ABSTRACT
The research work was set out to appraise the impact of inflationary trend on exchange rate, that is, price of the domestic currency in terms of another currency. The objective of this study is to examine the effect of exchange rate on inflation on the Nigerian economy and also determine the relationship between exchange rate policy and their effect on the Nigerian economy.
The study adopted the use of econometric statistical tools in estimating the relationship between inflation rate and exchange rate in Nigerian economy. Regression was employed using multiple regression analysis in obtaining the numerical estimates of the coefficients in the model formulated. Data were collected from secondary source spanning from 1990 to 2009. The source of data is Central Bank of Nigeria (CBN). The result that there is a negative relationship between inflation rate and exchange rate in Nigeria with F = 6.536. Also, it was revealed that there is a positive relationship between gross domestic product, inflation rate and exchange rate in Nigeria with F = 10.327. Finally, the research found that there is a positive relationship between gross domestic product, inflation rate, exchange rate and money supply in Nigeria with F = 6.544. Based on the empirical findings, the study suggest that The monetary authorities need to continuous monitor the exchange rate to ensure that it is within a competitive level that would ensure that simultaneous attainment of internal and external balance. Inflation rate should be manage and kept within levels at which the external sector remains competitive in the local economy.
CHAPTER ONE
INTRODUCTION
1.O BACKGROUND OF STUDY
The tradition definition of money as anything that is generally accepted as a medium of exchange, which can also serve as a store of value has stressed money as an assets held in interim between receiving payment and making payment. Comprehensively, money is the set of liquid financial assets which has a close correlation with the development of the economy and is potentially subjected to the control of monetary authorities. From this definition above one can conclude that money is a central to the efficient working of any modern economy that relies on specialization and exchange.
Furthermore there is a general saying that no man is an Island, so I believe no country is also an Island, that there is scarcely any country that lives in absolute autarky in this globalised world. The economies of all the countries of the world are linked directly or indirectly through asset or/and goods markets. This linkage is made possible through trade and foreign exchange. The price of foreign currencies in terms of a local currency (i.e. foreign exchange) is therefore important to the understanding of the growth trajectory of all countries of the world.
The consequences of substantial misalignments of exchange rates can lead to output contraction and extensive economic hardship. Moreover, there is reasonably strong evidence that the alignment of exchange rates has a critical influence on the rate of growth of per capita output in low income countries (Isard, 2007).
Nigeria, like many other low income open economies of the world, has adopted the two main exchange rate regimes for the purpose of gaining internal and external balance. The augments and conditions for and against each of the regime is clear given that they are all aimed at maintaining stability in exchange rates. Direct administrative control exchange rate policy was used to manage Nigeria’s foreign exchange from independence in 1960. The country changed to a market regulated regime in 1986 for obvious reasons.
What is however yet to be clear is the relative advantage of the various organized market arrangement for selling and buying the foreign exchange under the dirty float regime that the country now operates. The country has and is still experimenting with various market arrangements. First in 1986, it chose to operate the Second Tier Foreign Exchange Market (SFEM) on an auction basis. More than two decades now after the introduction of the flexible exchange regime, Nigeria has operated several variants of the auction system (Auction System, Dutch Auction System, Wholesale Dutch Auction System, and Retail Dutch Auction System) towards determining the exchange rate of the naira to US dollar.
Trade as well know is widely accepted as a major engine of economic growth. This has been the experience of Nigeria since the 1960s even though the composition of trade has changed over the years. For instance, in the 1960s, agricultural exports (including cocoa, cotton, palm kernel and oil, groundnuts and rubber) were the country’s main sources of foreign exchange and revenue to the government. But with the discovery and export of crude oil in the late 1960s and early 1970s, the important role of agricultural exports began to wane, replaced by crude oil exports.
Therefore exchange rate is a relative price that measure s the worth of domestic currency in terms of another currency. It relates the purchasing power of a domestic currency, in terms of the goods and services it can purchase vis-à-vis a foreign or trading partner’s currency, over a given period of time. Since the exchange rate expressed the value of one currency in terms of another, when one currency appreciates, the other will depreciate.
However, when exchange of goods are made in the international market in a higher proportion of currency, example dollars to naira, that is, the value of dollars appreciate while naira depreciates, the effect of this on nation is that importation price becomes high reflecting on final price level of such goods at the local market.
Subsequently, due to the risk in importation cost, few goods are imported which reduces the supply of such goods. The net effect of this is that, if effective demand for such goods rises, much more money will be chasing few available goods in local market, better still we say inflation arises. Therefore inflation as defined the neo-classicalist is always and everywhere a monetary phenomenon and can be produce only by a more rapid increase in the quality of money than output. The most important features of the definition of inflation are; there must be a persistent increase in the general price level, it must be noticeable in the whole economy, and it must persist over a period of time.
Conclusively, the study of exchange rate is useful for macro economic management since it reflects the performance of both the domestic and external sectors of the economy.
Importantly, if exchange rate is managed, it will sprout the attainment of a stable and realistic exchange rate that will lead to a locative efficiency in the foreign exchange market, increase domestic productivity, guarantee the attainment of internal balance, encouragement of export activities leading to improve foreign exchange earnings, attraction of foreign direct investment and reduce the inflationary spiral.
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