ABSTRACT
The research work was set out to appraise the
impact of inflationary trend on exchange rate, that is, price of the domestic
currency in terms of another currency. The objective of this study is to
examine the effect of exchange rate on inflation on the Nigerian economy and
also determine the relationship between exchange rate policy and their effect
on the Nigerian economy.
The study
adopted the use of econometric
statistical tools in estimating the relationship between inflation rate and
exchange rate in Nigerian economy. Regression was employed using multiple
regression analysis in obtaining the numerical estimates of the coefficients in
the model formulated. Data were collected from secondary source spanning from
1990 to 2009. The source of data is Central Bank of Nigeria (CBN). The result that
there is a negative relationship between inflation rate and exchange rate in
Nigeria with F = 6.536. Also, it was revealed that there is a positive
relationship between gross domestic product, inflation rate and exchange rate
in Nigeria with F = 10.327. Finally, the research found that there is a
positive relationship between gross domestic product, inflation rate, exchange
rate and money supply in Nigeria with F = 6.544. Based on the empirical
findings, the study suggest that The monetary authorities need to continuous
monitor the exchange rate to ensure that it is within a competitive level that
would ensure that simultaneous attainment of internal and external balance.
Inflation rate should be manage and kept within levels at which the external
sector remains competitive in the local economy.
TABLE
OF CONTENT
Title
Page i
Certification
ii
Dedication
iii
Acknowledgement
iv
Abstract v
Table
of contents vi
CHAPTER
ONE
INTRODUCTION
1.0
Background of Study 1
– 4
1.1
Problem Analysis 4
1.2
Objectives of The Study 5
1.3
Research Questions 5
1.4
Statement of Hypothesis 6
1.5
Significance of Study 6
1.6
Scope of Study 7
1.7
Definition of Terms /
Concepts 7
– 8
References 9
CHAPTER
TWO
LITERATURE
REVIEW AND THEORETICAL FRAMEWORK
2.0
Introduction 10
2.1
Exchange Rate Concept 10
– 14
2.2
Foreign Exchange Policy
And Management 14 – 17
2.3
Determinants of
Exchange Rates 17
2.3.1 Demand
and Supply of Foreign Exchange 17– 18
2.3.2 Central Bank Intervention 18
2.3.3 Changes in Imports and Exports 18 – 19
2.3.4 Changes in Relatives Prices 19
2.3.5 Interest Rate 19
2.4
Types of Exchange Rate
Regimes 20
– 21
2.4.1 Advantages of Floating Exchange Rate 22
2.5
Theories of Exchange
Rate 23
– 26
2.6
Review of Nigeria’s
Exchange Rate 27
– 31
2.7
Historical Background
of The Foreign Exchange Market 32 – 33
2.7.1
Current Structure of
the Nigeria’ Foreign Exchange Market 34
2.7.2
Trends in the Foreign
Exchange Market 34 – 35
2.7.3
Analysis of the Trend
in Foreign exchange Inflows and Disbursement 35 - 40
2.8
Implication of Exchange
Rate Management of
an Economy 40
– 41
2.9
Major Challenges of
Foreign Exchange Management
in Nigeria 41
– 43
2.10
The way Forward 43
– 44
2.11
Exchange Rate Policy in
Nigeria 44
– 49
2.12
The Role of Central
Bank of Nigeria in Exchange Rate Management 49 – 51
2.12.1 CBN Initiatives in Managing the Exchange Rate
51
– 52
2.13
Inflation 52
– 53
2.13.1 The Meaning of Inflation 53
– 54
2.14
Theories of Inflation 54
– 56
2.14.1 Keynesian
Theories of Inflation 56
– 58
2.15
Causes of Inflation 59 - 61
2.16
Types of Inflation 61
– 62
2.17
Effects of Inflation 63
– 64
2.17.2 Factors Affecting Supply 64
- 65
2.18
Control of Inflation 65
– 67
2.19
Review of Exchange Rate
and Inflation 67
– 69
References 70
CHAPTER THREE
RESEARCH METHODOLOGY
3.0
Introduction 71
3.1
Research Design 71 – 72
3.2
Re-statement of
hypothesis 72
3.3
Data Analysis Method 73
3.4
Model Specification 73
– 76
3.5
Sources of Data 76
3.6
Limitation of Data 76
References 77
CHAPTER
FOUR
DATA ANALYSIS AND INTERPRETATION
4.0
Introduction 78
4.1
The Empirical Result s 78
– 80
CHAPTER
FIVE
SUMMARY,
CONCLUSION AND RECOMMENDATIONS
5.0
Introduction 88
– 89
5.1
Summary of Findings 89 – 90
5.2
Recommendations 90-
91
5.3
Conclusion 92
Bibliography 93
– 96
Appendix
CHAPTER
ONE
INTRODUCTION
1.O BACKGROUND OF STUDY
The tradition definition of money
as anything that is generally accepted as a medium of exchange, which can also
serve as a store of value has stressed money as an assets held in interim
between receiving payment and making payment. Comprehensively, money is the set
of liquid financial assets which has a close correlation with the development
of the economy and is potentially subjected to the control of monetary
authorities. From this definition above one can conclude that money is a
central to the efficient working of any modern economy that relies on
specialization and exchange.
