Exchange Rate Pass-through in Nigeria: Evidence from a Vector Error Correction Model

Aliyu, Shehu Usman Rano and Yakub, Ma'aji Umar and Sanni, Ganiyu Kayode and Duke, Omolara (2009): Exchange Rate Pass-through in Nigeria: Evidence from a Vector Error Correction Model.

Abstract

The paper investigates the degree of exchange rate pass-through to import and consumer prices in Nigeria between 1986Q1 and 2007Q4 on the basis of vector error correction methodology. Results reveal that exchange rate pass-through in Nigeria is low, slightly higher in the import than in the consumer prices, significant and persistent. A one percent shock to exchange rate, for instance, results in 14.3 and -10.5 percent pass-through effect to import and consumer prices four quarters ahead, respectively. This, among other things, suggests that exchange rate pass-through in Nigeria declines along the price chain, and partly overturns the conventional wisdom in the literature that ERPT is always considerably higher in developing and emerging economies than in developed economies. Although pass-through effect is envisaged to increase with greater integration of the economy into the global world in future, but, the fact that it was found to be incomplete implies that prices react less proportionately to exchange shock in Nigeria and this is very useful to policymakers, especially in the design and implementation of monetary policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: Exchange rate pass-through, cointegration, vector error correction, impulse responses, variance compositions
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F3 - International Finance > F31 - Foreign Exchange

References

An, Lian (2006) “Exchange Rate Pass-Through: Evidence Based on Vector Autoregression with Sign Restrictions”, Department of Economics, University of Kentucky, Lexington, KY, 40506

Anderton, R. (2003), Extra-Euro Area Manufacturing Import Prices and Exchange Rate Pass- Through, ECB Working Paper No. 219.

Anguyo, F. L. (2008) “Exchange Rate Pass-through To Inflation in Uganda: Evidence from a Vector Error Correction Model”, Working Paper (BOUWP/09/08), Research Department Bank of Uganda.

Bacchetta, P. and van Wincoop, E. (2003), “Why do Consumer Prices React Less than Import Prices to Exchange Rates?” Journal of European Economic Association, 1, 662-670.

Barhoumi, Karim (2006) “Exchange Rate Pass-Through and Structural Macroeconomic Shocks in Developing Countries: An Empirical Investigation”, GREQAM, Banque de France, Online at http://mpra.ub.uni-muenchen.de/6573/

Burstein, A., Neves, J. and Rebelo, S. (2003) “Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based-Stabilizations”, Journal of Monetary Economics, 50, 1189-1214.

Burstein, A., Eichenbaum, M. and Rebelo, S. (2005) “Large Devaluations and the Real Exchange Rate”, Journal of Political Economy, 113, 742-784.

Burstein, Ariel, Martin Eichenbaum, and Sergio Rebelo (2007). "Modeling Exchange Rate Pass-through after Large Devaluations", Journal of Monetary Economics, vol. 54 (March), pp. 346-68.

Campa, J. and Goldberg, L. (2004) “Exchange Rate Pass-Through into Import Prices”, CEPR Discussion Paper No. 4391.

Campa, J.M. and L.S. Goldberg (2002) “Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?” NBER Working Paper, No. 8934.

Central Bank of Nigeria (1997-2007) “Annual Reports and Statements of Accounts” Publication of the Central Bank of Nigeria.

Choudhri, E. and Hakura, D. (2006) “Exchange Rate Pass-Through to Domestic Prices: Does the Inflationary Environment Matter?” Journal of International Money and Finance, 25, 614-639.

Cunningham, Alastair, and Andrew W. Haldane (2000) "The Monetary Transmission Mechanism in the United Kingdom: Pass-Through and Policy Rules," Central Bank of Chile Working Paper No. 83. Santiago: Central Bank of Chile.

Devereux, M, and Engel, C. (2001), “Endogenous Currency of Price Setting in a Dynamic Open Economy Model”, NBER Working Paper No. 8559.

Dornbusch, R. (1987) “Exchange Rates and Prices”, American Economic Review, 77, 93-106.

Fagan, G., Henry, J. and Mestre, R. (2005) “An Area-Wide Model (AWM) for the Euro Area”, Economic Modeling, 22, 39-59.

Feinberg, Robert M. (2000) “The Role of International Discipline in Three Developing Economies: Exchange Rate Effects on Domestic Prices in Colombia, Korea and Morocco”, Review of International Economics, Vol. 8, No. 1, pp. 126-133.

Gagnon, J. and Ihrig, J. (2004) “Monetary Policy and Exchange Rate Pass-Through”, International Journal of Finance and Economics, 9, 315-338.

Goldberg, Pinelopi K. and Michael M. Knetter (1997) “Goods Prices and Exchange Rates: What Have We Learned?”, Journal of Economic Literature, Vol. 35, No. 3, September, pp. 1243-1272.

Goldfajn, Ilan, and Sergio Ribeiro da Costa Werlang (2000) “The Pass-Through From Depreciation to Inflation: A Panel Study”, Banco Central do Brasil Working Paper Series No. 5. Brasilia: Banco Central do Brasil.

Hahn, E. (2003) “Pass-Through of External Shocks to Euro Area Inflation”, European Central Bank Working Paper No. 243.

Ihrig, J., Marazzi, M. and Rothenberg, A. (2006), Exchange Rate Pass-Through in the G-7 countries, International Finance Discussion Paper No. 851, Federal Reserve Board of Governors.

Kim, Yoonbai (1991), “External Adjustments and Exchange Rate Flexibility: Some Evidence from U.S. Data”, The Review of Economics and Statistics, Vol. 73, No. 1, February,, pp. 176-81.

Kim, Ki-Ho (1998), “US Inflation and the Dollar Exchange Rate: A Vector Error Correction Model”, Applied Economics, Vol. 30, No. 5, May, pp. 613-619.

Laflechelll, Therese (1996) “The Impact of Exchange Rate Movements on Consumer Prices”, Bank of Canada Review, Winter, 1996-1997, 21-32.

McCarthy, Jonathan (2000), “Pass-Through of Exchange Rates and Import Prices to Domestic Inflation in Some Industrialized Economies”, Working Paper No. 79, Bank for International Settlements, Basel.

McCarthy, Jonathan (1999). "Pass-Through of Exchange Rates and Import Prices to Domestic Inflation in Some Industrialized Economies," BIS Working Paper No. 79. Basel: Bank for International Settlements, November.

Mihaljek, D. and Klau, M. (2000), A Note on the Pass-Through from Exchange Rate and Foreign Price Changes to Inflation in Selected Emerging Market Economies, BIS Papers, 8, 69-81.

Menon, Jayant (1995a), “Exchange Rate Pass-Through”, Journal of Economic Surveys, Vol. 9, No. 2, June, pp. 197-231.

Olivei, Giovanni P. (2002), “Exchange Rates and the Prices of Manufacturing Products Imported into the United States”, New England Economic Review, First Quarter, pp. 3-18.

Peter Rowland (2003) “Exchange Rate Pass-Through to Domestic Prices: The Case of Colombia, Banco de la Republica, [e-mail]

Rincón C., Hernán (2000), “Devaluación y Precios Agregados en Colombia, 1980-1998,” Desarrollo y Sociedad, Vol. 46, CEDE, Universidad de los Andes, Bogotá.

Romer, D. (1993), Openness and Inflation: Theory and Evidence, Quarterly Journal of Economics, 4, 869-903.

Taylor, J. (2000), Low Inflation, Pass-Through and the Pricing Power of Firms, European Economic Review, 44, 1389-1408.