EXCHANGE RATE, OUTPUT AND INFLATION IN NIGERIA (1970-2007)
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Date
2010-09-06
Authors
JAMEELAH, OMOLARA YAQUB
Journal Title
Journal ISSN
Volume Title
Publisher
University of Ibadan
Abstract
Exchange rate policy is central to improving the economic performance of a nation.
Over the years, Nigeria adopted both the fixed and managed float exchange rate systems in her
attempt at attaining a realistic exchange rate. This is to ensure efficient allocation of foreign
exchange resources that may pave way for a non-inflationary growth and a well diversified
economy. However, the attainment of these goals remained elusive. Earlier studies on the
effects of exchange rate on the Nigerian economy ignored differences in sectoral output
responses to changes in exchange rate and economic agents’ expectations. This study,
therefore, investigated the effects of anticipated and unanticipated changes in exchange rate on
aggregate and sectoral output, and inflationary trends in Nigeria between 1970 and 2007.
A macroeconometric model, based on a modified investment-saving and the liquiditymoney supply framework, was employed using secondary data, to capture the direct and
indirect relationships between exchange rate movements, output and inflation. Exchange rate
was split into anticipated and unanticipated components using the Autoregressive Moving
Average method. The behavioural equations were estimated with the three-stage-least-squares
technique and a general-to-specific estimation methodology was employed to ensure that
important information was not left out. Statistical tests were used to confirm the goodness of fit
of the estimated equations. The Theil’s inequality coefficients and the root mean squared errors
were used to gauge the model’s efficiency and tracking ability. Their parameter values were
within acceptable range. The model was then used to carry out ex post simulations of the
effects of anticipated and unanticipated exchange rate depreciation on output and inflation.
Some differences in sectoral output responses to anticipated and unanticipated
depreciation were observed. The coefficients of anticipated exchange rate in the equations for
aggregate output, agriculture, manufacturing, and output of services were -0.05, -0.15, -0.01,
and 0.09, respectively. All of these were statistically significant at 5.00%, implying that
anticipated depreciation reduced aggregate output and outputs of agricultural and
manufacturing sectors, while it increased services sector’s output. Unanticipated exchange rate
had insignificant negative effects on aggregate and sectoral outputs, except for manufacturing
where the effect was positive. Anticipated depreciation had a strong inflationary effect with a
significant coefficient of 0.28, while the impact of unanticipated exchange rate on inflation was
negligible. Simulation results indicated that, on the average, a 15.00% anticipated depreciation
would reduce aggregate output by 2.12% and agricultural, manufacturing and services sectors’
outputs by 9.23%, 2.00%, and 5.32% respectively; while it would raise inflation by 17.17%.
Anticipated real exchange rate depreciation had significant contractionary effects on
aggregate and sectoral outputs (except for the services sector) and promoted inflation, while
unanticipated depreciation had negligible effects. This implied that policy neutrality hypothesis
may not hold for the Nigerian environment and, more importantly, that existing structures
could not support an expansionary argument for exchange rate depreciation during the period
of study.