CAPÍTULO 3: DIAGNÓSTICO, ANÁLISIS Y DISCUSIÓN DE RESULTADOS
3.3 Los cursos de formación
1Njogo Bibiana O, 2Afolabi, Taiwo Grace, 3Oladele, Jaiyeoba. A.
1&2Department of Economics, Accounting and Finance, College of management sciences, Bells University of Technology, Ota, Ogun State, Nigeria
3Department of Taxation, Federal Polytechnic, Ilaro, Ogun State, Nigeria.
Abstract: The issue of high inflation rate has been a challenge to the Nigerian economy. Many studies have examined several factors that lead to high inflation rate yet the figures keep on increasing according to empirical data. Against this background, this study examined the effect of exchange rate depreciation on inflation rate in Nigeria. Annual time series data for 37 years (1981 – 2018) were gathered from the Central Bank of Nigeria statistical bulletin for the study.
The Augmented Dickey-Fuller unit root test, Fully Modified OLS and Error Correction Mechanism were used to analyze the data. This study found that lagged-one inflation (INFR-1), government expenditure (LGEXP), and money supply (LMS) were also stable in impacting inflation (INFR) with probability values of 0.0000, 0.0004, and 0.0081 respectively, and were all positively significant at 5% level. However, only real gross domestic product (LRGDP) was insignificant in impacting inflation (INFR) as its probability value of 0.1073 was not significant at 5% level. Finally, in the long run, exchange rate depreciation induces incremental effects on inflation rate in Nigeria during the period examined with probability values of 0.3063 and 0.7008 respectively for lagged-one and lagged-two exchange rate. The study thus recommended, amongst others, that the Central Bank of Nigeria should stop the practice of managed exchange rate whereby gains from crude oil price increase were being used to cushion the naira at the foreign exchange market. This practise depletes the scarce foreign exchange and hence unsustainable in the long run.
Keywords: Exchange Rate Depreciation, Inflation, Exchange Rate, Nominal Exchange Rate
Introduction
Historically, most developing nations have employed strict exchange rate controls and heavy protection of domestic industry with policies now thought to be at odds when considering sustainable and desirable rates of economic growth (Gnansounou &Verdier-Chouchane, 2012).
By contrast, many East Asian nations maintained exchange rate regimes designed to achieve an attractive climate for exports and an “outer-oriented” development strategy. Evidence from Latin American, Asian, and African countries is often quoted to support the view that the link between exchange rate behaviour and economic performance is quite strong (Edwards, 2006).
Literature affirmed that the two essential elements of measuring macroeconomic performance in any country are inflation and exchange rate because they exert significant spillover effect on economic well-being of any nation (Wellington, Chidoko & Zivanomoyo, 2013). However, the depreciation in exchange rate could boost domestic production through stimulating the net export component through an increase in international competitiveness of domestic industries leading to the diversion of spending from foreign goods whose prices become high, to domestic
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goods (Dada & Oyeranti, 2012). Therefore, the effect of exchange rate depreciation is an essential aspect of economic management in order to safeguard competitiveness, macroeconomic stability, and economic growth.
Some of the studies in the country indicate that exchange rate depreciation is transmitted directly to consumer prices only through a decrease in the final goods and services that are supplied from foreign countries (Chuba, 2015; Fatukasi, 2013; Imimole & Enoma, 2011 among others) while others indicated the contrary (Audu & Amaegberi, 2013; Zubair, Okorie &
Sanusi, 2013).
Thus, there is no consensus in literature regarding the influence of exchange rate depreciation on inflationary pressure in Nigeria. Therefore, is exchange rate depreciation a cause or a consequence of rising inflation rate in Nigeria? Exchange rate depreciation may be transmitted indirectly to consumer prices through an increase in the price of the capital goods imported by the manufacturers as input or through an increase in net exports and aggregate demand. While rising inflation rate could increase the cost of domestic production and make domestic outputs less competitive, thereby inducing depreciation of the naira. The significant of this study is to critically examine the effect of exchange rate depreciation in respect of the increasing inflation rate in Nigeria.
