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How Nigeria’s Central Bank Inflates the Money Supply

In April 2021 the governor of Edo State, Godwin Obaseki, said that the federal government printed an additional NGN 60 billion (60 billion naira) to be shared between all the states at the Federation Account Allocation Committee (FAAC). This was denied by the minister of finance, Hajia Zenab Ahmed. The Central Bank of Nigeria (CBN) governor, Godwin Emefiele, was a bit more forthright. He said, “That is our job. To print is about lending money. So, there is no need of putting all the controversy about printing of money as if we go into the factory, print the naira and start distributing on the streets…. It’s very inappropriate for people to give colouration to printing of money as if it’s some foreign words coming from the sky.”

It’s understandable that the CBN governor became frustrated at a state governor exposing an open secret of the CBN, since Nigeria’s inflation rate, as of the end of 2020, was 31 percent, according to economist Steve Hanke. Usually when the federal government inflates the nation’s currency, it does not use crude means like printing new money, as this could led to an increase in inflationary expectations by the populace, causing them to demand less of the currency and eventually to dump it quickly for other assets—land, cars, jewelry, bitcoin—that can hold their value much longer, precipitating hyperinflation. The CBN and other central banks around the world use more sophisticated and clandestine means of increasing the money supply.

If the government falls prey to the temptation of printing a great deal of new money, it could result in a phenomenon called hyperinflation, where the currency of the economy loses its purchasing power and essentially becomes useless as a medium of exchange for goods and services. This was the case in Germany in the 1920s, and more recently in Zimbabwe in the late 2000s and Venezuela in the mid-2010s.

Figure 1: Money supply growth versus inflation in Zimbabwe, 1994–2009

Source: Reserve Bank of Zimbabwe.

Generally, the government increases the money through its central bank’s control over private commercial banks. So, while Obaseki was right about the fact that the NGN 60 billion was created out of thin air to share at the FAAC, he may have been wrong about how the money was created. We say ‘may’ because Nigeria is still very much a cash economy; that is, most Nigerians still make payments for goods and services with physical paper currency, so the possibility of increasing the money supply by actually printing more paper money is high. But printing more money than necessary is not recommended for the reasons stated above.

The Central Bank and the Supply of Money

The CBN was established by the CBN Act of 1958. As contained in the more recent 2007 act, the principal objectives of the bank include: “[E]nsure monetary and price stability; issue legal tender currency in Nigeria; maintain external reserves to safeguard the international value of the legal tender currency; promote a sound financial system in Nigeria; and act as banker and provide economic and financial advice to the Federal Government of Nigeria.” Through certain tools called monetary policy, the CBN tries to achieve its objectives.

The CBN is the only organization allowed to issue money in Nigeria, and this is one of its primary objectives. Through legal tender laws, the CBN ensures that the dominant currency in Nigeria is the currency called the naira. By law the naira is the only type of money approved as a medium of exchange in Nigeria.

The objective of ensuring monetary stability in a nutshell means ensuring the stability of the price of money or its purchasing power. Here it is important to note that money is not a price. Prices are represented in money, hence even money has a price. The price of money is its purchasing power.

So how does the central bank really increase the supply of money in the economy? It does this by adjusting the deposit-to-reserve ratio of all commercial banks, providing credit to commercial banks at a rediscount rate, and through open market purchases. Let’s break this down.

Deposit-to-reserve ratio: The CBN calls this the cash reserves ratio. This is the fraction of a depositor’s money a commercial bank is required to have in its reserve. Based on the latest CBN annual report (2018), the reserve ratio stands at 22.5 percent, which is approximately a reserve ratio of one to four. This means that for every hundred naira a bank has in its vaults, it can loan just 77.5 naira to the public with interest. Remember that the bank’s original depositor of those hundred naira still believes he has one hundred naira in the bank that he can get at any time. But the bank only has 22.5 naira in its vault. Now remember that there is 77.5 naira out there in the economy, being used by those who borrowed it from the bank to buy things. Hence the total money in the economy is now NGN 100 plus NGN 77.5.

The cash reserves ratio is set by the CBN, and based on this ratio commercial banks can loan money up to the limit. By adjusting the cash reserves ratio, the CBN can add or remove money from the economy.

The rediscount rate: The CBN calls this the monetary policy rate, and with it the CBN can provide loans to banks at below-market rates. These low rates are meant to encourage banks to use this monetary policy instrument: the banks can borrow money at low prices and then loan the same money at a higher rate to the general populace and make a clean profit. In 2018 this rate was 14 percent. Hence if a bank borrowed NGN 100 billion at 14 percent and loaned it at 25 percent, the bank would make NGN 11 billion in profit.

Open market purchases: The CBN calls this open market operations. This is the most common way the CBN increases the money supply in the economy. The CBN could go on the market to buy any asset if it wanted to increase money supply throughout the economy; it does this in a sophisticated way. For example, if the CBN wanted to increase the money supply by NGN 60 billion and the cash reserves ration were 10 percent, it could decide to buy a supercomputer for a price of NGN 6 billion from Okonkwo Computers Limited. This NGN 6 billion is printed out of thin air. The CBN would give Okonkwo a check for NGN 6 billion. But Okonkwo does not have an account with CBN; only banks have accounts with the CBN. Okonkwo would take the check to his bank, Olumide Bank, for example, and make the deposit. Olumide Bank would then increase Okonkwo’s checking account balance by NGN 6 billion. Olumide Bank now has a check against the CBN. It deposits the check at the CBN and the CBN now increases Olumide Bank’s reserves by NGN 6 billion. Based on the cash reserves ratio, Olumide can now make loans using the formula change in reserves * (1 – rr), where rr is the reserve ratio. Hence it is NGN 6 billion * (1 – 0.1) = NGN 5.4 billion. Olumide Bank can now make up to NGN 5.4 billion in loans.

Let’s say Olamide Bank loans this NGN 5.4 billion to Lola Cosmetics, which deposits the money at another bank, maybe Bank of Nigeria. Now, because all banks in the economy—Olamide Bank and Bank of Nigeria included—have a reserve ratio of 10 percent, per our current example, Bank of Nigeria will then be able to make up to NGN 4.86 billion in loans based on the formula change in reserves * (1 – rr).

After many banks receive the different deposits from loans made by other banks, we will have the following: NGN 6 billion + NGN 5.5 billion + NGN 4.86 billion + NGN 4.374 billion + … = NGN 60 billion.

This way the CBN gradually increases the money supply in the economy by NGN 60 billion but only has to physically print NGN 6 billion

In general, the CBN does not make purchases like a supercomputer or anything of that nature. Instead, it buys securities (bonds), as these assets are highly liquid. In general, it purchases government securities, like state government bonds, to avoid the serious political issues that could arise if it were perceived that the CBN is propping up certain companies unfairly in the market. But in April 2020, due to the recession brought about by the government’s response to covid-19, the CBN stated it would purchase corporate bonds.

We have seen what happens when countries continue to print and spend new money. A contemporary example close to home is Zimbabwe, whose dollar collapsed due to excessive money supply in February 2009. And this is what Nigeria must avoid. Nigeria does not want to get to the point of no return. The Obaseki/CBN money-printing saga has reduced public confidence in the naira as a store of value and increased inflationary expectations in the populace. It is our hope that the Nigerian government and the CBN will stop inflating dramatically and reduce their budgets.