Monetary policy and macroeconomic management: A simulation experiment

Abstract

The dynamic nexus between money supply, fiscal deficit, inflation, output and exchange rate management has generated much debate in economic literature in Nigeria in recent times. To contribute to this debate, this paper uses 3SLS estimation technique as well as carried out policy simulation experiment to investigate how monetary variables interact with aggregate supply, demand and prices in order to aid stabilization policies. The results show that monetary variables and government finance is linked through the government’s net indebtedness to the banking system. The simulation results show that a 20 percent monetary squeeze would reduce inflation rate faster than if the reduction in money supply were 10 percent. This reduction in money supply also leads to a reduction in output, employment and government and government expenditure, which may hurt the domestic economy. Thus, the study concludes that there is a trade off between higher GDP growth and inflation in Nigeria.