Theoretical Review
Purchasing Power Parity (PPP) Theory
The purchasing power theory as posited by Kuttner and Posen (2006) assumes that the normal equilibrium rate of exchange existing between two inconvertible currencies is determined by the ratios of their purchasing powers; hence the rate of exchange tends to be established at the point of equality between the purchasing powers of the two currencies. In essence, when one country’s inflation rate rises relative to that of another country, the decrease in exports and increase in imports depress the country’s currency. The theory attempts to quantify inflation-exchange rate relationship by insisting that changes in inflation-exchange rate are caused by the inflation rate differentials (Kara & Nelson, 2002). In absolute terms, PPP theory states that the exchange rate between the currencies of two countries equals the ratio between the prices of goods in these countries implying that exchange rate must change to adjust to the change in the prices of goods in the two countries. However, the expected inflation differential equals the current spot rate and the expected spot rate differential.
The PPP in its simplest form asserts that in the long run, changes in exchange rate among countries will tend to reflect changes in their relative price level. Kamin and Khan (2003) are of the view that if exchange rates are floating, the observed movement can be explained entirely in terms of changes in relative purchasing power while if it is fixed, equilibrium can be determined by comparing satisfactory methods for:
i) explaining the observed movements in exchange rates for countries whose rates were floating,
ii) determining equilibrium parity rates for those countries whose surviving rates were out of line with post war market conditions, and
iii) assessing the appropriateness of an exchange rate.
Despite criticisms of PPP theory, the theoretical foundation and explanation may sound reasonable and acceptable but its practical application in real situation maybe an illusion, especially in the long run (Gujarati, 2004). The pitfalls notwithstanding, PPP theory is
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generally a sine-quo-non in the exchange rate determination literature and continues to remain relevant in the determination of exchange rate among countries of the world (Nucu, 2011).
Law of One Price and Purchasing Power Parity
The theoretical foundation on which the relationship between prices and exchange rates is based evolves from the doctrine of purchasing power parity (PPP), an offshoot of the law of one price (LOOP), with the assumptions that there are no trade barriers and transport costs.
However, in real world situations, trade frictions exist and these distort the underlying assumptions of PPP. Notwithstanding these developments, the law of one price is still useful in understanding the relationship between prices and exchange rates. This relationship, linking the domestic price to exchange rate, follows from the LOOP which states that in the absence of trade frictions and under conditions of free competition and price flexibility, identical goods sold in different locations must sell for the same price when prices are expressed in a common currency.
Therefore, at equilibrium, the prices of tradable goods in two markets are not expected to differ when expressed in the same currency and thus, guaranteeing a complete pass-through. Thus, a change in domestic currency in a market would have equal change in price in the other market, even though the markets are in two different countries. Algebraically, PPP with no transport costs and tariffs can be written thus:
𝑃𝑡𝑎 = 𝐸𝑋𝐶𝑡𝑃𝑡∗ (1)
Where 𝑃𝑡𝑎 represent domestic price at time “t”, 𝑃𝑡∗ stands for the world import price and 𝐸𝑋𝐶𝑡is the nominal exchange rate. However, because of trade frictions, the LOOP may or may not hold in certain instances. This is based on the fact that many factors such as cost of production, producers’ mark up and exchange rate movements influence domestic import prices. The principle of PPP is the macroeconomic counterpart to the microeconomic LOOP. While LOOP relates exchange rates to the relative prices of an individual good, PPP relates exchange rates to the relative prices of a basket of goods. Both theories are used as theoretical background of exchange rate pass-through depending on whether the emphasis is at firm level or at macroeconomic level. However, PPP does not hold in the short run due to transaction costs, non-traded goods, price stickiness, imperfect competition and some legal obstacles (Feenstra and Taylor, 2008).
Empirical Review
Inflation may be one of the factors affecting exchange rate while it may also be the fact or affected by the exchange rate. In the literature, both views have been tested and examined.
