EXCHANGE RATE DEPRECIATION AND INFLATION IN NIGERIA: ERROR CORRECTION MODEL
This study set out to investigate the impact of exchange rate on inflation in Nigeria, time series data from 1981 to 2009 period are use and various econometric tools such as cointegration and error correction modeling (ECM) were employed to carry out the empirical analysis.
The result of the study shows that exchange rate depreciation has a weak negative effect on inflation in short run and a stronger negative effect on inflation in the long run. It is imperative for the monetary authorities to recognize the relative importance of the supply channel of the link between the real sector of the economy and the monetary system.
TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION
1.1 Background of the Study
1.2 Statement of Research Problem
1.3 Objective of the Study
1.4 Statement Hypothesis
1.5 Scope of The Study
CHAPTER TWO: LITERATURE REVIEW
2.2. Definitions of Exchange Rate
2.3 Concept of Nominal Exchange Rate (NER)
2.4. Concept Of Real Exchange Rate (RER)
2.5 Concept Of Exchange Rate And Inflation
2.6 Determinants Of Exchange Rate Inflation (Movement)
2.7 The Effect Of Exchange Rate Inflation
2.8 Exchange Rate Inflation in Nigeria Economic
(PRE SAP AND POST SAP)
CHAPTER THREE: RESEARCH METHODOLOGY
3.2 Specification of The Model
CHAPTER FOUR: EMPIRICAL ANALYSIS
4.1 Unit Root Testing
4.2 Cointegration Analysis
4.3 The Error Correction Mechanism (Ecm)
4.4 Long Run Relationships
CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
5.1 Summary of Findings
Monetary policy has always been seen as a fundamental instrument over the years for the attainment of macroeconomic stability, often view as prerequisite to achieving sustainable output growth. Thus, in the pursuit of macroeconomic stability, the managers of monetary policy have often set targets on intermediate variables which include the short term interest rate, growth of money supply, and of course the exchange rate. Among these intermediate variables, the exchange rate is argued to have a greater influence of the economy through its effect on the value of domestic currency, the external sector, macroeconomic credibility, capital flows, financial stability and of course domestic inflation increased exchange rate directly affects the price of imported commodities and an increase in the price of imported goods and services contributes directly to increase in inflation (CBN, 2008). The adverse consequence of inflationary pressure from exchange rate depreciation have been a serious concern for the monetary authorities, economists and policy analyst, given that these variables exchange rate and inflation –are the key determinants of economic performance. Consequently, assessing the link between exchange rate and inflation is pertinent because an understanding of the link between these variables is prerequisite for the successful conduct and adoption of inflation targeting. The Nigerian government has also made this, her primary objective in the attainment of its macroeconomic objective (Iyoha et al, 2008).
Under inflation targeting, monetary policy stance through changes in short term interest rate affects inflation through a large set of variables including exchange rate (Mukherjee and Bhotta Charya, 2011). Inflation is one of the macroeconomic problems facing many developing countries today and Nigeria is not exempted. Inspite of the use of monetary and fiscal policy measure, inflation still remains a serious and contentious problem in Nigeria. It is widely accepted that the pursuit of price stability is primary to long-run growth and development should be concern of every economy, and one of the reasons for this is the high varying inflation rate which has social and economic stocks on the economy as a result of its negative effect on price stability savings and investment. Given this scenario, the focus of low inflation rather than output or employment.
In Nigeria, there have been several studies for various time period on the cause of inflation. For instance, Oyejiede (1972), Akinnifeh (1984), Adeyeye and Fakiyesi (1980), Osakwe (1983) and Asogu (1991), attempted empirically to ascertain the cause of inflation in Nigeria. Oyejide (1972), made empirical enquiry into the impact of deficit financing on inflation and capital formation. He related domestic money supply to inflation using Fischer’s type of equation. Since there seems to exist a direct correlation between general price level and measurement of deficit financing overtime, he concluded that less emphasis on deficit financing may limit the growth of price inflation. According to Akinnifesi (1984), factors such as changes in money supply, lagged system, government deficit expenditure, industrial production, and food price indices were variables captured while changes in the annual data for 1960-1983 were used in empirical estimation. The study showed that changes in the above factors, jointly explained inflationary tendencies in Nigeria. The study however emphasized that the increase in government expenditure financed by monetization of oil revenue and credit from the banking system were responsible for the expansion of money supply which in turn with a lagged in effect contributed immensely to inflationary tendencies.
A study conducted in the research department of the Central Bank of Nigeria (CBN) for the period 1960-1994, confirmed that growth in the money supply is a major determinant of inflation in Nigeria. In the periods of high monetary growth (1980, 1990, 1992-1994), inflation surged accordingly, though with some lag. As the increase in narrow money rose from (xx) 4.1% in 1988, the inflation rate increased from (xx) 5.4% to 38.3% during the same period following peaked at 50.0% in 1989. Similarly, when the money supply growth increased substantially inflation also accelerated. On the other hand, the decline in the monetary growth rate in 1994 led to a consequent decline in inflation rate. This confirmed that there is a strong link between increases in money supply and inflation.
1.2 STATEMENT OF RESEARCH PROBLEM
Inflation rate as reported by the National Bureau of Statistics (NBS,2011), averaged 10.61% reaching on all time high of 15.60% in February of 2010 and a record low of 3% in July of 2006. Economists have agreed that high rate of inflation cause problems not just for individuals but for aggregate economic performance. High inflation is and has never been favorable to economic growth.
There is almost a universal census that macroeconomic stability, specifically defined as low inflation is positively related to economic growth. Over the years the question of the existence and nature of the link between exchange rate, inflation and growth has been the subject of considerable interest and debate (Erbaykal and Okuyan, 2008). Although the debate about the precise relationship between these variables is still open, the continuing research on this issues has uncovered some important result s in particular, it is generally accepted that inflation has a negative effect on medium and long term growth (Bruno and Easterly, 1998). Inflation impedes efficient resource allocation by observing the signaling role of relative price changes, the most important guide to efficient economic decision making (Fischer, 1993). Kumpayi et al (2012), reveals that over the last few decades high inflation in Nigeria has caused yield on investment to decline while government policy objectives has been adversely affected as the real size of its budget shrinks with rising inflation which has hampered economic growth. Inflation is inimical to growth and if follows that policy makers aim at a low rate of inflation. But how low should it be? The empirical test of this study shall provide answer to it and how it can be tackled.
1.3 OBJECTIVE OF THE STUDY
The study will be aiming at the following objectives:
1. Reviewing the exchange rates and inflation rates from the 1980s to the end of the first decades of the new millennium.
2. Ascertain the relationship between exchange rate depreciation and inflation rate in Nigeria.
3. Analyzing issues relating to policies regarding exchange rate in Nigeria and,
4. Providing appropriate recommendations to the problem of inflation in Nigeria.
1.4 STATEMENT OF HYPOTHESSS
The research Hypotheses are as follow;
1. There is no significant relationship between exchange rate depreciation and inflation.
2. There is significant relationship between exchange rate depreciation and inflation.
3. Government expenditure is has positive relationship with inflation.
INF= αo+ α EXR+ α2 ¬¬RGDP+ α3 M+ α4 MRR + α5 GE
1.5 SCOPE OF THE STUDY
The essence of this is to capture the major determinants of exchange rate and inflation in Nigeria in order to make statement that are based on facts and figures as well as to enhance unbiasedness.
A period of thirty (30) years covering 1980 - 2012 would be considered and will apply some macroeconomic variables as independent variable while inflation rate is the dependent variable.