Exchange rate pass-through to inflation in Nigeria

Abstract

The study examined the degree of exchange rate pass-through to domestic prices in Nigeria. The vector error correction model (VECM} methodology was applied to annual data from 1980-2010. The long and short-run results showed that exchange rate pass-through to price level in Nigeria is incomplete because the pass-through is less than 1. Further analysis revealed that the impact of the exchange rate on domestic price is more severe in the long-run than in the short-run; it impacted 76.0 and 31.0 per cent in the long and short run, respectively. This implied that shock to exchange rate or exchange rate pass-through would translate to increase in domestic price for two consecutive periods after initial decrease. The result of the model also showed that effect of oil price pass-through to domestic price is more severe than the exchange rate, and that the pass-through from import prices to domestic prices is quite low despite its high impact in the long-run. For effective monetary policy implementation, therefore, the study recommends that in the management of the exchange rate, a sharp depreciation should be avoided due to its impact on domestic prices. Hence, exchange rate stability, and when necessary, a gradual approach to exchange rate depreciation, should be undertaken.