Several empirical studies that have been undertaken to identify the possible determinants of inflation in Nigeria and elsewhere have identified exchange rate as another inflation determining variable. Okoli, Mbah & Agu (2016) investigated the impact of inflation on real exchange rate volatility in Nigeria, using a quarterly data of 181 series from the first quarter of 1970 all through to the last quarter of 2014. The models used in this work are GARCH (1, 1) model and granger causality in Vector Auto-Regressive. The conditional variance of the volatility in the real exchange rate at time t was found with the use of GARCH (1, 1) model to be susceptible to its conditional variance in the previous time period, the squared error term in the previous time period, the inflation rate, imported inflation, broad money supply and the lagged nominal exchange rate. The granger causality test shows that there is a uni-directional causality running from inflation to real exchange rate volatility and there is a causality running from the whole sample variable to imported inflation which is proxied with import; an
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indication that there is a relationship between imported inflation, real exchange rate volatility and other sample variables.
Audu and Amaegberi (2013) empirically evaluate the impact of exchange rate fluctuation on inflation targeting on the Nigerian economy. The study adopted annual times series data spanning a period of 43 years (1970 to 2012) using Phillips–Perron (PP) class of unit root test, Johansen Co-integration test, Vector Autoregressions (VAR) and parsimonious ECM. They found that the current exchange rate statistically exerts significant influence on inflation rate but the impact was negative.
Similarly, Zubair, Okorie and Sanusi (2013) use the impulse response from an estimated structural autoregressive model of the inflation process to estimate the dynamic exchange rate pass-through to consumer prices for Nigeria, using quarterly data for the period 1986-2010.
The results suggest that the exchange rate pass through is incomplete, low and fairly slow. On impact, for instance, the elasticity of inflation to exchange rate changes is about 0.02, and it takes eight quarters to reach its full-impact of only 0.26. The variance decomposition analysis suggests that money supply has contributed more to Nigeria’s inflation process relative to the exchange rate.
Ogundipe and Egbetokun (2013) stated that the increasing over dependence of Nigerian economy on imports has necessitated the need to continually examine the effect of exchange rate shocks on consumer prices. They adopt a structural vector autoregressive to estimate the pass-through effect of exchange rate changes to consumer prices. Using the variance decomposition analysis, they found a substantially large exchange rate pass-through to inflation in Nigeria. Their findings show that exchange rate has been more important in explaining Nigeria’s rising inflation phenomenon than the actual money supply. Similarly, Fatukasi (2013) examined the determinants of inflation rate in Nigeria covering period from 1981 to 2003. The study found that exchange rate exerts significant positive effect on inflation rate in the country.
Dynamics of exchange and inflationary rate and money supply in Nigeria was examined by Akinbobola (2012) using quarterly data from 1986Q1 to 2008Q4. The model was estimated using VEC Model. It confirms that in the long run, there is a negative and significant association between inflationary rate and foreign exchange rate as well money supply. He argued that possible justification for the inverse effect of money supply on price level is that inflation may not be due to aggregate demand pressure but rather due to hiccups in the supply chain of goods both from the domestic and foreign supply outlets. The study emphasized that empirical deductions also signify the presence of significant feedback from the long run to short run disequilibrium. However, there exists a causal linkage between inflation, money supply and exchange rate in Nigeria. Imimole and Enoma (2011) examined the impact of exchange rate depreciation on inflation in Nigeria for the period 1986-2008, using Auto Regressive Distributed Lag (ARDL) Co-integration Procedure. They regressed one year lagged value of inflation rate, current nominal exchange rate of the naira in terms of US dollar, current nominal broad money supply, current government expenditure and real GDP in the current period on current inflation rate. They found that exchange rate depreciation, money supply and real gross domestic product are the main determinants of inflation in Nigeria, and that naira depreciation is positive, and has significant long-run effect on inflation in Nigeria.
Adetiloye (2010) examined the relationship that exists between exchange rates and consumer Price Index in Nigeria for the period from 1970 to 2008. The study adopted the techniques of correlation and granger causality to determine the causality of the relationship that exists
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between consumer price index and the exchange rate. The result showed that parallel exchange rate impacts against the official rate causing a pull on the rates while the official and parallel rates both impact the consumer price index as expected with the parallel rates being of higher significance. The granger causality shows that consumer price index can cause import ratio to increase. Its causality in the consumer price index is high and significant in both directions.
