Exchange Rate Variation and Inflation in Nigeria

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Max

School of Technology and Society

MASTER DEGREE PROJECT

EXCHANGE RATE VARIATION AND INFLATION IN NIGERIA (1970- 2007)

Master Degree Project in Economics and Finance D-Leval 15 ECTS Spring term Year 2008 Onosewalu Okhiria 761130-P319 Taofeek Sesan Saliu 761130-P719 Supervisor: Bernd-Joachim Schuller(PhD) Examiner: Max Zamanian (PhD)

ABSTRACT

This study examines the impact of exchange rate on inflation in Nigeria economy between 1970 and 2007. We analysed the trend of inflation and exchange rate in the last 38 years by evaluating the relationship between government expenditure, money supply, Oil revenue, exchange rate and inflation as the dependent variables. We adopted the Augmented Dickey- Fuller to carry out the unit root test and cointegration with Johansen test. Our result shows that the individual variables are integrated order one, that is a unit root exist. This means that each variable tends to follow a random walk. On the other hand, inflation rate, exchange rate, oil revenue, government spending and money supply are cointegrated. This revealed a strong relationship among the variables though inflation rate and exchange rate show no long term relationship, but short term relationship seems to exist between them.

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Acknowledgements We would like to express our gratitude to all those who gave us the possibility to complete this thesis. We want to thank the Department of Financial Economics for giving our opportunity to commence this program and the thesis in the first instance, to do the necessary research work. We are deeply indebted to my supervisor Bernd-Joachim Schuller (PhD) whose advice, stimulating suggestions and encouragement helped ours in all the time of research for and writing of this thesis. We thank almighty God, for sustaining us during the program, furthermore thanks to and all our lecturers, especially Hans Mörner and Max Zamanian (PhD) whose role as lecturers gave us enduring foundation. Finally thanks to our family members.

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TABLE OF CONTENTS Abstract-----------------------------------------------------------------1 Acknowledgements---------------------------------------------------2 Table of content-------------------------------------------------------3 CHAPTER ONE: INTRODUCTION

1.1 Introduction-------------------------------------------------------5 1.2 Statement Problem-----------------------------------------------7 1.3 Objective of Study-----------------------------------------------8 1.4 Justification of Study--------------------------------------------8 1.5 Study Methodology----------------------------------------------9 1.6 Scope of the study------------------------------------------------9 1.7 Plan of Study------------------------------------------------------9 1.8 Type and Sources of Data---------------------------------------9 CHAPTER TWO: The Foreign Exchange Market in Nigeria 2.1 Foreign Exchange Market Evolution--------------------------10 2.2 The Exchange rate Channel of Monetary Policy-------------11 2.3 Exchange Policy in Nigeria-------------------------------------13

CHAPTER THREE: Literature Review 3.1 Exchange Rate-----------------------------------------------------17 3.2 Money Supply Mechanism--------------------------------------24 3.3 Government Expenditure----------------------------------------26 3.4 Theories of Inflation----------------------------------------------28 3

3.5 Review of Empirical Studies------------------------------------33 3.6 Phenomenon of the Dutch Disease Model---------------------38 CHAPTER FOUR: 4.1 Model and Empirical Estimation--------------------------------40 4.2 Presentation of the Model----------------------------------------40 4.3 Interpretation of Result-------------------------------------------42 CHAPTER FIVE: Conclusion--------------------------------------------------------------47 Bibliography------------------------------------------------------------48 TABLE: 2.1 Annual...
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