Financial Integration, Exchange Rate Stability and Macroeconomic Variables in Nigeria: “A Structural Impact”

Abstract

This paper explores the structural impact of financial integration and exchange rate stability on macroeconomic variables (inflation, economic growth, inflation volatility, and growth volatility) in Nigeria from 1980 to 2012, using a structural model. The study employs the use of Vector Error Correction Model (Coefficient Diagnostic Wald Test, and Impulse Response Function of VECM) to achieve our objectives. Time series data was collected from World Bank Development Indicators, Central Bank of Nigeria bulletin (2012) and Azienman, Chinn and Ito (2013). Results indicates that exchange rate stability has no significant impact on inflation rate in the short run, while percentage increase in financial integration has a significant reduction impact on the rate of inflation in lag1&2 by 126% and 79% respectively. Again a percentage increase in exchange rate stability significantly increased economic growth in lag 1 &2 by 30% and 50% respectively, while financial integration together with the financial institution depth (money supply/GDP) and financial market depth (stock market capitalization/GDP) have no significant impact on economic growth. Furthermore, there is no significant impact of the financial integration and exchange rate stability on inflation and growth volatility in the short-run. Exchange rate stability transmitted positive shocks to economic growth and inflation volatility and negative shocks to inflation rate and growth volatility. The impulse response of inflation and economic growth to a unit shock from financial integration fluctuated for the periods, while shocks from financial integration emitted negative impulse on inflation and growth volatility. In addition, impulse response of exchange rate stability and financial integration to unit shock from inflation, growth volatility and financial sector development (stock market capitalization/GDP, money supply/GDP) remained negative. The results imply that the combination of financial integration and exchange rate stability policy is a viable instrument towards achieving a stable economy. Therefore, this paper suggests that government should pay closer attention towards policies that will ensure stability in socio-economic and political environment, if Nigeria will achieve greater benefits in exchange rate stability and more financial integration.