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University of Ibadan
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.