Abstract
Nigeria has experienced somersault of foreign exchange policies by the Central Bank. One policy concern in recent times is to have an appropriate target of the exchange and interest rates. Therefore, this paper seeks to provide a foundation for the targeting of an appropriate exchange and interest rates for the country. Using the Johansen Cointegration and Vector Error Correction Mechanism approaches, it specifically examines the relationships among Nigeria’s weak exchange rate, its local rate of interest and world interest rate. Contrary to many studies, a control measure involving inclusion of inflation, money supply and national output in the model is done. The analysis showed an equilibrium association between exchange rate and interest rate-cum-other variables and steady rectification of deviance from long-run stability over a sequence of incomplete short-run modifications. Increase in domestic and world interest rate, inflation, money supply and GDPat equilibrium would strengthen the exchange rate. Besides, further findings showed some bidirectional causal associations among the variables. By long-run implication, the targeting of an appropriate exchange rate in Nigeria requires a tightened monetary policy that is not inflation and growth biased. However, increase in world interest rate, money supply and inflation rate must be moderate in order not to worsen the exchange rate as suggested by the short-run result.
Highlights
In the midst of another recession in Nigeria which began in 2016 after 25 years is a worsen exchange rate and a low return on investment, that is, interest rate, given the high level of inflation
The standard deviation of exchange rate, money supply, inflation rate, domestic interest rate, domestic output level and world interest rate from their respective long term mean values in every quarter stood at 2.1%, 3.9%, 1.5%, 2.7%, 2.2%, and 2.0%
We estimated on Nigeria, the relationship between domestic and world interest rates and exchange rate with money supply, national output and inflation serving as controlled variables
Summary
In the midst of another recession in Nigeria which began in 2016 after 25 years is a worsen exchange rate and a low return on investment, that is, interest rate, given the high level of inflation. The unfortunate scenario is that Nigerian economy remains fragile with its growth being largely financed by oil revenue (see Babatunde, 2015, Olagbaju & Akinbobola, 2016).There remains theoretical concerns as well as constraints in the choice of exchange rate regime in both developed and developing countries. This is because the choice of exchange rate regime as well as theoretical model of exchange rate ought to consider the link with financial discipline, inflation and economic development. It implies that commitment to an exchange rate policy should be compatible with the main macroeconomic equilibrate; otherwise it will not be sustainable (see Dordunoo & Njinkeu, 1996; Bohl, Michaelis & Siklos, 2016)
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