The Nigerian economy has not fared as well as expected despite its rich human and natural endowments and its claim to be the ‘giant’ of Africa.  When compared with the emerging Asian economies, particularly, Thailand, Malaysia, China, India and Indonesia that were far behind Nigeria in terms of GDP per capita in 1970, these economies have been transformed and are not only miles ahead of Nigeria, but are also major players on the global economic arena.  Indeed, Nigeria’s poor economic performance, especially in the last forty years, is better illustrated when compared with China which now occupies an enviable position as the second largest economy in the world. In 1970, while Nigeria had a GDP per capita of US$233.35 and was ranked 88th in the world, China was ranked 114th with a GDP per capita of US$111.82 (Sanusi, 2010).  By 2013, Nigeria’s GDP per capita was US$1,555 as against China’s US$6,188 (World Bank, 2013).


Available data have variously put the percentage of the population falling below the poverty line in the country at 70% (Central Intelligence Agency [CIA], 2013) and 46% (World Bank, 2013).  The World Economic Forum ranks Nigeria among the poorest countries in the Global Competitive Index (GCI) 2013 -2014.  The country went down by five slots from the 115th position it occupied last year to 120th position presently, out of the total 148 countries on the list (Ibekwe, 2013).  Similarly, there has been rising unemployment with the 2013 level by the National Bureau of Statistics (NBS) put at 23.9% (Emejo, 2013). Moreso, the country lags behind its peers in most human development indicators. For example, Nigeria’s score of 24.2% in the 2008-2012 Global Hunger Index is much higher than those of China (3.4%), Thailand (9.0%), Indonesia (18.6%), Chile (0.5%), and Malaysia (12.7%) (International Food Policy Research Institute [IFPRI], 2013).


The poor economic performance of the country has been traced to a number of factors including political instability, lack of focused and visionary leadership, economic mismanagement and corruption (Sanusi, 2010). Economic management includes monetary policy management which is the concern of this paper. Monetary policy management involves management of money supply which is regarded as a powerful tool for controlling the economy. This paper wants to investigate the effects of money supply on the Nigerian economy.


The importance of money cannot be overemphasized.  Money has been linked to changes in economic variables that affect all of us and that are important to the health of the economy (Mishkin, 2007:8).  From inception, apart from helping man to overcome the cumbersome nature of barter, it has performed very useful functions.  Whether money is shells or rocks or gold or paper (Mushkin, 2007:50), it has performed four primary functions including serving as a medium of exchange, unit of account, standard for deferred payment, and store of value. Indeed, the introduction of money has greatly facilitated exchange.


The focus of this study is not on the functions of money, however, but on its influence on the economy.  To stress the point of the influence of money on the economy, Bromley (2006:13) wrote, “Money may not make the world go around, but it sure makes the economy go up and down.” Establishing the influence or otherwise of money, the channels, and the extent of its influence on the economy has been of great interest to economists over time.  It has also been an issue of great debate among economists.  Consequently, a number of theories have been formulated to explain the impact of money on the economy.  The debate is predominantly between the Monetarists and the Keynesian economists.  The two major theories of these contending groups respectively are the quantity theory of money (QTM) popularized by Irving Fisher and later Milton Friedman, and the liquidity preference theory propounded by John Maynard Keynes.  The bone of contention has been the role of money supply in determining the price level and total production of goods and services (aggregate output) in the economy.


The quantity theory of money was developed by the classical economists in the nineteenth and early twentieth centuries and deals with how the nominal value of aggregate income is determined.  It also tells how much money is held for a given amount of aggregate income; hence, it is also a theory of the demand for money.  The theory states that nominal income is determined solely by movements in the quantity of money (Mishkin, 2007).  Its contention is that changes in the quantity of money lead to equal changes in the price level in the long run and no changes in output.  The classical economists’ quantity theory of money acknowledges the medium of exchange and unit of account functions of money.


