EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

ABSTRACT 

CBN typically intervenes directly in the foreign exchange market to ensure that the value of the Naira is stable. However, direct foreign exchange purchases and sales by the monetary authorities could be very costly and are hardly effective in reducing exchange rate volatility when the local currency is under pressure to depreciate. Researchers have found that this kind of interventions have little or no desired effect, and may lead to undesired volatility in the exchange rate. In an environment of tight monetary policy, additional monetary tightening could have effect on the exchange rate. If this is so, then reserve loss in period of speculations can be prevented. This study sets out to examine if Additional Monetary Tightening (AMT) can be used to achieve exchange rate stability in Nigeria, as a potential substitute or complementary tool to the direct intervention. The study identified the period of AMT from 2007- 2015, capturing the periods by the use of dummy variable. The variables of the study includes Monetary Policy Rate (MPR), Cash Reserve Requirement(CRR), Liquidity Ratio(LR), Upper interest rate Corridor (UCORR), and Lower interest rate Corridor (LCORR), were estimated using GARCH (2,2) with lag of one period for all the variables and was found to be appropriate. The result shows that AMT is negative and statistically significant at 10% in reducing the exchange rate volatility in the variance equation and also negative and significant at 1% in appreciating the exchange rate in the mean equation. Although all variables were correctly signed in the variance equation except CRR, only AMT, and LR, were statistically significant at 10% and 1% respectively in the variance equation. This suggests that, AMT can be adopted as an alternative/complementary tool in attaining exchange rate stability in Nigeria. From these findings, the study recommends that where it is feasible, CBN should consider AMT as a useful tool for exchange rate management vii and prevent reserve loss. This also suggests that CBN must use this tool cautiously since AMT can hurt the economy via investment and spending.

TABLE OF CONTENTS

Title page ………………………………………………………………………… i

Declaration ………………………………………………………………………… ii

Certification ………………………………………………………………………… iii

Dedication ………………………………………………………………………… iv

Acknowledgement ………………………………………………………………………….. v

Abstract …………………………………………………………………………. vi

Table of Contents …………………………………………………………………………. viii

List of Figures …………………………………………………………………………. xi

List of Tables ………………………………………………………………………… xii

List of Appendices …………………………………………………………………………. xiii

1.0 INTRODUCTION

1.1 Background to the Study………………………………………………………… 1

1.2 Statement of Research Problem………………………………………………… 6

1.3 Research Problem……………………………………………………….…………. 8

1.4 Objective of the Study…………………………………………………………… 8

1.5 Research Hypothesis………………………………………………………………. 9

1.6 Justification of the Study………………………………………………………… 9

1.7 Scope and limitation of the Study………………………………………………… 10

1.8 Organization of the Study…………………………………………………………. 11

2.0 LITERATURE REVIEW

2.1 Introduction…………………………………………………………………………. 12

2.2 An Overview of the Foreign Exchange Market in Nigeria……………………… 12

2.3 Conceptual Literature……………………………………………………………… 16

2.3.1 The Concept of Monetary Policy and Exchange Rate…………………………….. 16

2.3.2 Exchange Rate Volatility…………………………………………………………… 19

2.3.3 Additional Monetary Tightening……………………………………………………. 22

2.4 Theoretical Literature……………………………………………………………… 25

2.5 Theoretical Framework…………………………………………………………… 38

2.6 Empirical Literature……………………………………………………………… 39

3.0 RESEARCH METHODOLOGY

3.1 Introduction…………………………………………………………………………. 53

3.2 Conceptual Framework for Analysis……………………………………………… 53

3.3 Empirical Framework……………………………………………………………… 57

3.4 Unit Root Test………………………………………………………………………. 62

3.5 Data and Sources…………………………………………………………………… 63

4.0 PRESENTATION AND DISCUSSION OF RESULTS

4.1 Introduction…………………………………………………………………………. 65

4.2 Episodes of Additional Monetary Tightening in Nigeria (2007-2015)………… 65

4.3 Trend of/ and Exchange Rate Volatility in Nigeria (2007-2015)………………… 67

4.4 GARCH Model Estimation………………………………………………………… 71

4.4.1 Normality Test Result………………………………………………………………. 71

4.4.2 Unit Root Test Result……………………………………………………………….. 72

4.4.3 Effect of Additional Monetary Tightening on Exchange Rate Volatility…………… 73

4.5 Extent to which Additional Monetary Tightening can be a Complementary Tool

5.0 SUMMARY, CONCLUSION AND RECOMMENDATION

5.1 Summary……………………………………………………………………………… 79

5.2 Conclusion……………………………………………………………………………. 80

5.3 Recommendations…………………………………………………………………… 81

REFERENCES………………………………………………………………………………….84

APPENDICES…………………………………………………………………………………..89

List of Figures

Figure 3.2.1 The Conceptual Framework for Analysis

Figure 4.2.1 Additional Monetary Tightening

Figure 4.3.1a Trend of/and Exchange Rates Volatility in Nigeria

Figure 4.3.1b Additional Monetary Tightening and Exchange Rates

List of Tables

Table 4.4.1 Descriptive Statistics Results

Table 4.4.2 Augmented Dickey Fuller Unit Root Test Results

Table 4.4.3a GARCH Estimations: Conditional mean and Variance Equation

Table 4.4.3b ARCH-LM Diagnostic Test

Table A1 Empirical Studies on Monetary Tightening and Exchange Rate

List of Appendices

Appendix A Empirical Studies on Monetary Tightening and Exchange Rate

Appendix B Glossary of Selected Terms

Masters Project Topics in Economics

EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

Department:  Economics (M.Sc)

Format: MS Word

Chapters: 1 - 5, Preliminary Pages, Abstract, Appendices

Pages: 108

Price: 5000 NGN

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