Furthermore there is a general
saying that no man is an Island, so I believe no country is also an Island,
that there is scarcely any country that lives in absolute autarky in this
globalised world. The economies of all the countries of the world are linked
directly or indirectly through asset or/and goods markets. This linkage is made
possible through trade and foreign exchange. The price of foreign currencies in
terms of a local currency (i.e. foreign exchange) is therefore important to the
understanding of the growth trajectory of all countries of the world.
The consequences of substantial
misalignments of exchange rates can lead to output contraction and extensive
economic hardship. Moreover, there is reasonably strong evidence that the
alignment of exchange rates has a critical influence on the rate of growth of
per capita output in low income countries (Isard, 2007).
Nigeria, like many other low income
open economies of the world, has adopted the two main exchange rate regimes for
the purpose of gaining internal and external balance. The augments and
conditions for and against each of the regime is clear given that they are all
aimed at maintaining stability in exchange rates. Direct administrative control
exchange rate policy was used to manage Nigeria’s foreign exchange from
independence in 1960. The country changed to a market regulated regime in 1986
for obvious reasons.
What is however yet to be clear is
the relative advantage of the various organized market arrangement for selling
and buying the foreign exchange under the dirty float regime that the country
now operates. The country has and is still experimenting with various market
arrangements. First in 1986, it chose to operate the Second Tier Foreign
Exchange Market (SFEM) on an auction basis. More than two decades now after the
introduction of the flexible exchange regime, Nigeria has operated several
variants of the auction system (Auction System, Dutch Auction System, Wholesale
Dutch Auction System, and Retail Dutch Auction System) towards determining the
exchange rate of the naira to US dollar.
Trade
as well know is widely accepted as a major engine of economic growth. This has
been the experience of Nigeria since the 1960s even though the composition of
trade has changed over the years. For instance, in the 1960s, agricultural
exports (including cocoa, cotton, palm kernel and oil, groundnuts and rubber)
were the country’s main sources of foreign exchange and revenue to the
government. But with the discovery and export of crude oil in the late 1960s
and early 1970s, the important role of agricultural exports began to wane,
replaced by crude oil exports.
Therefore
exchange rate is a relative price that measure s the worth of domestic currency
in terms of another currency. It relates the purchasing power of a domestic
currency, in terms of the goods and services it can purchase vis-à-vis a
foreign or trading partner’s currency, over a given period of time. Since the
exchange rate expressed the value of one currency in terms of another, when one
currency appreciates, the other will depreciate.
However,
when exchange of goods are made in the international market in a higher
proportion of currency, example dollars to naira, that is, the value of dollars
appreciate while naira depreciates, the effect of this on nation is that
importation price becomes high reflecting on final price level of such goods at
the local market.
Subsequently,
due to the risk in importation cost, few goods are imported which reduces the
supply of such goods. The net effect of
this is that, if effective demand for such goods rises, much more money will be
chasing few available goods in local market, better still we say inflation
arises. Therefore inflation as defined the neo-classicalist is always and
everywhere a monetary phenomenon and can be produce only by a more rapid
increase in the quality of money than output. The most important features of
the definition of inflation are; there must be a persistent increase in the
general price level, it must be noticeable in the whole economy, and it must
persist over a period of time.
