Acta Universitatis Danubius. Œconomica, Vol 11, No 2 (2015)

Abstract

This paper investigates the long-run and short-run relationships between foreign reserves inflows and domestic credit in a small open economy(Nigeria). The money demand function was formulated and used in the analysis of the monetary approach to the balance of payments in Nigeria. The Johansen cointegration test and the Error Correction Mechanism(ECM) estimation techniques were adopted in the determination of the long-run and short-run relationships between foreign reserves inflows and domestic credit.Also,the Pantula Principle was used as a complementary estimation technique in the selection of the most appropriate cointegration model. The study found that domestic credit, real GDP, real exchange rate and interest rate are significant in the determination of foreign reserves inflows in Nigeria during the period under consideration. Furthermore, our results show a one-way long-run causality from domestic credit to foreign reserves inflows. The study recommends that the monetary authorities should impose stringent ceilings on domestic credit as excessive borrowing could cause drastic reduction in the inflows of foreign reserves.