Exchange Rate Pass-Through and Inflation Dynamics in Nigeria: New Evidence from The Post-Fx Market Reforms Era

Abstract

Oreoluwatoni Adenike Coker and Apinran Martins Olugbenga

This study examines the exchange rate pass-through (ERPT) to inflation in Nigeria using monthly data from 2010–2024, a period encompassing significant foreign exchange market reforms. Employing a Vector Autoregression (VAR) model with five macroeconomic variables-Consumer Price Index (CPI), Exchange Rate (EXR), Monetary Policy Rate (MPR), GDP Growth Rate (GDPGR), and Oil Price—the analysis reveals important insights into Nigeria's inflation dynamics. The empirical results show a 12-month cumulative ERPT coefficient of 21.8%, indicating that a 1% naira depreciation generates approximately a 0.22 percentage point increase in consumer prices, representing incomplete pass-through consistent with pricing-to-market behavior and local currency invoicing practices. Impulse response functions demonstrate that exchange rate shocks peak within 3-4 months and persist for approximately 12 months. Forecast Error Variance Decomposition (FEVD) analysis shows that own shocks explain 60% of inflation variation initially, declining to 45% after 24 months, while exchange rate shocks account for 15–20% of medium-term inflation dynamics. Monetary policy shocks contribute roughly 10% to inflation variance, suggesting moderate policy effectiveness. Granger causality tests confirm unidirectional causality from exchange rate to inflation (p = 0.013). The model passes all diagnostic tests, exhibiting stability, no serial correlation, and homoscedastic residuals. These findings have critical implications for monetary policy formulation and inflation targeting in Nigeria's evolving macroeconomic environment. Policy recommendations include maintaining exchange rate stability, enhancing domestic production capacity, strengthening monetary policy credibility, and implementing structural reforms to reduce import dependency.

PDF