Keynes’s liquidity preference theory introduced the element of interest rate in the transmission mechanism.  It assumes that money changes will only affect output or prices through its effect on a set of conventional yields – the market interest rate of a small group of financial assets, such as government or corporate bonds.  A given change in the stock of money will have a calculable effect on these interest rates, and the interest rate changes are then used to derive the change in investment spending, the induced effects on income and consumption, and so forth (Fand, 1970).  Keynes’s theory not only acknowledges the medium of exchange and unit of account functions of money but also introduces the standard for differed payment and store of value functions (“Monetary policy: Transmission mechanism,” 2003).  (Details of these theories will be presented in the second chapter of this paper).


A steady stream of empirical research has been carried out on the subject of money and the economy worldwide.  Most of the work has been confined to the industrial countries, especially the United States and the United Kingdom.  Relatively fewer studies have been conducted on developing countries, though work has been increasing in recent years (Sriram, 1999).  In the last few decades, the important issue for economists, researchers and policy makers has been the study of the causal relationship between money supply, price, and output because such relationship reveals the appropriate monetary policy as well as its effectiveness (Mishra, Mishra, & Mishra, 2010).  There have been several empirical studies in many economies – both developed and developing – but the results have shown no consensus.  While some studies indicate a bi-directional causality between money, income, and prices, others show a uni-directional causal relationship between them.


For example, Ahmed (2002) investigated the issue of multivariate causality among money, interest rate, prices and output in selected South Asian Association for Regional Cooperation (SAARC) economies, namely, Bangladesh, India, and Pakistan. He conducted bivariate, multivariate, and block causality tests. The causality tests suggested that interest rate, though controversial in developing countries, deserved to be a good policy variable in Bangladesh and Pakistan while money deserved to be a good policy variable in India. A bi-directional causality existed between money and prices in Bangladesh and Pakistan leading, in turn, to an increase in money stock. The finding is in consonance with the view of real business cycle theorists who postulate that monetary changes only affect prices. His block causality tests also revealed that interest rate and money as a block caused output and price, but output and price did not cause interest rate and money in Bangladesh. The situation was, however, reversed in Pakistan and India.


Again, Muhd Zulkhibri (2007) did an empirical study on the causality relationship between monetary aggregates, output and prices in Malaysia using monthly data for the period 1979 – 2000. The study was based on a vector auto regression (VAR) model applying the granger no-causality procedure developed by Toda and Yamamoto (1995). The results indicated a two-way causality running between monetary aggregates, M2 and M3 and output which was consistent with theoretical views of Keynesian and Monetarists whereas there was a one-way causality running from monetary aggregate, M1 and output. Also, the results suggested that all monetary aggregates have a strong one-way causality running from money to prices and thus, lending empirical support to the argument that inflation is a monetary phenomenon.


In relation to Nigeria, most of the studies indicate a causal relationship from money to these variables implying that money supply has some influence in the Nigerian economy.  What is not agreeable among these studies is the extent or degree of influence of money supply on the economy.  While some show a stronger influence, others indicate a weaker influence. Studies on Nigeria include those by Omanukwue (2010), Chimobi and Uche (2010), Ogunmuyiwa and Ekone (2010), Nwafor, Nwakanma, Nkansah, and Thompson (2007), and Anoruo (2002)  Others include Kumar, Weber, and Fargher (2010), Omotor (2011),  and Chukwu, Agu, and Onah (2010). For instance, Chimobi and Uche (2010) found that money supply has a strong causal effect on price and output in the country. The results of the work by Nwafor, Nwakanma, Nkansah, and Thompson (2007) collaborated this finding and added that money supply also affects interest rates. On the other hand, the study by Omanukwue (2010) established the existence of ‘weakening’ uni-directional causality from money supply to core consumer prices in Nigeria. According to the paper, inflationary pressures were dampened by improvements in real output and financial sector development.



This study seeks to investigate the impact of money supply on the Nigerian economy through application of the quantity theory of money (QTM) and liquidity preference theory – the two major monetary theories. Money supply is an important tool for controlling the economy. It is critical to achieving the monetary policy goals which include: price stability; high employment; economic growth; stability of financial markets; interest rate stability; and stability in foreign exchange markets (Mishkin, 2007).


