An Empirical Analysis of Monetary Policy Reaction Function: Evidence from Nigeria

The changing and unpredictable nature of the money demand function has led many Central Banks authorities around the world to shift from exchange rate and monetary policy targeting to inflation targeting framework. The gradual shift to inflation targeting has reawakened interest in the Taylor’s Rule which states that nominal anchor interest rate must be raised by more than a proportionate change in inflation to achieve price stability. The objective of this study is to examine the Central Bank of Nigeria monetary policy reaction function and how the CBN responds to the dynamic and evolving macroeconomic environment. The monetary policy response function developed for this study is derived following the basic structure of the Taylor’s rule. Using secondary time series data sourced from the Central Bank of Nigeria Statistical Bulletin covering the periods 1998:Q1-2014:Q2, the study builds on the Taylor rule to formulate a model that track the Central Bank of Nigeria monetary policy reaction function. The method adopted in carrying out the study is the Auto Regressive Distributed Lag Modeling technique and the Error Correction modeling framework. The stylized fact of the study shows that monetary policy variables are moving along same path accompanied by declining inflation and improved productivity. Results obtained from the study will be used to track stability and dynamics of the Central Bank reaction function and to predict the future direction for monetary policy in Nigeria.