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Paper Money: How the money supply myth kills growth

Despite remarkable growth in FX inflows for Q1 of 2024, the naira remains embattled, having depreciated substantially from its N900/$ rate at the close of 2023.

Substantial volatility has left many weary and sceptical of the gains we have seen in recent weeks. Inflation is at levels unseen since the Abacha years, driven by piercing food inflation which eats incessantly at the buying power of ordinary Nigerians. Supply side challenges persist and exchange rate pass through, pushes basic necessities out of the reach of ordinary Nigerians.

It’s against this backdrop that the Monetary Policy Committee met last week. Anticipation was high. After an agonising wait, the analysts were near unanimous in their desire to see the committee double down on their commitment to inflation busting and monetary tightening.

The committee delivered once again, prescribing a further 200 basis point hike in the monetary policy rate to 24.75%, and an increase in the cash reserve ratio (CRR) for merchant banks from 10 to 14%. They kept CRR for commercial banks at 45% and the liquidity ratio at 30%.

The move was met with little surprise. Finally, it seemed, CBN was serious about taking on the burgeoning money supply which has become synonymous with inflation. Markets reacted positively. However, the data suggests that we’ve been getting it wrong.

While it may sound heretical, sober reflection on trends in money and credit suggest that much of the angst for hawkish tightening is misplaced. MPC is prescribing the right medicine for the wrong diagnosis to anchor inflation expectations, and if the alarm is not sounded, the consequences may be dire.

In February 2024 panic set in. M3 jumped by 18.21% in January 2024, when compared to December 2023, to N93.72 trillion, an alarming 76% compared to January 2023. Social media swirled with accusations, how could the government deny that it was printing money, just like the ways and means excesses it had criticised the Buhari administration for.

Much of this drove and justified the rapid depreciation in the currency to a low of N1900/$ in people’s minds. The focus on the headline figures obscured a shift which has important implications for how we approach our persistent inflation.

There are three tools that we generally use as a measure of money supply: M1, M2 and M3. M1 measures all the actual naira which can be used on demand. That’s the money in your deposit accounts and the cash that’s out of banks – so basically everything that can be spent as it is.

M2 takes M1 and adds all the stuff that’s so liquid that it could soon be money but is a bit more difficult to spend – that’s things like savings, fixed deposits and, importantly, foreign currency deposits. Finally, you have M3, which is M2 + any CBN bills held by the money holding sectors.

M1 is the closest measure of the actual money chasing goods in the economy, hence its name, narrow money. M1 has consistently fallen as a proportion of M2. What does that mean? As money supply grows, less and less of it is flowing in the real economy.

This trend is to be expected, indeed, those locked in deposits are a sign of a deepening banking system. However, if most of the new money supply was tied down, how could it have been driving inflation, and how could it have been chasing the dollar?

(Data Source: Money and Credit Statistics, CBN. Graph by Author.)

The angst about ‘money supply’ grew further still when it hit a new all-time high of N95 trillion In February. Pundits grappled with how money supply could have increased by 79% year on year; many pointed fingers at the Federal Government with the now familiar accusation of “printing money”.

One popular economist, in a Channels TV presentation, argued that “the big elephant in the room is money supply growth”. He went on, “if your GDP is at 3.4% and your money supply growth is at 79%, you have issues – you’re 73% underwater… so we need to tighten at this time, you can’t call it choking.”

The analysis follows the same argument which dominates the public discussion: there is a positive correlation between inflation and money supply growth; ergo money supply must be curtailed to combat inflation.

It’s based on a fallacy which fails to see the shift in the dynamics of money over the near and longer term. Worse still, the analyst misleadingly related nominal M3 growth, which does not account for inflation, to real GDP growth, which does.

For the first six months of 2023, growth in broad money was driven by increased lending, with a 31.15% increase in domestic claims, and a 39.64% increase in net claims on central government over the preceding December 2022.

Quasi money was being driven by increased holdings in government securities (borrowing). One thing we seem to have missed is that, with naira floatation, M2 is vulnerable to the kind of illusory growth implied by rapid depreciation. For the next 6 months, and indeed ever since, the primary driver of the growth in M3 has been the impact of revaluation in the aftermath of the CBN’s move to float the currency.