Similarly, Aliyu, Yakub, Sanni and Duke (2009) examined exchange rate pass-through in Nigeria for the period 1986 to 2007. Quarterly series was employed and Vector Error Correction Model estimation was used in the estimation process. The authors found that exchange rate pass-through in Nigeria during the period under consideration was low and declined along the price chain, which partly overturns the conventional wisdom in the literature that exchange rate pass-through is always considerably higher in developing countries than developed countries. The authors concluded that in the long run, pass through would likely increase and monetary policy should be designed to accommodate the effect.
Omotor (2008) examined the impact of price response to exchange rate changes in Nigeria using annual from1970-2003. Evidence from the paper revealed that exchange rate policy reform is important in the determination of inflation in Nigeria. Other studies which have reached similar conclusions are Odusola and Akinlo (2001), Nnanna (2002), Lu and Zhang (2003).
Odusola and Akinlo (2001) applied the restricted Vector Autoregressive (VAR) model to demonstrate how devaluation impacted on output and prices (inflation) in Nigeria. Quarterly values of real Gross Domestic Product (GDP), broad money supply, official exchange rate, parallel exchange rate, prices (consumer price index; CPI) and lending rates were used in the study for the period from 1970 to 1995. Evidence from the study revealed that official exchange rate shocks were followed by increased prices, money supply and parallel exchange rate.
Model Specification
In an attempt to assess the relationship between exchange rate depreciation and inflation for the Nigerian economy, this study adopts the model by Imimole and Enoma (2011) which was based on the Purchasing Power Parity (PPP) postulation. Their empirical model is expressed in equation (1):
INFRt= β0+β1INFRt-1+ β2InEXCRt+ β3InMSt+ β4InGEXPt+ β5InRGDPt (1) Where: INFRt = Inflation in period t (Proxied by Consumer Price Index)
INFRt-1 = Inflation in lagged one period EXCRt = Exchange rate to US$1 in period t RGDPt = Real Gross Domestic Product in period t
MSt = Money supply proxied by broad money supply in period t GEXPt = Government Expenditure in period t
Ut = Error term
Table one below showed the a priori expectations of all the independent variables on inflation.
Table 1: A priori Expectations
Proxy Variables Definitions Measurements Expected Sign
INFRt-1 Inflation rate in the previous
period In percentage (%) Positive (+)
56 Broad Money
supply(MS)
Money supply used to examine the possibility of demand pull inflation on exchange rate. If increase money supply raise the exchange rate: there is demand pull inflation
In billion (N) Positive (+)
EXCR
Exchange rate used to examine the effect of exchange rate (to US$1) on inflation
In naira (N) Negative (-)
RGDP
Real GDP used to examine the influence of real income on general price level
In billion (N) Positive (+)
GEXP
Government expenditure used to evaluate the influence of fiscal behaviour on inflation
In billion (N) Negative (-) Source: Authors’ compilation (2018)
This study employed descriptive and econometric technique of analyses. Secondary data covering the period from 1981 to 2016 was sourced from Central Bank of Nigeria. This period was chosen because of the increasing inflationary pressure in Nigeria due to the excesses of the civilian administration of former president Shagari between 1981 and 1985, which set the course for oscillating trends of inflation rate in the country.
This study employed Augmented Dickey Fuller unit root test, Fully Modified Ordinary Least Square (FMOLS) estimation technique and Error Correction Mechanism to determine the effect of exchange rate depreciation on inflation rate.
Analysis of Result Unit Root Test
The summary of results of the ADF unit root test presented in Table 2 shows that all the variables (inflation rate, exchange rate, broad money supply, total government expenditure and real gross domestic product) are stationary after first difference at 5% significant level.
