The Interaction Of Exchange Rate Movement, Output And Selected Macroeconomics Variables In Nigeria

This study examines the interactions between among exchange rate, output and four other macroeconomic variables in Nigeria from 1981 to 2014. Using principal component analysis for the construction of financial sector development indices, Autoregressive Distributed Lag (ARDL) Bounds test technique, Johansen cointegration and TYDL causality approach, this study finds that effective exchange rate, output and the four selected macroeconomic variables are cointegrated in the long-run. We find that exchange rate has a positive impact on output in the long-run which coexist with the short-run lagged impact. Taking exchange rate movement as the dependent variable, the selected macroeconomic variables have significant long-run interaction effect on the exchange rate. Even though we control for the influence of financial sector development index, real income per capita, trade openness, interest rate, and government expenditure still show much significant impact on exchange rate. Also, unidirectional causality runs from macroeconomic variables to exchange rate movement. There is unidirectional granger causality running from trade openness to national output. The findings of this study offer some important policy implications. Great attention must be given to real exchange rate. This is because when exchange rate is targeted at too high, the risk in terms of output might be enormous. Therefore, there should be less risk associated policies that maintain the real exchange rate at equilibrium or stable state by encouraging a sufficiently rapid depreciation of nominal exchange rate and prevent further real appreciation. Hence, attempt to keep the real exchange rate at too low might have some adverse effect on output.