Rate of Interest, Money Supply, Prices and Output Interdependences in Nigeria: A Vec Approach

Abstract

Recent developments, in the financial system in Nigeria have generated a renewed attention on the nexus between real and nominal economic variables. This study examined the relationship between nominal rate of interest, nominal money supply, prices and real output using quarterly data on these variables from 1980:1 to 2012:4. The study adopted a Vector Error-Correction Mechanism to test for the short - and long – run relationships and found out that nominal money supply has no contemporaneous effect on real output in Nigeria but does have significant impact on the latter in the long-run thereby refuting the money neutrality hypothesis. Consequent upon its bid to further examine these interdependences, Granger Causality tests, Impulse Response Functions and Variance Decompositions were carried out. The major findings are that nominal money supply and inflation rate are the most important endogenous variables in explaining variations and shocks to other variables like real output and inflation in Nigeria. The study recommends, inter alia, that money supply, not interest rate, should be used appropriately as an intermediate policy variable with real output being the final target and that appropriate inflation-targeting policies be put in place because of its significant role in explaining variations in long – run real output.