Table 2: Results of ADF Unit Root Test
Variables ADF Test Statistics Critical Value
Order of
integration Remarks
Level 1ST diff 1% 5%
INFR -2.9171 -5.8771 -4.2529 -3.5484 I(1) First Difference
LEXCR -1.2388 -5.3630 -4.2436 -3.5442 I(1) First Difference
LMS -0.7639 -3.2975 -3.6394 -2. 9511 I(1) First Difference
LGEXP 0.17630 -4.6036 -4.2627 -3.5529 I(1) First Difference
LRGD 0.0973 -3.2294 -3.6394 -2.9511 I(1) First Difference
Source: Researcher’s computation (2018)
Estimation of Long-run Elasticities: Fully Modified Ordinary Least Square (FMOLS) The FMOLS was employed to evaluate the long-run impact of the independent variables on the dependent variable The summary of FMOLS estimation result presented in Table 2 reveals that inflation rate in the previous period, exchange rate, government expenditure and broad
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money supply are statistically significant at 5 per cent since their individual p-value is less than 0.05 but real gross domestic product is statistically insignificant. Also, all the significant explanatory variables had their expected signs. The adjusted R-square of 0.754 indicated that the explanatory variables (inflation rate in previous period, exchange rate, government expenditure, broad money supply and real gross domestic product) explained 75.4 per cent of the changes in inflation rate in the long run and other explanatory variables not modeled explained 24.6 per cent. Thus, the goodness of fit of this model is adequate with high predictive power.
Specifically, a percentage increase in inflation in the previous period induces 0.66 per cent increase in current inflation rate in the long run and vice versa. This suggests that inflation rate exert cumulative effect in Nigeria in the long run. Furthermore, 1 percent increases in exchange rate induces 15.58 per cent increase in inflation rate in the long run. This suggests that exchange rate is one of the long-term determinants of inflationary pressure in Nigeria.
Also, 1 percent increase in government expenditures induces 37.4 percent increase in inflation rate in the long run. The reasons for the significance and positive sign could be attributed to the over eighty per cent of the federal government spending on recurrent disbursements which increase the money supply in the economy with no immediate contribution to productive capacity. Also, the prevalence of fiscal deficits induced by the vicious cycle of fiscal indiscipline, debt accumulation and debt financing starve the economy of productive funds and compound inflationary pressure. Similarly, 1 per cent increase in broad money supply induces 26.9 per cent in inflation rate in the long run similar to previous findings of Fatukasi (2013), Imimole and Enoma (2011). This is due to the fact that increase in money supply is not compensated with commensurate and corresponding rise in the prices of goods and services.
Table 3: Results from Fully Modified Ordinary Least Square (FMOLS)
Variable Coefficient Std Error t-Statistic Prob.
INFR(-1) 0.66 0.10 6.81 0.00
LEXCR 15.6 4.46 3.50 0.00
LGEXP 37.4 9.40 3.98 0.00
LMS 26.9 9.44 2.85 0.00
LRGDP -26.16 18.27 -1.43 0.16
C 271.4 16.32 1.66 0.11
R – squared 0.88 Adjusted R-squared 0.75 Source: Author’s estimation (2018)
Error Correction Mechanism
Table 4 presents the summary of the error correction estimates of inflation rate model (INFR) which is used to assess the short run determinants of inflation rate in Nigeria. The adjusted R square of the model of 0.672 indicate that the inflation rate in previous period, exchange rate, broad money supply, government expenditures and real gross domestic products (explanatory variables) jointly explained 67.2 per cent variations in Nigeria inflationary pressure which is a good fit while other factors not captured in this model explained 32.8 per cent of the variations.
Also, the error correction term of this study is statistically significant at 5 per cent and indicates that the model possessed 86.2 per cent speed of adjustment. This implies that the model adjust
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very fast back to equilibrium after any disturbance. Likewise, the model possess overall statistical significance at 5 per cent since probability value of F (0.002) is less than 0.05.
In the short run, inflation rate in previous period, government expenditures in previous period, and broad money supply in previous period are statistically significant determinants of Nigeria inflation rate at 5 per cent while real gross domestic product and exchange rate are insignificant.
Specifically, a 1 per cent increase in inflation rate in previous period induces 1.16 per cent increase in current inflation rate in the short run which suggests that previous inflation exert overbearing cumulative effect on current inflationary pressure. Also, a 1 per cent increase in government expenditures in the previous period would induce 38 per cent increase in the current inflation rate in the short run. The short run estimates of broad money supply in the previous period indicate that a per cent increase in it induces 38 per cent increase in current inflation rate. Contrary to expectation, exchange rate was found to exert no significant influence on inflation rate in the short run possibly due in part to the frequent regime switch from pegged to floating to manage floating. This creates a situation of exchange rate uncertainty making exchange rate pass through effect not to be observed in the short run.