According to Adesoye (2012), monetary aggregates in Nigeria have been on the increase since independence. The early 1960s opened with tight monetary measures aimed at controlling inflation and instilling confidence in the national currency issued by the then newly established central bank of Nigeria. But sooner, the need to finance rapidly expanding expenditures meant greater resort to the mint, since the instruments for financing government borrowing were not yet fully developed. In the 1970s, the expansionary monetary stance was further given an impetus by the monetization of oil earnings. Hence, the growth rate of money supply on the average rose from 10.9% in 1960s to 18.8% in Pre-SAP era; 21.5% in SAP era; 20.5% in Post-SAP; and 22.1% in NEEDS era. The growth of money supply peaked at 44.5% in 1975 during Pre SAP era; 35% in 1993 during SAP era; 32% in 2000 during Post-SAP era; and 31.8% in 2008 during the NEEDS era.

These increases in money supply are supposed to stimulate and induce growth of the economy, but that has not been the case. A perusal of some of these economic indicators in Nigeria shows a sordid picture as seen in the previous section.  Furthermore, in 2012, the inflation rate was 12.2%, unemployment rate 25.7%, GDP growth rate, 6.6%, and interest rate (prime lending rate) 17% (Central Bank of Nigeria [CBN], 2012).


Meze (2012) investigated the implications of money supply on output in Nigeria for the period, 2000 to 2009, and discovered that money supply does not significantly influence output. Odiba, Apeh, and Daniel (2013) investigated the effect of money supply on inflation in Nigeria between 1986 and 2009. They also examined the effect of aggregate demand on inflation. The objective of the study was to ascertain how far money supply could explain the inflationary phenomenon in Nigeria. The study results indicated that money supply and aggregate demand were the main determinants of inflation in Nigeria during the review period.


Furthermore, Omanukwue (2010)examined the long run relationship between money, prices, output, interest rate and ratio of demand deposits/time deposits (proxy for financial development) and found convincing evidence of a long run relationship in line with the quantity theory of money.  The study established the existence of ‘weakening’ uni-directional causality from money supply to core consumer prices in Nigeria. In all, the results indicated that monetary aggregates still contain significant, though weakening, information about developments in core prices in Nigeria. The paper found that inflationary pressures were dampened by improvements in real output and financial sector development.


Factually, the Nigerian economy has remained gloomy and apparently backward. It is characterized by poverty, high inflation and unemployment, high interest rate, and low productivity. Despite the application of various economic tools including the tool of money supply by successive governments to stimulate the economy, the Nigerian economy remains deplorable raising the questions: Why have these tools failed to boost the health of the Nigerian economy? Why has the Nigerian economy remained sick despite the application of the powerful tool of money supply, among others? This study has chosen to address the question of the effectiveness of money supply as a tool for treating the ailing Nigerian economy.


Money supply has largely been regarded as a powerful tool for controlling the economy.  Consequently, monetary theories have been formulated to explain the role of money in the economy.  The two major theories often referred to by researchers are the quantity theory of money and the liquidity preference theory.  These are the theories of interest in this study.  Empirical application of these theories in an economy often indicates what monetary policy the authorities should pursue.


Given the dismal look of the Nigerian economy as noted above as well as in the previous section, an application of these monetary theories in the Nigerian economy will be necessary to determine the impact of money supply on the Nigerian economy; determine the theory that best explains reality in the country; and determine a monetary policy course to pursue for better economic health.  This is the challenge of this study.


In this study, two interest rate variables, nominal and real interest rates, are included in the analyses. This became necessary because of arguments by some economists that nominal and real interest rates tell different stories. This was demonstrated by the contrasting results posted by early Keynesians and monetarists who analysed the impact of the monetary policy on the United States (U.S.) economy using evidence from the Great Depression period. The Keynesians used the evidence of an extremely low nominal interest rates and concluded that monetary policy was easy (expansionary). Because monetary policy was not capable of explaining why the worst economic contraction in the U.S. history occurred, early Keynesians concluded that changes in money supply have no effect on aggregate output – in other words, money does not matter.


