A Theoretical Investigation into the Optimal Monetary Policy Framework for a Commodity-Dependent Developing Economy

Standard New Keynesian monetary policy frameworks developed for diversified economies with deep financial markets are inadequate for commodity-dependent developing economies facing the distinctive shocks and structural constraints that characterise Nigeria, and developing an original optimal monetary policy framework for such economies constitutes a significant theoretical contribution. This study developed an original optimal monetary policy framework for commodity-dependent developing economies, with theoretical derivation and calibration grounded in Nigeria's macroeconomic structure. A dynamic stochastic general equilibrium approach was employed, developing an original model that extends the standard small open economy DSGE framework to incorporate commodity sector endogeneity, shallow financial markets, dual exchange rate dynamics, and incomplete monetary policy transmission. Model parameters were calibrated to Nigeria's quarterly macroeconomic data from 2005 to 2022. Optimal policy rules were derived and compared against three benchmark rules (Taylor, strict inflation targeting, and nominal GDP targeting). The original model confirmed that optimal monetary policy in commodity-dependent developing economies deviates significantly from standard inflation targeting prescriptions. An exchange rate-augmented rule incorporating commodity price stabilisation provided the best welfare outcomes under oil price shock scenarios. Fiscal dominance constraints were incorporated as binding restrictions on monetary policy independence. Expert review by 20 macroeconomists confirmed the model's theoretical originality. The study recommends CBN exploring an official commodity-augmented monetary policy framework and investing in macro-financial modelling capacity to operationalise the theoretical insights.

Keywords: optimal monetary policy, commodity dependence, DSGE model, Nigerian economy, original framework