The Exchange Rate Pass-Through, Monetary Policy, and Price Stability in Nigeria

Abstract

This research conducted a comprehensive examination of the effects of exchange rate pass-through on Nigerian monetary policy and price stability from 1981 to 2023. The Augmented Dickey-Fuller test, an extension of the Dickey-Fuller test, was employed to assess the presence of unit roots. The findings revealed that all variables, including monetary policy, real gross domestic product, domestic price index, consumer price index, nominal exchange rate, and interest rate, were integrated at order one I(1). To confirm the long-term relationships among these variables, a Johansen Co-integration model was utilized, along with an Error Correction Model (ECM) to rectify any errors in the model. The analysis indicated that both monetary policy and price stability exhibited a positive correlation with exchange rate pass-through, albeit at a level below 100%, suggesting that the exchange rate pass-through effect is insufficient and incomplete. This finding highlights a significant long-term relationship, indicating that exchange rate depreciation is reflected in domestic prices and that fluctuations in exchange rates considerably affect monetary policy decisions and their effectiveness. Consequently, the study concludes with recommendations for policymakers to implement reforms aimed at enhancing foreign exchange earnings through export diversification, promoting non-oil exports, attracting sustainable foreign direct investment, and bolstering diaspora remittances. Furthermore, enhancing the efficiency and transparency of the foreign exchange market is essential to reduce speculation and alleviate inflationary pressures.