Abstract

The study aims to find the short-run empirical analyses of the impact of oil price fluctuation on the monetary instrument (Exchange rate, Inflation, Interest rate) in Nigeria. We explored the frequently used Toda–Yamamoto model (TY) model, by adopting the TY Modified Wald (MWALD) test approach to causality, Forecast Error Variance Decomposition (FEVD) and Impulse Response Functions (IRFs).The study covered the period 1995 to 2018 (monthly basis), and our findings from MWALD test indicated that there is a uni-directional causality of the log of oil price (lnoilpr) to log of the exchange rate (lnexchr) at 10% level of significance, also there is a contemporaneous response of log of consumer price index (lncpi) to log of exchange rate (lnexchr) and log of interest rate (lnintr), and jointly (lnoilpr, lncpi and lnintr) granger cause lncpi. Also at 5% level of significance lnintr responded due to positive change in lnoilpr and lnexchr, and jointly causes lnintr at 5% level of significance. This is complimented with our findings in FEVDs, and IRFs. The empirical analyses shows that oil price is a strong determining factor of exchange rate, cost of borrowing and directly influences inflationary or deflationary tendencies in Nigeria.

Highlights

  • There are many established empirical analyses on the macroeconomic consequence of oil price shocks to net exporting countries, this is based on the dependency between oil price and the business cycle which can be explained through the impact of the oil price shocks on aggregate demand

  • The oil prices are sensitive to structural shifts and, the causality approach with gradual/smooth shifts indicates oil price shocks influencing the currencies of Indonesia and South Africa, interest rates in Brazil and India, and inflation in South Africa and Turkey

  • This analysis aims at investigating the effect and the interrelations existing between the impact of oil price fluctuation on the monetary instrument (Exchange rate, Inflation, Interest rate)

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Summary

Introduction

Crude petroleum is one of the fundamental sources of energy in the world and plays an important role in economic growth and development of many economies. The effect permeates into households, oil price fluctuation induces the consumers to reschedule their expenditures on durable goods This suggested that oil price shocks have serious concerns for all types of economies as aggregate demand is reduced from both consumption and investment sides. According to [16, 17], the economy of Nigeria was affected by the decline in the revenue due to a fall in the price of crude oil alongside production They cited that in about twenty months, the oil price has nosedived rapidly from as high as about one hundred and thirty dollars per barrel to as low as twenty-eight dollars and quantity dropped from 2.15 Mbpd to 1.81 Mbpd in the earlier months of 2016, this resulted to a recession. According to Nweze and Edeme [19], as quoted by Adedokun [16], CBN [20] opined that on average, 75% of government revenues and on average 93% of foreign earnings from trade in goods and services, in the last ten years come from oil export, which informs part of the major sources used in financing the country’s imports

Literature review
Methodology
Toda and Yamamoto model (1995) and the modified Wald test statistic (MWALD)
Model specification
VAR modified Wald test (MWALD)
Stationarity tests
Modified Wald (MWALD) test for Granger causality
Correlation matrix for TY-VAR
VAR residual serial correlation LM tests
Test for normality of TY-VAR residuals
Modified Wald test for Granger causality test (M(WALD))
Forecast error variance decomposition (FEVD) and impulse response functions (IRFs)
Forecast error variance decomposition (FEVD)
Response functions (IRFs)
Findings
Conclusion and recommendation

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