Monetary Tightening and Its Impact on Development Finance Flows: Evidence from Nigeria

Abstract

This study adopted two long run regression models to assess the effect of monetary tightening on development finance flows in Nigeria from 1990 to 2023, using the fully modified ordinary least squares (FMOLS) technique. The study specifically assessed the long run effects of money supply, exchange rate, monetary policy rate, the U.S. Federal Reserve rate and inflation rate on official development assistance and foreign direct investment, which serve as measures of development finance flows. The regression estimates for the ODA model indicate that the exchange rate has a positive significant effect on ODA, while the monetary policy rate has a negative significant effect, signifying that domestic monetary tightening reduces official development assistance inflows. For the FDI model, the findings show that increases in the U.S. Federal Reserve rate considerably reduce FDI in Nigeria as investors redirect funds toward safe and high yielding assets in advanced economies. On the other hand, the domestic monetary policy rate (MPR) has a positive significant effect on FDI, indicating that increases in MPR can attract foreign investors seeking high returns especially portfolio and short run investments. Based on these findings, the study recommends that government adopt a fair approach to monetary management and avoid undue tightening that may discourage donor support. Additionally, policies should be implemented to stabilize the exchange rate and diversify external finance sources that are critical for sustaining development finance flows.