Abstract
This paper investigates the asymmetric exchange rate pass-through (ERPT) to inflation in Nigeria, employing both Autoregressive Distributed Lag (ARDL) and Nonlinear ARDL (NARDL) models over the period 2010Q1 to 2024Q2. The analysis incorporates key policy changes, such as the 2023 exchange rate unification, and explores both the short- and long-run impacts of exchange rate fluctuations on food and headline inflation. In particular, the study highlights the response and pass-through periods of exchange rate shocks, with depreciation demonstrating a stronger and more immediate effect on inflation compared to appreciation. Results reveal that exchange rate depreciation exerts significant cost-push pressures, with a pass-through effect observed within 3 to 4 quarters, while the effect of appreciation is weaker and more prolonged. This asymmetry is especially pronounced for food inflation, where the dependency on imported goods accelerates the transmission of exchange rate shocks to consumer prices. The study also finds that the cumulative depreciation has a much more pronounced effect on inflation, while appreciation offers minimal relief, reflecting Nigeria’s vulnerability to exchange rate volatility due to its reliance on imports. The findings shows the importance of managing exchange rate fluctuations to control inflation, particularly given the asymmetry in how depreciation and appreciation affect prices. By providing a comprehensive analysis of both long- and short-run dynamics, this study contributes to the understanding of ERPT in Nigeria, offering insights for policymakers to implement targeted interventions that can mitigate inflationary pressures in the context of exchange rate instability. Keywords: Inflation, Asymmetric, Interest-Rate-Spread, Exchange Rate, NARDL 1.0.Introduction Exchange rates and inflation are widely recognized as critical indicators of economic health (Olanrewaju, 2019). In Nigeria, an economy heavily reliant on imports, fluctuations in exchange rates have a significant pass-through effect on inflation, especially as changes in the prices of traded goods and services directly influence domestic price levels. This dynamic is particularly acute in Nigeria, where higher domestic prices escalate reliance on foreign goods, thereby increasing demand for foreign currency and reducing the competitiveness of the local currency (Ani, Joel, & Baajon, 2019). Consequently, the persistent depreciation of the naira exacerbates inflationary pressures, making the Nigerian economy highly susceptible to exchange rate fluctuations. In response, the government introduced the exchange rate unification policy in 2023, aiming to stabilize the foreign exchange market and control inflation. However, despite these intentions, the policy proved ineffective, as the naira continued to depreciate significantly against the US Dollar, leading to further inflationary pressures. Between March 2023 and March 2024, the naira depreciated by over 227.05%, with the official exchange rate falling to ₦1,481.43 per US Dollar by the end of Q2 2024, compared to ₦607.75 in 2023. This substantial devaluation resulted in the headline inflation rate rising sharply from 22.04% to 34.20%, and food inflation soaring from 24.45% to 40.79%. These figures represent historic highs in both exchange rate devaluation and inflation over the past two decades in Nigeria. The surge in inflation has further eroded household purchasing power, pushing more Nigerians below the poverty line. This reinforces the critical role of exchange rate fluctuations in shaping macroeconomic outcomes, particularly through their impact on local prices and the speed at which these changes pass through the economy. When Exchange Rate Pass-Through (ERPT) is high, significant shifts in relative prices occur, affecting trade balances by reducing the demand for imports as imported goods become more expensive, thereby encouraging consumers to turn to locally produced commodities. Conversely, a low ERPT suggests that exchange rate changes have a more subdued effect on domestic prices and trade balances. The exchange rate regime itself plays a pivotal role in shaping ERPT. In a fixed exchange rate system, economic agents may adjust prices more swiftly, treating exchange rate shifts as permanent. Meanwhile, in a flexible exchange rate system, agents might delay price adjustments, assuming the changes to be temporary (Razafimahefa, 2012). For developing economies like Nigeria, where inflation is high and market structures are less competitive, ERPT tends to be more pronounced, amplifying inflationary pressures. Empirical studies on ERPT in Nigeria have consistently shown an incomplete pass-through, which decreases within the price chain, differing from previous conclusions. While some scholars argue that inflation targeting and economic policy credibility determine the pass-through rate, there is no consensus on the factors contributing to a low pass-through. The fear of floating, where small and open economies are more susceptible to the effects of exchange rate fluctuations, partially explains the adoption of inflation targeting both in emerging and developed economies. The objective is to minimize the impact of exchange rate fluctuations on consumer prices (inflation) (Dağlaroğlu et al., 2018). While some studies have identified a short-run pass-through effect on inflation (Adekunle, Tiamiyu, & Odugbemi, 2019; Fatai & Akinbobola, 2015), others have found a long-run pass-through effect (Sa’ad, Usman, Omaye & Yau, 2023; Adedokun, Ogbaekirigwe & Tiamiyu, 2022). However, most empirical studies have overlooked the possibility of an asymmetric effect of exchange rates on price indexes, particularly in Nigeria. The asymmetric impact is more significant as it can influence inflation positively and negatively, explained as price variations (Pham et al., 2020; Nasir et al., 2020). Understanding and monitoring the ERPT coefficient is crucial for the Central Bank, whose primary objective is to maintain price stability. This study aims to fill the gaps left by previous research by using recent data that captures current economic conditions, including the 2023 exchange rate unification policy and other relevant policy shifts. Furthermore, this study introduces a new variable, the interest rate spread, into the model. Interest rate spreads have been extensively used in the literature to measure the role of banks and policy authorities in real sector performance (Akinlo & Owoyemi, 2012; Nwafor, 2022). A wider interest rate spread often reflects inefficiencies in the financial sector, which can reduce the availability of credit for productive investments and limit consumption, indirectly influencing inflation by affecting aggregate demand. In this context, interest rate spreads reflect the monetary policy stance, particularly in controlling inflation through lending rates and influencing overall economic activity. Therefore, this study seeks to investigate the asymmetric ERPT on inflation in Nigeria, providing a comprehensive analysis in both the long and short run using quarterly data from 2010Q1 to 2024Q2.
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