Dynamics of Inflation, Interest and Exchange Rates with the Effects of Money Supply and GDP in Nigeria: Evidence from BVARX Models

Abstract

Economic theory revealed evidence of interrelationships among inflation, interest and exchange rates. Such theory further states possible effects of money supply and GDP on inflation, interest and exchange rates. This study focuses on the dynamic interrelationships among inflation, interest and exchange rates with the effects of money supply and GDP in Nigeria using Bayesian Vector Autoregression with Exogenous variables (BVARX) models. To achieve this, data was sourced from the Central bank of Nigeria (CBN) website spanning the period of 2010Q1-2020Q4. The study proposed six (6) versions of BVARX models with lag 2 using Normal-Wishart, Normal Flat and Flat-Flat priors. The results revealed superior BVARX models with Flat-Flat prior using Root Mean Square Error (RMSE) and Mean Absolute Error (MAE) as means of model selection. Lastly, evidence from Bivariate Granger causality testing reveals that the past lag values of inflation rate help in predicting exchange rate in Nigeria.