INTRODUCTION 1.1 Background of the study

Rapid output growth and low inflation are the most common objectives of macroeconomic policy in both developed and developing economies. In Nigeria, the formulation and implementation of monetary policy by the Central Bank of Nigeria (CBN) was aimed at maintaining price stability which is consistent with the achievement of sustainable economic growth. The monetary authority strives to achieve the governments overall inflation objective through effective monetary management, which entails setting intermediate and operating targets in tandem with the assumed targets for GDP growth, inflation rate and balance of payments.

The growing interest in price stability as a major goal of monetary policy is an acknowledgement of the observed phenomenon that high inflation disrupts the smooth functioning of a market economy. High inflation is known to have many adverse effects: it imposes welfare costs on the society; impedes efficient resource allocation by obscuring the signaling role of relative price changes; discourages savings and investment by creating uncertainty about future prices; inhibits financial development by making intermediation more costly; hits the poor excessively, because they do not hold financial assets that provide a hedge against inflation; and reduces a countrys international competitiveness by making its exports relatively more expensive, thus impacting negatively on the balance of payments, and perhaps more importantly, reduces long-term economic growth (See Ghosh and Phillips, 1998; Khan and Senhadji, 2001; Billi and Khan, 2008; Frimpong and Oteng-Abayie, 2010). Overall, businesses and households are thought to perform poorly in periods of high and unpredictable inflation, Barro (1996).