CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The Nigerian economy has not performed as well as its human and natural endowments and its claim to be the giant of Africa would suggest. The World Bank's April 2026 Nigeria Development Update, as reported by Nairametrics (2026), puts poverty at 63 per cent in 2025, about 140 million people, up from 56 per cent in 2023, even though headline inflation fell sharply over the period. Inflation itself has swung widely, from 34.80 per cent in December 2024 to 15.15 per cent in December 2025, according to National Bureau of Statistics data (Hallmark News, 2026). Monetary policy management, which centres on the control of the money supply and the cost of credit, is among the main instruments for dealing with these outcomes, and it is the concern of this study.

Money is important because it is linked to economic variables that affect everyone and that matter for the health of the economy. Whatever form it takes, money serves four primary functions: it is a medium of exchange, a unit of account, a standard of deferred payment and a store of value. Its introduction greatly eased exchange by overcoming the difficulties of barter. This study is not concerned with these functions, however, but with the influence of money on the economy.

Economists have long debated whether money influences economic outcomes, through which channels and how strongly. The debate is chiefly between monetarists and Keynesians, and two theories represent the opposing views. The quantity theory of money (QTM), associated with Irving Fisher and later Milton Friedman, holds that nominal income is determined by the quantity of money, so that in the long run changes in the money stock produce proportional changes in the price level and none in output. Keynes's liquidity preference theory adds the interest rate to the transmission mechanism: changes in the money stock affect interest rates, interest rates affect investment, and investment in turn affects income, consumption and output. The disagreement concerns the role of money supply in determining the price level and the output of goods and services. The details of the two theories are presented in Chapter Two.

Empirical research on money and the economy has produced mixed findings, and recent studies of Nigeria illustrate this. On prices, Danlami et al. (2020) used data for 1970 to 2017 and found that increases in the money supply were inflationary only in the short run, with no significant long-run effect on inflation, which led them to question the monetarist view that money supply is the sole source of inflation in Nigeria. On output, Baruwa et al. (2024), covering 1994 to 2023, found that money supply had a negative effect on the output gap in the short run and a positive and substantial effect in the long run. On interest rates, Ogbu et al. (2025) analysed 1990 to 2023 and found a long-run positive relationship between broad money and interest rates, consistent with the Fisher effect, and a negative relationship between narrow money and interest rates. They also found that interest rates Granger-cause broad money, which suggests that causation may run from interest rates to money as well as the reverse. On private investment, Bitrus (2025) found that broad money (M2) had a significant positive long-run effect on private sector investment in Nigeria between 1981 and 2023.

These results show that Nigerian findings differ by variable and by time horizon. What the studies agree on is that money supply carries information about prices, output and interest rates, but its strength, timing and even direction of influence remain contested. The environment in which money supply operates has also changed: the Central Bank of Nigeria (CBN) raised its policy rate to 27.5 per cent by early 2025, noting at that time the effects of recent exchange market reforms (CBN, 2025a), and in November 2025 held the rate at 27.0 per cent while observing that inflation, though easing, remained in double digits (CBN, 2025b).

1.2 Statement of the Problem

This study investigates the impact of money supply on the Nigerian economy by applying the quantity theory of money and the liquidity preference theory, the two main theories of money. Money supply is regarded as an important tool for managing the economy. It is central to the goals of monetary policy, which include price stability, high employment, economic growth, stability of financial markets, interest rate stability and stability in foreign exchange markets.

Successive governments have used money supply, alongside other tools, to try to improve economic performance, yet outcomes remain poor. Poverty is high and rising (Nairametrics, 2026), inflation has been volatile (Hallmark News, 2026), and lending rates are among the highest in the region (CBN, 2025b). This raises two questions: why have these tools not improved the economy as expected, and how effective is money supply as an instrument for doing so?

The empirical literature does not settle the question. Money supply has no significant long-run effect on inflation in one study (Danlami et al., 2020), it affects output differently in the short and long run in another (Baruwa et al., 2024), and in a third there is evidence that interest rates cause broad money, not just the reverse (Ogbu et al., 2025). Most of these studies examine one outcome at a time. This study examines the effects of money supply on the price level, output, nominal interest rates and real interest rates together, so that the quantity theory and the liquidity preference theory can be compared on the same data. It seeks to establish the impact of money supply on the economy, to identify which theory better explains the Nigerian experience, and to indicate the monetary policy course that follows.

Both nominal and real interest rates are included because they can tell different stories. The classic illustration is the Great Depression in the United States. Early Keynesians pointed to very low nominal interest rates, concluded that monetary policy had been easy, and, since it had not prevented the contraction, concluded that money does not matter. Monetarists replied that nominal rates are a misleading indicator of the true cost of borrowing, that real rates were in fact very high, and that policy had therefore been highly contractionary. Because the two measures can point in different directions, both are analysed here. The prime lending rate serves as the nominal interest rate.

