Econometrics Analysis of Exchange Rate and Inflationary Rate on Economic Growth in Nigeria (1970-2018)
Chapter One
Objective Of The Study
The Objective of this study is to Econometrically analyze the exchange rate and inflationary rate on Economic Growth in Nigeria. (1970-2018); it will examine if exchange rate changes significantly affect the total national output and whether this influences the development of Nigeria’s economy. Specifically the study to:
- Empirically examine the relationship between exchange rate and inflation
- Determine the effect of exchange rate on inflation in Nigeria
- Examine the effect of exchange rate and inflation in Nigeria on Nigeria Economy
CHAPTER TWO
REVIEW OF RELATED LITERATURE
Conceptual Review
Exchange rate and inflation have been described as the key determinants of economic performance of any economy (Philip & Oseni, 2012). In view of this, assessing its relationship is pertinent because, an understanding of the nexus between exchange rate and inflation is very important for a successful adoption of inflation targeting as it would help to achieve some macroeconomic objectives of the country. Exchange rate is a key macroeconomic variable used as a measure for assessing international competitiveness. It can be described as an indicator of competitiveness of country’s currency in which there is inverse relationship between the competitiveness of the currencies (Rasaq, 2013). To this end, as the value of the indicator decreases, the competitiveness of the country’s currency increases in the international arena.
Jhingan (2005) in his opinion identified variables influencing exchange rate of a country to include exports, imports and structural influences. When country’s exports level is greater than its imports level, demand for the country’s currency increases and it would positively affect the nation’s exchange rate position. However, when the country’s level of imports exceeds its exports level, demand for foreign currency would rise and exchange rate position of the country will move upward. Therefore, any policy that leads to increase in exports volume more than import volume of a country, will have tendencies to raise domestic currency value, vis-à-vis other foreign currencies. Philip & Oseni (2012) in supporting this argument explained that exchange rate influences an economy by affecting the values of domestic currency, external sector, domestic inflation, macroeconomic credibility, capital flows and financial stability. Therefore, increase or decrease in exchange rate of a country affects prices of imported goods and services, and hence, contributes to high inflation in the economy (CBN, 2008). In the same view, Adekunle (2010) opined that volatile exchange rate would make foreign trade and investment decisions more difficult, as volatility increases exchange rate risk.
Noer, Arie & Piter (2010) argued that the effect of exchange rate on inflation is a function of exchange rate policy position of a country. The regime of exchange rate policy of a nation plays key role in reducing fluctuations and risk in the real exchange rate, which affects inflation level and the entire economy. Imimole & Enoma (2011) described exchange rate depreciation as being responsible for increased local currency cost of imported inputs goods, such as raw materials and intermediate capital goods, as well as final goods via the channel of cost push inflation. It should be noted here that since non-tradable goods cannot be imported, excess demand for the goods leads to increase in prices in short run. Dewett (1982) postulated that currency devaluation makes imports of the devaluing country costlier and its demand for imports is elastic. A higher amount would adversely affect the balance of payments of the devaluing country. Then, if the demand for exports is elastic, with a fall in prices of exports as a result of devaluation, the foreigners will help to restore equilibrium in the demand for imports that is elastic and imports of the country will significantly reduce.
According to Umeora (2010), exchange rate, money supply, government deficit budget and interest rates are mainly responsible for inflation growth in different parts of the world in various degrees. However, the developing countries are worst affected by high inflation level. During high inflation period, currency loses its purchasing power. Adetiloye (2010) opined that inflation is a determinant of money supply, induced by price increases in an economy. It is affected by persistent currency depreciation in the process of exchange to goods and services. For import dominated economy, exchange rate devaluation will have positive effect on stock market by increasing input costs. Import dependence has serious implications on an economy.
The least among them is imported inflation, which influences domestic prices of final goods. Sunusi (2007) cited in Bobai, Ubangida & Umar (2013) explained that a stable exchange rate is crucial for maintenance of price stability, as well as to attract foreign investment in an economy.
CHAPTER THREE
RESEARCH METHODOLOGY
Research Design
This study will examine the relationship between exchange rate and inflation, as well as the impact of exchange rate on inflation in Nigeria for the period 1970-2018. The study will adopt ex-post facto research design in the investigation. The analytical methods that will be employed in the study include Co-integration test, Vector Error Correction Model (VECM) and Partial Correlation Coefficient analysis. The Co-integration test examines the long run equilibrium relationship between exchange rate and inflation, while the Vector Error Correction Model (VECM) looks into the short run dynamics and long run relationship between the variables. More so, the Partial Correlation Coefficient analysis test investigates examine the degree of correlation between exchange rate and inflation in Nigeria. The variables employed in study include inflation rate (INFR) as the dependent variable, whereas the independent variables include exchange rate (EXCR), money supply (MS) and real gross domestic product (RGDP). In order to obtain estimation results, computer application of econometric package of E-view version 7.0 is used to estimate the econometric approaches mentioned above.
