Yinusa, D. Olalekan (2008): Exchange Rate Volatility, Currency Substitution and Monetary Policy in Nigeria. Published in: Botswana Journal of Economics , Vol. Vol. 5, No. Issue 9 (10 October 2008): pp. 61-83.
Download (259kB) | Preview
This 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.
|Item Type:||MPRA Paper|
|Original Title:||Exchange Rate Volatility, Currency Substitution and Monetary Policy in Nigeria|
|English Title:||Exchange Rate Volatility, Currency Substitution and Monetary Policy in Nigeria|
|Keywords:||Demand for money, Exchange Rate Volatility, Currency Substitution, Monetary Policy and Nigeria|
|Subjects:||F - International Economics > F3 - International Finance > F31 - Foreign Exchange
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money
|Depositing User:||Olalekan D. Yinusa|
|Date Deposited:||15 Jul 2009 13:42|
|Last Modified:||10 Feb 2016 18:56|
Adams, C. and B. Goderis, 2006. Monetary policy and oil price surges in Nigeria, A paper prepared for the Central Bank of Nigeria Workshop on Economic Policy Options for a Prosperous Nigeria, Abuja, October 23-24.
Agenor, P. 2004. The Economics of Adjustment and Growth, Second Edition, Harvard University Press, Cambridge Massachusetts.
Akinlo, A. E. 2003. “Exchange Rate Depreciation and Currency Substitution in Nigeria”. African Review of Money, Finance and Banking, Supplementary Issue of Savings and Development Quarterly Review, Italy.
Bernanke, Ben, and Ilian Mihov, 1998. Measuring Monetary Policy. The Quarterly Journal of Economics, Vol. 113(3):869-902.
Branson, W.H. and D.W. Henderson, 1985. The Specification and Influence of Asset Markets’, in R.W. Jones and P.B. Kenen (eds). Handbook of International Economics. Vol. II. Amsrerdam: North Holland.
Brischetto, Andrea and Graham Voss, 1999. A Structural Vector Autoregression Model of Monetary Policy in Australia, Research Discussion paper 1999-11, Economic Research Department, Reserve Bank of Australia, pp. 1-55.
Calvo, G.A. 1996. Money, Exchange Rates and Output. The MIT Press, Cambridge Massachusetts.
Central Bank of Nigeria, 2007. Direction of Monetary Policy Beyond 2007,
Clarida, Richard, and Mark Gertler, 1997. How the Bundesbank Conducts Monetary Policy. in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy, University of Chicago Press for NBER.
Corrado, G. 2008. An open economy model with currency substitution and real dollarization, Journal of Economic Studies, Vol. 35(1):69-93.
Cuddington, J.T. 1983. Currency Substitutability, Capital Mobility and Money Demand. Journal of International Money and Finance, Vol. 2:111-33.
Cushman, D.O. and T.A. Zha, 1997. Identifying Monetary Policy in a Small Open Economy Under Flexible Exchange Rates. Journal of Monetary Economics, Vol. 39(3):433-448.
D’Arista, Jane, 2000. Dollarization: Critical U.S views. Paper presented at a conference On: To dollarize or not to dollarize: exchange-rate choices for the western hemisphere, (Oct. 4-5) Ottawa, Canada.
Dornbusch, R. and A. Reynoso, 1993. Financial Factors in Economic Development. In R. Dornbusch (ed.), Policy Making in the Open Economy: Concepts and Case Studies in Economic Performance, Oxford University Press.
Dungey, M. and A. Pagan, 1998. Towards a structural VAR for the Australian Economy. Latrobe University, Mimeo.
Faust, Jon and Eric M. Leeper. 1997. When Do Long-Run Identifying Restrictions Give Reliable Results? Journal of Business and Economic Statistics. Vol. 15(3):345 – 354.
Friedman, A.A. and A. D. Verbetsky, 2001. Currency Substitution in Russia. Economics Education and Research Consortium Working Paper Series, Working Paper No 01/05
Friedman, M. 1956. The Quantity Theory of Money: A restatement. in M. Friedman, editor, Studies in the Quantity Theory of Money. Chicago: University of Chicago Press. Reprinted in Friedman, 1969
Fung, Ben S.C. 2002. A VAR Analysis of the Effects of Monetary Policy in East Asia. BIS Working Papers No. 119, Bank For International Settlements, Monetary and Economic Department.
Girton, L. and D. Roper, 1981. Theory and implication of currency substitution. Journal of Money, Credit and Banking, Vol.13(1):12-30.
Grilli, V. and N. Roubini, 1996. Liquidity Models in Open Economies. European Economic Review, Vol. 40:847-859.
Gruben, W.C and Darryl McLeod, 2004. Currency Competition and Inflation Convergence. Center for Latin American Economics, Federal Reserve Bank of Dallas. http://www.fordham.edu/economics/mcleod, accessed April, 2006.