Conclusively,
the study of exchange rate is useful for macro economic management since it
reflects the performance of both the domestic and external sectors of the
economy.
Importantly,
if exchange rate is managed, it will sprout the attainment of a stable and
realistic exchange rate that will lead to a locative efficiency in the foreign
exchange market, increase domestic productivity, guarantee the attainment of
internal balance, encouragement of export activities leading to improve foreign
exchange earnings, attraction of foreign direct investment and reduce the
inflationary spiral.
1.1 PROBLEM ANALYSIS
In
an economy that is dependent on international trade, exchange rate will be the
important price, in that it will determine virtually all other prices. The
problem of exchange rate in Nigeria includes; relative shifts in money supply,
real output and inflation rates between trade partners.
This
research work is aim at identifying the reforms that need to be considered in
unifying and improving the efficiency of the foreign exchange market and
allowing for more flexible determination of the exchange rate and also policy
measure should be directed at moving these aggregates towards the desired
levels.
A
realistic exchange rate should be stable, prevent short term volatility in
capital flows and overtime, more towards its equilibrium level and stabilize
the balance of payments.
1.2 OBJECTIVES OF THE STUDY
1.
The specific objective of this study is to examine the effect of changes in
exchange rate on inflation in Nigeria.
2.
To determine the relationship between exchange rate policy and their effect on
the Nigeria economy.
3.
To proffer possible policies to exchange rate policy on how effective exchange
rates could help achieve the major macro economic objectives.
1.3 RESEARCH QUESTIONS
The
research study makes an attempt to answer the following questions;
1. What
are the roles of Central Bank of Nigeria (CBN) in Nigeria foreign exchange
market?
2. What
is the relationship between exchange rate and inflation in Nigeria?
3. What
are the effects of exchange rate policy on Nigerian economy?
4. Is
there any relationship between exchange rate and money supply in Nigeria?
5. What
are the effects of inflation rate on Nigerian economy?
6. What
are the effects of inflation on exchange rate?
1.4 STATEMENT OF HYPOTHESIS
The
hypotheses that will be formulated and tested for this study includes;
Ho:
There is no positive relationship between inflation rate and exchange rate in
Nigeria.
H1: There
is a positive relationship between inflation rate and exchange rate in Nigeria.
Ho:
There is no positive relationship between gross domestic product, inflation
rate and exchange rate in Nigeria.
H1:
There is a positive relationship between gross domestic product, inflation rate
and exchange rate in Nigeria.
Ho:
There is no positive relationship between gross domestic product, inflation
rate, exchange rate and money supply in Nigeria.
H1:
There is a positive relationship between gross domestic product, inflation
rate, exchange rate and money supply in Nigeria.
1.5 SIGNIFICANCE OF STUDY
The
exchange rate serves as the fundamental channel to the economy. The study is
important because it is directed towards ascertaining whether exchange rate
have lived up to expectation, as a medium of improving the country economy by
implementing a number of sensitive exchange rate policy which will affect the
economy positively. Those that will benefit from this study are the monetary
authority and the Nigerian economy as a whole.
1.6 SCOPE OF THE STUDY
For
this research work, the researcher implores the use of data on exchange rate,
inflation and gross domestic product and money supply within the year 1990 to
2008. This is aimed at enabling the researcher to be able to critically analyze
the relationship between the variables in question (exchange rate, inflation,
gross domestic product and money supply).
1.7 DEFINITION OF TERMS / CONCEPTS
C.B.N –
Central Bank of Nigeria is the country leading bank, generally responsible for
overseeing the banking system, acting as clearing banker for commercial Banks
and for implementing Monetary policy, also responsible for handing the
government budgetary account’s and for managing the country’s external monetary
affairs, in particular the exchange rate.
DAS-
Dutch Auction System is a means of selling goods and services to the highest
bidder among the member of potential customers.
EXCH-
Exchange Rate is the price of one currency expressed in term of some other
currency.
FEM-
Foreign Exchange Market is a market engage in the buying and selling of foreign
currencies, such a market is required because each currency involved in the
international trade and foreign exchange.
GDP-
Gross Domestic Product is the total monetary value of all final goods and
services produced in an economy over a one year period.
IFN-
Inflation rate is an increase in general level of prices in an economy that is
sustained over a period of time.
MS-
Money Supply is the amount of money in circulation any economy.
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