MODELLING MACROECONOMIC DYNAMICS AND MONETARY POLICY TRILEMMA IN NIGERIA: A BAYESIAN VAR APPROACH

Abstract

In the wake of contagious shocks affecting open economies, the
conduct of monetary policy in an open-economy is increasingly
becoming challenging for policymakers. Hence given the
macroeconomic dynamism originating from either economic size,
inflation, trade openness, or financial development Thus, this paper
seeks to find the impact of macroeconomic dynamic on monetary
policy trilemma in Nigeria. To this end, the Mudell-Fleming
framework was used and the Bayesian VAR was applied as the
estimation technique. The paper found that a positive domestic
output shock that is associated with a rise in net export will
indirectly lead to exchange rate stability in both the short and long
term. An attempt to accommodate this shock with the view of
increasing the level of export growth was found to be detrimental
to Monetary Policy Independence (MPI). More so, under the rising
influence of domestic output growth, the paper finds that trade
openness is beneficial to exchange rate stability in Nigeria for the
period under review. Furthermore, owing to a temporal capital
inflow effect relative to outflow, financial development was found
to have a net-negative effect triggering exchange rate instability.
Effectively inflationary shock was found to have an inconsequential
effect on MPI. The paper also found the difficulty with which
policymakers implement monetary policy in an open economy
(open capital account) without giving up some level of autonomy in
stabilizing domestic output. The paper concludes that the trilemma-
solution that is in tune with stable inflation and output is a middle
ground that allows for some degree of weight shared between MPI
and CAO while placing full weight on ERS.