Output, real exchange rate and interest rate response to excess liquidity in Nigeria.

Abstract

This study investigates the responses of output, real exchange rate and interest rate to shocks to excess liquidity in Nigeria. Following Joan and Andrea (2006), the authors used structural VAR to estimate the model. The results show that GDP responds to shocks to excess liquidity in a relatively quick fashion and assume downward trend right from the first quarter. However, the negative impact on the economy starts from the second quarter lasting throughout the period. This result reveals that excess liquidity is detrimental to real output according to expectation. It also shows that shocks to excess liquidity depreciates the real effective exchange rate and reduces interest rate in the domestic economy. The result implies that speculators immediately react to shocks to excess liquidity taking advantage of excess monetary expansion for speculative activities which further depreciate the exchange rate in Nigeria. The paper recommends contractionary monetary policy and prudent use of monetary instrument to mop-up liquidity that is detrimental to economic growth.