Model Specification
The model illustrating the relationship between exchange rate and inflation in Nigeria is specified as follows:
CHAPTER FOUR
ANALYSIS, RESULTS AND DISCUSSION
Presentation and Interpretation of Result
Unit Root Test
Table 1: Augmented Dickey Fuller (ADF) Unit Root Test Trend and Intercept (Series at level)
CHAPTER FIVE
CONCLUSION AND RECOMMENDATIONS
The primary objective of the study is to examine the relationship between exchange rate depreciation and inflation, as well as the impact of the exchange rate on inflation in Nigeria for the period from 1980 to 2013, through the applications of Co-integration test, Vector Error Correction Model (VECM) and Correlation Coefficient analysis. The study employed ex-post facto research design by employing Nigeria’s data obtained from the Central Bank of Nigeria (CBN) statistical bulletin from 1980 to 2013. The variables used for the investigation include inflation rate (INFR) as the dependent variable, whereas the independent variables involves exchange rate (EXCR), money supply (MS) and real gross domestic product (RGDP). Unit root test was conducted, and the result indicated that all the data series were integrated of the same order at second difference at 5% and 10% level of significance.
More so, the result of the Johansen co-integration test demonstrated that long run equilibrium relationship exists between inflation rate and the independent variables such as exchange rate (EXCR), money supply (MS) and real gross domestic product (RGDP). The result of the Vector Error Correction Model (VECM) revealed that exchange rate (EXCR) does not have significant effect on inflation rate (INFR) in Nigeria. On the average, it was estimated that 1% increase in exchange rate, decreases inflation in Nigeria by 24.9%. ECT result indicates that it will take 59.9% annually to correct temporary deviation within long run equilibrium relationship in the economy. Furthermore, the results of the partial correlation coefficient test illustrated that weak and negative correlation exists between the dependent variable (inflation rate) and the independent variables (exchange rate, money supply and real gross domestic product). This implies that a change in each of the independent variable(s) does not significantly lead to changes in the dependent variable.
In view of the findings above, the study therefore recommends as follows: that government should consider the activities of the parallel exchange rate market in its exchange rate policies while tackling inflation problem in the economy, as effort to stabilize prices would always be altered by unofficial exchange rate activities. The study also recommended that government should expand the scope of monetary authorities in order to strengthen them to control the activities of parallel exchange market in order to avoid continuous hike in exchange rate as seen in the corridors of foreign exchange market today, as depending solely on official exchange rate would not capture the reality of the exchange market. Similarly, government
should look inward to encourage production of export goods, rather than continuing to devalue or depreciate the country’s currency without tradable goods to export and reap the gain accrue to such devaluation policy.
The researchers appreciate that no work is all encompassing. We therefore suggest that further study should include other macroeconomic variables in the model and also expand the scope of the data, if data are available, to capture larger sample size.
POLICY RECOMMENDATIONS
In line with the findings of this study, the following policy recommendations are suggested to develop a more stable exchange rate as follows.
- Incentives should be provided for small scale manufacturing industries, to ease cost of production and enable them increase output level in terms of both quality and volume.
- The government should develop effective export promotion strategies in order to encourage domestic industries to produce and export more. This would strengthen the country’s export base against its import base resulting in a surplus balance of trade.
- The government should stimulate export diversification in agriculture, agro- investments, and agro-allied industries. These will improve foreign exchange earnings and strengthen the real GDP.
- The government should invest more in infrastructural development, in both rural and urban centres, to attract foreign investments into the economy. Such infrastructure will foster job creation, increase income, and improve the standard of living of the people.
- The government should focus its attention on developing policies that will impact the country’s balance of payment, thus creating a favorable balance between the domestic and foreign sectors.
- Stricter import tariffs should be put in place to discourage importers from bringing foreign goods into the country.
- Finally, the government should influence the foreign exchange rate, by positive economic reforms that will reduce the adverse effect of unstable foreign exchange rate on the Nigerian economy with respect to trade flow.
REFERENCES
- Adeniji, S.O. (2013). Exchange rate volatility and inflation upturn in Nigeria: Testing for Vector Error Correction Model. Munich Personal RePEc Archive, 2-19.
- Adetiloye, K. A. (2010). Exchange rates and the consumer price index in Nigeria: A causality approach. Journal of Emerging Trends in Economics and Management Sciences, 1 (2): 114-120.
- Adeyemi, A. O., Paul, O. & Oluwatomsin, M. O. (2013). Estimating the long run effects of exchange rate devaluation on the trade balance of Nigeria. European Scientific Journal, l9 (25), 233-249.
- Alalade, S. Y., Adekunle, O. & Joseph, O. A. (2014). Foreign exchange rate regimes and non-oil export performance in Nigeria (1986 – 2010). International Journal of Business and Behavioral Sciences, 4 (1), 122
- Aminu, U., Bello, M. S. & Salihu, M. (2013). An empirical analysis of exchange rate volatility on export trade in a developing economy. Journal of Emerging Trends in Economics and Management Sciences, 4 (1), 42-53.
- Asher, O. J. (2012). The impact of exchange rate fluctuation on the Nigeria economic growth. Unpublished Project, Caritas University, Enugu State, 1-97.