Table 4: Results from ECM estimation
Variable Coefficient Std. Error t-Statistic Prob
D(INFR(-1) 1.16 0.51 2.30 0.03
D(INFR(-2) -0.69 0.46 -1.49 0.15
D(LGEXP(-1) 38.21 11.56 3-31 0.00
D(LGEXP(-2) 28.16 16.43 1.71 0.10
D(LMS(-1) 38.21 11.56 3.31 0.00
D(LMS(-2) D(LRGDP(-1)
14.01 -18.17
30.59 10.77
0.46 -1.69
0.65 0.10
D(LRGDP(-2) 53.76 78.70 0.68 0.50
D(LEXCR(-1) -15.47 14.75 -1.05 0.31
D(LEXCR(-2) 4.50 11.54 0.39 0.70
ECM(-1) -0.86 0.41 -2.10 0.04
C 6.77 8.16 0.83 0.41
R –squared 0.69 Adjusted R-sqaured 0.67 Source: Author’s estimation (2018)
Conclusion
This study determines the effects of exchange rate depreciation on inflation in Nigeria and found that broad money supply and government expenditure are significant determinants of inflation rate in the country. Thus, the behaviour of inflation in this country can be explained by these factors as well as other factors not included in the model. Therefore, efforts that are geared towards curtailing inflationary pressure should focus more on fiscal behaviour of the
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government. Since the monetization policy of the Nigeria Government is major determinant of inflation in the economy. By the policy, a huge sum of money is pumped into economy without a corresponding increase in the provision of goods and services.
Although exchange rate depreciation may not directly control inflation in the short run, it helps to restructure the price mechanism of both import and export in the long run, such that Naira depreciation subtly tends to moderate prices in Nigeria, especially imported price inflation. It is therefore suggested that policy makers should not totally rely on this instrument to control inflation, but should use it to complement other macro-economic policies. More so, policies should be put in place to increase domestic production of export commodities, which are currently short-supplied.
Recommendations
1. This study recommends that the Central Bank of Nigeria (CBN) should stop the practice of managed exchange rate whereby gains from crude oil price increase were being used to cushion the naira at the foreign exchange market. This practice depletes the scarce foreign reserves and hence unsustainable in the long run. Rather, floating exchange rate regime should be systematically employed in phases.
2. Furthermore, the policy makers in the country should ensure that monetary policy and fiscal policy are effectively harmonized and their objectives synchronized. A strict monetary policy aimed at curtailing inflation would be counterproductive when fiscal behaviour of the federal government is expansionary.
3. The growth of the money supply should continually be kept in check given its long-run potential and magnitude of exerting inflationary pressure on the economy. Appropriate steps that will moderate the expansion of the money supply without consistence and costly mobbing up by the CBN should be adopted.
4. Also, the monetary authority should be consistent in the formulation and implementation of exchange rate policy measures taken or being adopted because policy reversals and time inconsistency have tendencies of destabilizing the general price level.
References
Adetiloye, K. A. (2010). Exchange Rates and the Consumer Price Index in Nigeria. Journal of Emerging Trends in Economics and Management Sciences, 2(5), 114 - 120.
Akinbobola, T.O. (2012). The dynamics of money supply, exchange rate and inflation in Nigeria. Journal of Applied Finance and Banking, 2(4), 117 - 141.
Aliyu, S.U.R, Yakub, M.U, Sanni G.K. & Duke, O.O (2009). Exchange rate pass-through in Nigeria: Evidence from a vector Error Correction Model. Paper presented at the CSAE Conference, Oxford University, UK.
Audu, N. P. & Amaegberi, M. (2013). Exchange rate fluctuation and inflation targeting in an open economy: Econometric Approach. European Journal of Accounting, Auditing and Finance Research, 1(3), 24 - 42.
Chuba, M. A. (2015). Transmission mechanism from exchange rate to consumer prices in Nigeria. European Journal of Business and Social Sciences, 4(3), 110 - 126.
Dada, E. A. & Oyeranti, O.A. (2012). Exchange rate and macroeconomic aggregates in Nigeria. Journal of Economics and Sustainable Development, 3(2), 93 – 101.