Inflation and Exchange Rate Volatility Pass-Through in Nigeria

Abstract

The paper investigates the impact of exchange rate volatility pass-through on price inflation in Nigeria. Annualised time-series data ranging from 1981 to 2015 was used and due to adjustment and generation of data for other variables from the sourced data, the paper used 30 years annualised data for its estimation. Vector Error Correction Model (VECM) was used to estimate the relationship that exists between the stated key variables. VECM estimation shows that all the variables specified in the model are relevant in Granger causing inflation in the long-run. ECM at long-run indicates a correction of deviation in one period and this is statistically significant at the 1 per cent significance level. We found no short-run relationship between inflation and exchange rate volatility, likewise with government expenditure, import, foreign direct investment and trade openness. However, money supply exhibited a positive relationship with inflation in the short-run. Variance decomposition makes it evident that other salient variables/factor included in the model contribute to change in inflation more than exchange rate volatility. We recommend that federal government agencies in Nigeria especially the Central Bank of Nigeria (CBN) and the Federal Ministry of Finance (FMF) should continue to take inflation targeting in the long-term as part of its monetary policy regime. The CBN should start given attention to the trade openness and foreign direct investment in managing the inflation. This paper discredits the public opinion that exchange rate volatility warranted inflation in the short-run. The paper investigates the impact of exchange rate volatility on inflation in Nigeria.