Hamilton, J.D. 1994. Time Series Analysis. Princeton, NJ: Princeton University Press.
Ikhide, S.I. 1997. Financial Sector Reforms and Growth of Capital Market in Nigeria, IDE, V.R.F. Series, No. 291 (Feb.).
Ikhide S.I 1996. Financial sector Reform and Monetary Policy in Nigeria. IDS Working Paper, 68
Johansen, S. 1988. Statistical Analysis of Cointegration Vectors. Journal of Economic Dynamics and Control, Vol. 12:231-54 (June-September).
Kim, S. and N. Roubini, 1999. Exchange Rate Anomalies in the Industrial Countries: A solution with a Structural VAR Approach. University of Illinois, Urbana-Champaign, Mineo.
Lutkepohl, H. 1993. Introduction to Multiple Time Series Analysis, Springer, Berlin.
Miles. M.A. 1978. Currency substitution, flexible exchange rates and monetary independence. American Economic Review, Vol. 68:428-36.
Mizen, P.D. and E.J. Pentecost, 1996. Currency Substitution in Theory and Practice. in Mizen, P. and J. Pentecost (eds.) The Macroeconomics of International Currencies: Theory, Policy and Evidence. Edward Elgar Publishing Company. USA
Mizen, P.D. and E.J. Pentecost, 1994. Evaluating the Empirical Evidence for Currency Substitution: A Case Study of the Demand for Sterling in Europe. The Economic Journal, Vol. 104:1057-69.
Ndekwu, E.C. 1995. Monetary Policy and the Liberalization of the Financial Sector. in Akin Iwayemi (ed.) Macroeconomic Policy Issues in an Open Development, NCEMA. Ibadan.
Ndung’u, N.S. 2001. Liberalization of the foreign exchange market and the short-term capital flows problem, AERC Research Papers 109, African Economic Research Consortium, Nairobi, Kenya.
Ojo, M.O. 1992. Monetary Policy in Nigeria in the 1980s and prospects in the 1990s. CBN, Economic and Financial Review, Vol. 30(1)
Olomola, P.A. 1999. An Empirical Investigation of Currency Substitution in Nigeria. Ife Journal of Economics and Finance, Vol. 4(1 & 2)
Oresotu, F.O. and N.O. Mordi 1992. The Demand for Money Function in Nigeria: An Empirical Investigation. Central Bank of Nigeria, Economic and Financial Review, Vol. 30(1):32-69
Prock, Jerry, Gokce A. Soydemir and Benjamin A. Abugri, 2003. Cuurency Substitution: Evidence from Latin America. Journal of policy Modeling, Vol. 25:415-430.
Reinhart, C., K. Rogoff and M. Savastano (2003). ‘Addicted to dollars’, NBER Working Paper No. 10015.
Rogers, J.H. 1996. The Currency Substitution Hypothesis And Relative Money Demand In Mexico And Canada. in Mizen, P. and J. Pentecost (eds.) The Macroeconomics of International Currencies: Theory, Policy and Evidence. Edward Elgar Publishing Company. USA.
Sahay, Ratna and Carlos A. Vegh, 1996. Dollarization in Transaction Economies: Evidence and Policy Implications” in Mizen and Pentecoste (eds.) The Macroeconomics of International Currencies: Theory, Policy and Evidence. Edward Elgar Publishing Company. USA. pp. 193-224.
Savastano, M.A. 1996. The pattern of currency substitution in Latin America: An overview. in Mizen, P. and J. Pentecost (eds.) The Macroeconomics of International Currencies: Theory, Policy and Evidence. Edward Elgar Publishing Company. USA.
Seater, J.J. 2002. The Demand for Currency Substitution. http://www4.ncsu.edu/~jjseater/PDF/WorkingPapers/CurrencySubstitution.pdf, accessed July 2005.
Sims, C.A. 1980. Macroeconomics and Reality. Economectrica, Vol. 48(1):1-48).
Tobin, J. 1958. Liquidity preference as behaviour towards risk. Review of Economic Studies, Vol. 25:65-86.
Walsh, C. E. 2003. Monetary Theory and Policy, Second Edition, The MIT Press, Cambridge, Massachusetts.
Zervoyianni, A. 1988. Exchange rate overshooting, currency substitution and monetary policy. Manchester School, Vol. 56:247-67.
Zervoyianni, A. 1992. International Macroeconomic Interdependence, Currency Substitution and Price Stickiness. Journal of Macroeconomics, Vol. 14:59-86.
Yeyati, Eduardo Levy, 2006. Financial dollarization: Evaluating the Consequences, Economic Policy, CEPR, (January).
Yinusa, D.O. 2007. Between dollarization and exchange rate volatility: Nigeria’s portfolio diversification option, Journal of Policy Modeling, doi:10.1016/j.jpolmod.2007.09.007