Monetary Policy and Financial Deepening in Nigeria: A VECM and Impulse Response Analysis

Abstract

This study investigates the dynamic relationship between monetary policy and financial deepening in Nigeria using annual data (1995–2024) from the Central Bank of Nigeria (CBN) statistical bulletin. Employing Vector Error Correction Model (VECM), and impulse-response analysis, the paper identifies a long-run equilibrium linking Cash Reserve Ratio (CRR), Liquidity Ratio (LQR) and the Monetary Policy Rate (MPR) with financial deepening (measured as ratio of credit to private sector to gross domestic product) and traces how shocks to these instruments affect credit depth over time. Results acknowledge cointegration between the variables, and persistent negative effects of reserve and liquidity tightening on credit, while MPR shocks produce more complex short-run responses. Furthermore, a significant error-correction term (−0.144) was also found, implying partial adjustment to equilibrium. The study recommends: prioritizing easing of binding reserve and liquidity constraints to deepen finance while applying phased adjustments to reserve requirements, among others.