwal and Leal 1997), (Kim and Singal 2000), and (Levine and Servos 1998). Monetary policy targeting in Nigeria is centered on a financial programming approach that contain an implicit inflation target and external reserves consistent with the growth of real economic activity and growth of money supply from which the economy’s absorptive capacity for domestic credit is derived. This study would therefore be a significant departure from the studies on inflation in Nigeria by incorporating forward-looking expectations and volatility effects of prices in determining the long direction of monetary policy action. Consequently, the objective of this study is to determine whether inflation expectation and price volatility have any significant influence on inflation in Nigeria, and factor determine the extent to which monetary policy have eliminated expectations and volatility in the price level.


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