MONETARY EFFECTS OF BANKING CRISIS IN NIGERIA

ABSTRACT

The study arose out of the need to tackle the challenges which emanated from the distortion of money demand and stress on inflation as banking crisis occurred. The challenges include liquidity squeeze and increased interest rate which undermined monetary policy implementation, reduced investment and sharply contracted economic activities. The study estimated the effects of banking crisis on money demand and inflation in Nigeria from 1970 Q1 to 2014 Q2. The specific objectives were to construct a banking crisis index; ascertain optimal threshold level of banking crisis; compare the behaviour of narrow and broad money demand as well as estimate inflation trend during banking crisis in Nigeria. Four research questions and three hypotheses were formulated. The objectives of the construction of banking crisis index and threshold level were addressed using Burnside and Dollar (2000) as well as Hansen (2000) threshold regression approaches, respectively. Macro-econometric model method of data analysis was used to investigate the objectives of money demand and inflation. The result of the construction of banking crisis index revealed a continuum with varying degree of severity which ranged from -0.0513 to -0.5253. The optimal threshold level was put at 1%-2%, beyond which banking crisis was not conducive to the economy. The in-sample simulation result showed that on the average, broad and narrow money demand were 1.18% and 1.36%, respectively and their P-level was 0.932. For inflation, when broad and narrow money definition were used in the inflation specification, the values were 0.14% and 0.34%, respectively. For out-of-sample with increased (decreased) scenario it was 12.13%(-10.62%) and 16.33%(-6.23%) for broad and narrow money demand, respectively with a P-level of 0.271(.079). For inflation, using broad and narrow definitions of money, the values from the increased (decreased) scenario were 13.88%(-14.13%) and 7.02%(-2.9%p), respectively. The findings depict that there was no difference between the behaviour of broad and narrow money demand during banking crisis; and banking crisis adversely affected inflation. Hence, it is recommended that during banking crisis, the monetary authority should mitigate inflation by ensuring monetary policy rate is not increased.