1.3 Objectives of the Study

The main objective is to investigate the effects of money supply on the Nigerian economy. The specific objectives are to:

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

1.4 Research Questions

The study is guided by the following questions:

1. To what extent does a change in money supply affect the price level in Nigeria?
2. To what extent does a change in money supply affect 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 rate in Nigeria?

1.5 Hypotheses of the Study

The following null hypotheses are tested with respect to the long-run effects of money supply:

1. H01: A change in money supply has no significant effect on the price level.
2. H02: A change in money supply has no significant effect on output.
3. H03: A change in money supply has no significant effect on the nominal interest rate.
4. H04: A change in money supply has no significant effect on the real interest rate.

1.6 Scope of the Study

1. The sample period is 2000 to 2024, a 25-year period long enough for a meaningful investigation. It covers the most recent quarter-century, including the monetary tightening and exchange market adjustments of 2023 to 2025.
2. To follow the specifications of the two theories closely, only their core variables are used: money supply, output, the price level and the interest rate.

1.7 Significance of the Study

The study tests the validity of the quantity theory of money and the liquidity preference theory in explaining the effects of money supply on the Nigerian economy. It adds to the empirical literature and will be useful to students, instructors, researchers and monetary authorities.

Students. It exposes students to a useful area of research and offers a guide to how such research is conducted.

Instructors. It supports teaching and renewed interest in the area, which may in turn lead to more research that informs monetary policy.

Researchers. It provides results and insights that can stimulate further work on money supply and the economy, and it identifies areas for future research.

Monetary authorities. It adds information for policymaking and helps in selecting more appropriate policy measures, particularly since recent evidence shows that the effects of money supply differ across variables and time horizons (Baruwa et al., 2024; Danlami et al., 2020; Ogbu et al., 2025).

1.8 Limitations of the Study

The study concentrates on the core variables of the two theories, namely money supply, output, the price level and the interest rate, and it does not include investment, which is an important element of both theories. The quantity theory treats investment as constant, whereas the liquidity preference theory treats it as variable: a fall in interest rates caused by an increase in money supply raises investment and, through investment, output. Excluding investment is therefore a limitation, although recent evidence suggests it is a promising subject for further study (Bitrus, 2025).

REFERENCES

Baruwa, B. B., Adelowokan, O. A., & Ajayi, F. O. (2024). Effect of money supply on output gap in Nigeria. Journal of Public Administration, Finance and Law, (32), 114–131. https://www.ceeol.com/search/article-detail?id=1415908

Bitrus, G. (2025). Impact of monetary policy on private sector investment in Nigeria. ADSU International Journal of Applied Economics, Finance and Management, 10(1). https://ajaefm.adsu.edu.ng/index.php/journals/article/view/138

Central Bank of Nigeria. (2025a). Monetary policy communiqué No. 156 (20 February 2025). https://www.cbn.gov.ng/Out/2025/CCD/Central_Bank_of_Nigeria_Comminique_No.156_20_February_2025.pdf

Central Bank of Nigeria. (2025b). Monetary policy communiqué No. 160 (25 November 2025). https://www.cbn.gov.ng/Out/2025/CCD/MPC%20Communique%20No.%20160%20%20November%2025%202025.pdf

Danlami, I. A., Hidthiir, M. H., & Hassan, S. (2020). Money supply and inflation in Nigeria: The myth of the monetarist theory of inflation. Journal of Economics and Sustainability, 2(2). https://repo.uum.edu.my/id/eprint/30085/

Hallmark News. (2026, April). Nigeria's poverty rate climbs to 63% despite falling inflation – World Bank [Report citing National Bureau of Statistics inflation data]. https://hallmarknews.com/nigerias-poverty-rate-climbs-to-63-despite-falling-inflation-world-bank/

Nairametrics. (2026, April 10). Nigeria's poverty rate hits 63% in 2025 despite inflation slowdown – World Bank [Report on the World Bank's Nigeria Development Update, April 2026]. https://nairametrics.com/2026/04/10/nigerias-poverty-rate-hits-63-in-2025-despite-inflation-slowdown-world-bank/

Ogbu, A. A., Wadinga, B., Jibrilla, A., & Yahaya, A. (2025). Relationship between money supply and interest rate in Nigeria 1990–2023. ADSU International Journal of Applied Economics, Finance and Management, 10(4). https://ajaefm.adsu.edu.ng/index.php/journals/article/view/315