In the Nigerian economy, the gravitas of money supply as a predictive variable in determining key economic parameters has been disdained. Thus reigniting the thoery of how the amount of supply of money adjudicates Inflation rate, Nominal GDP and Interest rate is of paramount importance.
According to the U.S Federal Reserve, Money supply, normally denoted by “M2” is simply the total amount of money—cash, coins, and balances in bank accounts—in circulation.
The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments. For example, U.S. currency and balances held in checking accounts and savings accounts are included in many measures of the money supply.
Data from the Central Bank of Nigeria, Money Supply M2 in Nigeria increased to 42,572,203.40 NGN Million in November 2021.
CBN reports reveals money supply in the economy has been on a rise from the beginning of the year of 2021. Money supply increased from N37,741,737.65 to N38,218,832.96 in the first quarter (Q1), representing a 1.26% percentage gain. Concurrently, Money Supply in Q2, Q3 and were N115,800,313.9 and N120,992,852.3 respectively.
The inclined slope of money supply trend line in 2021 is determined by a change in the base money or high-powered money, interest rate, money multiplier, liquidity and reserve ratios or real income and output.
How Money Supply affects Exchange Rate
As domestic prices increase ,the real money supply decreases and Exchange Rates in the Long Run . A permanent increase in a country’s money supply causes a proportional long run depreciation of of its currency.
In Nigeria, the money supply curve and official exchange rate curve are similar. As the circulation of money increases in the economy, exchange rate inclines in the same patterns. Therefore, there will be less demand for the currency and its value will tend to fall on the exchange rate markets.
Research conducted by Rate Captain reveals the correlation coefficient between M2 and exchange rate is 0.83. The correlation figure represents a strong positive relationship between the two variables. Thus an increase in money supply will lead to a proportional rise in exchange rate.
Money Supply and Nominal Gross Product
According to Omosuyi Temitope, a financial analyst, he explained that predicting the Nigerian economy is becoming increasingly complex due to the paucity of major leading indicators such as the Purchasing Managers’ Index (PMI) and Business and Consumer Confidence Index, which could provide useful insights.
Nonetheless, money supply (M2) can complement the list of predictive models you already have at your disposal. All you need to do is to estimate M2 and the GDP implicit price deflator. With these two numbers, predicting real GDP may now be as simple as ABC.
By the way, given the strong correlation between money supply and nominal GDP, it seems Irving Fisher’s quantity theory of money is still alive and potent.
Is There Any Relationship Between Money Supply and Inflation?
Inflation has been described as an economic situation where increase in money supply is faster than the new production of new goods and services in the same economy.
According to a study by Egwaikhide et al. (1994), research shows that there is a positive relationship between money supply and inflation rate. As a result, the government of Nigeria should put in place serious reforms that will ensure that more of the money in the circulation is in the productive sector.
Research conducted by Rate Captain reveals the correlation coefficient between M2 and exchange rate is -0.752392118. The correlation figure represents a strong negative relationship between the two variables. Thus an increase in money supply will lead to a proportional decrease in inflation rate (month on month).
Growth of money supply is an important factor not only for acceleration of the process of economic development but also for the achievement of price stability in the economy.
There must be controlled expansion of money supply if the objective of development with stability is to be achieved. A healthy growth of an economy requires that there should be neither inflation nor deflation. Inflation is the greatest headache of a developing economy.
Thus, increase in money supply affects vitally the rate of economic growth. In fact, it is now regarded as a legitimate instrument of economic growth. Kept within proper limits it can accelerate economic growth but exceeding of the limits will retard it. Thus, management of money supply is essential in the interest of steady economic growth
Nigerians have generally focused on using popular economic variables such as inflation, recession, and unemployment to access economic prosperity. However money supply also plays a crucial role in the outlook of the long term business cycle, exchange rate and gross nominal product in the economy.
Author: Ayeni Samson