On the other hand, monetarists argue that nominal interest rates are often a very misleading indicator of real interest rates. The group believes that real interest rates more accurately reflect the true cost of borrowing and, therefore, are more relevant to investment decisions than nominal interest rates.  They found that real interest rates on U.S. Treasury bills were extremely high during the Great Depression indicating that, contrary to the early Keynesian beliefs, monetary policy was not easy, and that, indeed, it had never been more contractionary (Mishkin, 2007).


Accordingly, both nominal and real interest rates have been included for analyses in this study for more reliable results. The prime lending rates represent the nominal interest rates (Soludo, 2008).



The main objective of this study is to investigate the effects of money supply on the Nigerian economy. Specific objectives of the paper include the following:

  1. To assess the effects of money supply on price level in Nigeria.
  2. To determine the effects of money supply on output in Nigeria.
  3. To analyse the effects of money supply on nominal interest rates in Nigeria.
  4. To analyse the effects of money supply on real interest rates in Nigeria.



The following research questions were formulated for the study:

  1. To what extent does an increase in money supply impact on price level in Nigeria?
  2. To what extent does a change in money supply impact on output in Nigeria?
  3. How far does a change in money supply influence the nominal interest rate in Nigeria?
  4. How far does a change in money supply influence the real interest rates?



For purposes of this work, the following Null hypotheses were tested with respect to the long run effects of money supply in Nigeria:

HO1: A change in money supply does not have a significant and positive effect on price level.

HO2: A change in money supply does not have a significant and positive effect on output.

HO3: A change in money supply does not have a significant and positive effect on nominal interest rate.

HO4: A change in money supply does not have a significant and positive effect on real interest rate.



The scope of the study is outlined as follows:

  1. The sample period for this study is 1987-2013; a 26-year period. This is considered a good enough period of time for such an investigation. The period covers the post Structural Adjustment Programme (SAP) era, up to 2013.
  2. To ensure strict adherence to the specifications of the theories, only the core variables of the theories have been used.



This study indicates the validity of monetary theories, namely, quantity theory of money and liquidity preference theory, in explaining the impact of money supply on the Nigerian economy.  It is an addition to empirical literature on the subject matter and useful to students, instructors, researchers in the area, and monetary authorities.  It will benefit these groups of people as follows:

  • Students

It will expose students to a very useful area of research and provide a guideline to approach such researches. As students delve into the area, they will discover a whole vast area of research and this will diversify students’ scope of research and help break the monotony of concentrating on just a few areas of study.

  • Instructors

To instructors, it will redirect interest in this area of study. Of course, the renewed interest will mean more research effort in the area and greater insights and innovations that will enhance the country’s monetary policy. Also, with more work in the area by students, the instructors will relish the benefit of diversification as against the monotony of reading works on just a few areas.

(c) Researchers

Researchers will benefit from the insights and results of the work. It will stimulate researchers’ interest in the area of money supply and the economy. Of course, such interest will result in more research in the area thereby increasing the stock of useful knowledge (Salter & Martin, 2001). The innovative ideas so generated will enhance the application of the tool of money supply to improve the health of the Nigerian economy.  The study may also highlight some areas for further research.


(d) Monetary Authorities

Monetary authorities will benefit from the study as the results of the study will provide additional information to guide their policy making. Obviously, the renewed interest in the area will of course generate better ideas for better policies. Hence, the study will be useful to monetary authorities in selecting more appropriate policy measures for the country.



The study focusses only on the core variables of the theories, quantity theory of money (QTM) and liquidity preference theory (LPT), namely, money supply, output, price level, and interest rate, and does not include investment which is a vital element in the theories. The QTM assumes investment to be constant while the LPT argues it is not stating that a decrease in interest rate resulting from an increase in money supply causes investment to increase and through that an increase in output.  Hence, LPT believes that investment is variable. Non-inclusion of investment as a variable thus constitutes a limitation of the study and will form an important basis for further studies in the subject matter.



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