Revisiting Exchange Rate Dynamics and Inflation Targeting

from Nigeria

Abstract

In recent times, the Naira has witnessed abrupt and pronounced depreciation vis-à-vis other currencies due mainly to lack of  diversification in production capacities and heavy reliance on the production and export of a single primary commodity. The objectives of this paper are investigating the impact of real exchange rate on inflation in Nigeria; determine the impact of food prices, energy prices and government expenditure in Nigeria and analyze the direction of causality between real exchange rate and inflation in Nigeria. This paper covered the period 1986 to 2023 under the Mundel-Fleming and inflation targeting frameworks. The variables used in this paper are inflation rate, exchange rate premium, nominal interest rate, oil price, government debt and broad money supply, food price, and inflation inertia. The Johansen normalized co integration and Granger causality techniques were utilized in the analytical framework. The results show a positive relationship between real exchange rate and inflation targeting while the Granger causality result showed no feedback effect between real exchange rate and inflation targeting. This paper concludes that there is indeed a positive relationship between real exchange rate management and inflation targeting for inflation reduction. Strengthening policy coordination and commitment to price stability is a matter of urgency for the policymakers since policy coordination remains a major challenge for fiscal and monetary policy units; commit to countercyclical fiscal policy and initiate policy measures (credit and facilities) to promote the agricultural value-chain.