Modelling Interest Rates Pass-through in Nigeria : An Error Correction Approach with Asymmetric Adjustments and Structural Breaks

This paper investigates the size and adjustment pattern of the interest rate pass-through (IRPT) between the policy-controlled interest rate (MPR) and seven (7) retail interest rates (lending and deposit rates) in Nigeria. This study departs from previous studies on Nigeria in the sense that it takes account of the effects of structural breaks in our modelling approach. First, we confirm the existence of long-run relationships between MPR and two retail rates (prime lending rate and savings deposit rate), albeit with significant structural breaks occurring in their cointegrating vectors at different periods. Second, we find evidence of incomplete pass-through in the response of the retail rates to MPR shocks. Third, most of the retail interest rates adjust symmetrically to changes in the policy rate, with the exception of the savings rate. This implies that the response of savings rate varies depending on whether the innovation in the MPR is positive or negative. Fourth, positive innovations in the MPR are fully reflected in the savings rate within 2 months as against 8 months for negative MPR shocks. Fifth, innovations in the MPR are fully transmitted to the prime lending rate in about 14 months while the complete pass-through to the 6-month time deposit rate occurs in about 11 months. In view of these findings, we recommend that the monetary authority should always have an eye on the size of the pass-through as well as the heterogeneity found in the adjustment process of the retail rates while taking decisions on its policy rate. Also, the low IRPT obtained suggests a stronger monetary policy stance or other supplementary measures if the objectives of MPR changes are to be fully realized