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Nigeria's central bank signals more quantitative tightening to curb inflation


Nigeria’s central bank, under the leadership of its new governor, Olayemi Cardoso, has pledged to restore price stability and steady the country’s battered currency by implementing tighter monetary policies to combat inflation.

Olayemi Cardoso said that the bank is considering raising interest rates and reducing liquidity in the system. He also urged banks to expand their capital base to boost their resilience to potential shocks. According to Mr. Olayemi Cardoso, the central bank's call for banks to expand their capital base is also important for the stability of the Nigerian financial system. He argued that a stronger capital base would make banks more resilient to potential shocks, such as a recession or a financial crisis. This would help to protect the deposits of Nigerian citizens and businesses.

Quantitative tightening (QT) is known to be a monetary policy tool used by central banks to reduce the money supply and curb inflation. It is the opposite of quantitative easing (QE), which is a policy aimed at boosting economic growth by increasing the money supply.

Inflation in Nigeria has been on the rise in recent months, reaching 21.47% in October 2023. This is the highest level of inflation in the country in 17 years. The central bank is concerned that rising inflation could erode consumer purchasing power and hinder economic growth.

Central banks, in general, implement QT by selling government bonds and other assets from their balance sheets. This reduces the amount of money in circulation, making it more expensive for businesses and consumers to borrow money. Higher borrowing costs can lead to decreased spending and investment, which can help to slow down economic growth and reduce inflation. It is used when inflation is rising and central banks believe that economic growth needs to be slowed down as is the case in Nigeria.

The use of QT presents many drawbacks, however. And one of the major drawbacks of QT is that it could lead to financial instability. Indeed, QT can lead to financial instability because when central banks sell government bonds, they drain liquidity from the banking system, making it more difficult for banks to meet their reserve requirements. As a result, banks may have to raise interest rates on loans, which can make it more difficult for businesses and consumers to borrow money.

Economists have argued that another potential problem of QT is that it could lead to deflation, and that deflation is bad for the economy. Is deflation really bad for the economy though? Sure, long-term deflation could have some negative consequences on the economy because the longer deflation is ongoing, the less consumers would be willing to spend on the premise that prices will continue to fall further.

However deflation, overall, is preferable to inflation because it allows consumers to buy more goods and services with the same amount of money, which obviously increases their purchasing power and economic growth as well. Furthermore, deflation can encourage individuals and businesses to save more, as the real value of their savings increases, which can then lead to a more stable and secure financial system. And this is what Nigeria needs.

A sustainable deflation would be one where the economic system is backed by a commodity since commodity-based economies are inherently deflationary systems where prices are far more stable than in fiat systems. While it is unlikely to see economies like Nigeria going back to a commodity-backed system because it wouldn’t be profitable to governments, this is, however, what would help the Nigerian financial system to stabilize and for Nigerian consumers to have a higher purchasing power.

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