TABLE
OF CONTENTS
Title page- –
– – – – – – – i
Certificate- – – – – – – – – ii
Dedication- – – – – – – – – iii
Acknowledgement- – – – – – – iv
Table of contents- – – – – – – – v
List of tables – – – – – – – – vi
List of graphs – – – – – – – – vii
Abstract – – – – – – – – – viii
Chapter one
INTRODUCTION
- Background of the study – – – – – 1
- Statement of problem – – – – – 3
- Objective of the study – – – – – 4
- Hypothesis of the study – – – – – 4
- Significance of the study – – – – – 5
- Scope of the study – – – – – – 5
Chapter two
LITERATURE
REVIEW
2.1 Theoretical Literature – – – – – – 6
2.2 Empirical Literature – – – – – – 12
2.3 Short-coming of previous studies – – – 15
Chapter three
METHODOLOGY
3.1 Theoretical framework – – – – – 17
3.1.1 Determinants of exchange rate
pass-through – – 17
3.1.2 Low and Declining exchange rate
pass-through– 18
3.2 Model specification – – – – – – 18
3.2.1 Model for reserve requirement – – – 19
3.2.2 Model for open market operation – – – 19
3.2.3 Model for interest rate – – – – – 20
3.2.4. Model for inflation rate – – – – – 20
3.3 Unit root test – – – – – – – 20
3.4 Justification of the model – – – – – 21
3.5 Estimation procedure – – – – – 21
3.6.
Data source – – – – – – – 22
3.7. Econometric software – – – – – 22
Chapter four
PRESENTATION
OF EMPIRICAL RESULT
4.1. Unit root test result – – – – – – 23
4.2. Model results – – – – – – – 24
4.2.1. The impact of exchange rate
pass-through on reserve requirement in Nigeria – – – – – – 24
4.2.2. The impact of exchange rate
pass-through on open market operation – – – – – – – 27
4.2.3. The impact of exchange rate
pass-through on interest rate in Nigeria – – – – – – – – 29
4.3. Long run relationship between
exchange rate pass-through, reserve requirement, open market operation,
interest rate and price stability in Nigeria – – – – 31
4.5. Error correction model (ECM) – – – – 33
4.6. Evaluation of Research Hypotheses – – – 34
Chapter five
CONCLUSION
AND POLICY RECOMMENDATIONS
5.1. Summary of findings – – – – – 36
5.2. Policy Recommendations – – – – – 37
5.3. Conclusion – – – – – – – 38
References – – – – – – – 39
Appendices – – – – – – – 42
LIST
OF TABLES
Table
1: The impact of exchange rate
pass-through in reserve requirement
in Nigeria
Table
2: The impact of exchange rate pass-through on
open market operation (OMO)
Table
3: The impact of exchange rate pass-through on
interest rate in Nigeria
Table
4: Long run relationship between
exchange rate pass-through, reserve requirement, open market operation,
interest rate and price stability in Nigeria.
Table
4.1: Co-integrated Test result
Table
4.2: Co-integrated Test result
Table
5: The ECM Result
Table
6: Integrated of order (1)
LIST
OF GRAPHS
Figure 1: Scatter plot of the reserve
requirement model
Figure 2: Scatter plot of open market operation model
Figure 3: Scatter plot of the interest rate model
Figure 4: Line graph of the Co-integration variables.
CHAPTER ONE
INTRODUCTION
BACKGROUND OF THE STUDY
The need for
appropriate adjustment mechanism to structural imbalances in many developed
countries, especially after the Great Depression of 1929-1933, culminated in
extensive researches on exchange rate pass-through (ERPT) with the primary
objective of determining a nominal anchor for inflation and inflation
expectations. It is widely believed that an understanding of the impact of
exchange rate movement on prices would help to gauge the appropriate monetary
policy response to currency movements. The increased openness of most developed
economies and the incidence of large fluctuations in nominal exchange rates
have led to a need for a better understanding of the determinants of the
transmission of exchange rate changes into import prices.
Exchange rate
pass-through refers to the change in domestic prices that can be attributed to
a prior change in the nominal exchange rate. In other words, it is the effect
of a change in the exchange rate on domestic prices. Balance of payment
postulations normally assume a one-to-one response of import prices to exchange
rates, which is known as complete exchange rate pass-through (Peter, 2003). A
one-to-one response of import prices to exchange rate changes is known as
complete ERPT while a less than one-to-one response is known as partial or
incomplete ERPT. The rate of ERPT has important implications for the effect of
monetary policy on domestic prices as well as for the transmission of
macroeconomic shocks and the volatility of the real exchange rate.
According to An, (2006)
understanding of exchange rate pass-through is of extreme importance for three
key reasons: First, the knowledge of the degree and timing of pass-through are
essential for the proper assessment of monetary policy transmission on prices
as well as for inflation forecasting. Second, the adoption of inflation
targeting requires knowledge of the size and speed of exchange rate
pass-through into inflations. Finally, the degree of exchange rate pass-through
has important implication for “expenditure switching” effects from the exchange
rate. In other words, a low degree of exchange rate pass-through would make it
possible for trade flows to remain relatively insensitive to changes in
exchange rates, though demand might be highly elastic.
In general, three
factors may determine the extent of pass-through of exchange rate to domestic
prices; the pricing behavior by exporters in the producer countries, the
responsiveness of mark-ups to competitive conditions and the existence of
distribution costs that may drive a wedge between import and retail prices
(Oliver, 2002; Campa and Goldberg, 2005). For instance, when exchange rate
changes, foreign firms can choose to pass exchange rate change fully to their
selling prices in export markets (complete pass-through), to bear exchange rate
change to keep selling prices unchanged (zero pass-through), or some combination
of these (partial pass-through). In reality, exchange rate pass-through is far
from complete, Goldberg and Knetter (1997) argued that “a price response equal
to one half the exchange rate change”. They discovered that only around 60
percent of exchange rate changes are passed on to import prices in the United States.
The main explanation
for incomplete pass-through is that many importing and exporting firms choose
to hold their prices constant and simply reduce or increase the mark-up on
prices, when the exchange rate is changing. Dornbusch (1987) justified
incomplete pass-through as arising from firms that operate in a market characterized
by imperfect competition and adjusts their mark-up (and not only prices) in
response to an exchange rate shock. Burstein et al (2003) instead emphasized
the role of (non-traded) domestic inputs in the chain of distribution of
tradable goods. Furthermore, Burstein et al (2005) pointed out the measurement
problems in CPI, which ignores the quality adjustment of tradable goods to
large adjustment in the exchange rate. Another line of reasoning stresses the
role that monetary and fiscal authorities play, by partly offsetting the impact
of changes in the exchange rate on prices (Goagnon and Ihrig, 2004).
In Nigeria, the emphasis on knowing the exchange rate pass-through is underpinned by the fact that the Nigerian economy is external sector driven such that the shocks from global commodity markets have serious implications on the economy. In addition, the need to make the external sector competitive through appropriate exchange rate adjustment has made the study of exchange rate pass-through in Nigeria imperative. Recent developments in the external sector of the Nigerian economy revealed that the naira exchange rate depreciated by 24.0 percent between October 2008 and February 2009 and the pressure is still on as crude oil receipts continue to dwindle due to both demand and supply factors (CBN, 2010). Concerns are what the magnitude and interrelationship of exchange rate pass-through, monetary policy and price stability in Nigeria would be.
STATEMENT OF PROBLEM:
EXCHANGE RATE PASS-THROUGH, MONETARY POLICY, AND PRICE STABILITY IN NIGERIA
