Exchange Rate Volatility, Currency Substitution and Monetary Policy in Nigeria
AbstractThis study analyzes the implications of currency substitution and exchange rate volatility for monetary policy in Nigeria. It adopts the unrestricted portfolio balance model of currency substitution, incorporating exchange rate volatility within the framework of the Vector Error Correction (VEC) technique. Results from both impulse response and the forecast error variance decomposition functions suggest that exchange rate volatility and currency substitution responds to monetary policy with some lags meaning that monetary policy may be effective in dampening exchange rate volatility and currency substitution in the medium horizon but might not be effective in the short horizon. The study concludes that currency substitution was not an instant reaction to the slightest policy mistake rather; it was fallout from prolonged period of macroeconomic instability. The major sources of this instability in Nigeria were untamed fiscal deficits leading to high domestic inflation, real parallel market exchange rate volatility, and speculative business activities of market agents in the foreign exchange rate market and poor/inconsistent or uncertainty in public policies. In terms of policy choice, our result favours exchange rate based monetary policy as against interest based monetary policy for stabilization in dollarized economies like Nigeria.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 16255.
Date of creation: 07 Oct 2008
Date of revision:
Publication status: Published in Botswana Journal of Economics Issue 9.Vol. 5(2008): pp. 61-83
Demand for money; Exchange Rate Volatility; Currency Substitution; Monetary Policy and Nigeria;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
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