The monetary model of exchange rate determination: the case of Nigeria

Abstract

The monetary model of exchange role proposes a strong relationship between exchange rate and monetary fundamentals. The model infers that the price of a country’s currency is determined by the interaction of demand and supply of money, hence the price level of two partner countries should not differ if expressed in the same currency. This study attempted to confirm this relationship for Nigeria using a bounds testing approach to cointegration. The result reveals that money supply differential is the most influential, followed by relative income and inflation variance. This lends support to the monetary model of exchange rate determination in Nigeria. The study, therefore, suggest that concerted efforts should be made to increase the country’s level of production, stabilise money supply and control inflationary spiral, so as to stabilise the value of the Naira vis-à-vis the US dollar.