Indeed, this revaluation effect has distorted the data, giving the impression of rapidly expanding credit and monetary laxity, when this new “money” only exists on paper, just like the exchange rate gains which propelled paper profits in the banking sector to levels they will be unlikely to replicate this year.

changes in Naira and Dollar(Data Source: Weighted Average Rate – Nigerian Foreign Exchange Market (NFEM); Money and Credit Statistics, CBN. Graph by Author.)


This is clear when one looks at the CBN’s Monthly Economic Reports for 2023. In May, M3 was being driven by a sharp expansion in domestic claims. Claims on the Central Government (in layman’s terms, government borrowing) grew by 22.57% over December 2022, contributing 14.25 points to M3 growth. The expansion in net domestic claims outweighed a decline in net foreign assets of 28.8%.

By November, this trend had reversed against the same benchmark of December 2022. Net claims on Central Government had fallen by 78.2%, constituting a drag of 35.5% points on M3 over December 2023, while net foreign assets grew 738.2% and contributed 54.36 points to M3 growth.

Indeed, the trend of money supply fell in step with fluctuations in the bilateral N/$ exchange rate as soon as the CBN floated the currency. Now, broad money is not driving depreciation, it’s the other way around.

This illusory growth is not limited to M2 and M3 alone, revaluation effect created a perception of rapidly expanding credit too. As the naira was floated, there was a sharp increase in both consumer and sectorial credit allocation.

Sectorial credit allocation kept step with fluctuations in the N/$ exchange rate from June through October, highlighting a significant FX credit exposure to the private sector. Increased consumer credit broke relationship with the N/$ exchange rate in August as people borrowed more to manage the sharp uptick in living costs but fell back in line by September.

What’s most concerning is that both forms of credit broke relationship in November. As the naira depreciated further, nominal credit to both consumers and the private sector trended downwards, suggesting a significant recession in both naira and FX denominated credit available. This was before the two MPC meetings which spoke and acted tough on liquidity.

exchange rate(Data Source: Weighted Average Rate – Nigerian Foreign Exchange Market (NFEM); Monthly Economic Reports, CBN. Graph by Author.)

So, if by November, the FG was borrowing less (net), consumers were borrowing less and the private sector was borrowing less, where was all the money? Initially, the average net closing industry balance trended upwards, from N236.99 billion in April to N568.42 billion in July.

Since then, it has been in steady decline – reaching N146.45 billion in the most recently available data from November 2023. Throughout this period, usage of the CBN’s standard deposit facility has grown substantially from a year low of N224.29 billion in April 2023, to a peak of N3011.3 billion in October 2023, moderating slightly at N2801.7 billion in November.

By the time the MPC met in February 2024, MPC member Aku Pauline Odinkemelu noted that most banks already “had CRR above the regulatory threshold of 32.50%” and that the industry average was 39.36% – 6.86 percentage points above the MPC imposed requirement. In short, banks were not on a borrowing spree, at least outside the financial sector.

Chnages in banking liquidity(Data Source: Money Market Indicators; Inter-Bank Rates; Money and Credit Statistics, CBN. Graph by Author.)

The money was with the CBN. Worse still, some banks were evidently borrowing to meet their short-term liquidity needs as key money market indicators – open buy back and interbank call rates – rose sharply from October when they sat at a monthly average of 6.3% and 7.2% respectively, to February when they averaged 19.33% and 19.39% respectively.

That increased deposits coincided with significant growth in interbank borrowing rates suggests that the macro-prudential picture is insufficient, either for understanding the conditions of liquidity in the banking sector, or for setting policy for it.

Naira Illiquidity through the Micro/Macro-Prudential Paradigm

Indeed, as Dr Ayo Teriba argues in a 2017 paper on monetary policy conundrums for Nigeria, the macro approach to the question of prudential policy has real costs in sacrificing growth by hamstringing banks that have no excess liquidity issues to target the specific ones that do. MPC, in mistaking a screw for a nail, has prescribed a hammer. This approach arises from two structural weaknesses in the Nigerian banking sector.

On one hand, despite advances over the last two decades, the banking sector still has very weak exposure to the critical sectors of the Nigerian economy.

As of November, sectorial credit allocation for agriculture was just 5.06% despite a contribution of 24.65% to GDP in Q4 2023.

On the other hand, there has – for decades – been a systemic weakness in “micro-prudential” regulation, forcing MPC to push up the cash reserve ratio – which has risen from just 1% in 2009, to 45% today – at the cost of growth.

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