Exchange Rate Depreciation and Inflation Rate in Nigeria (1981-2016)

The issue of high inflation rate has been a challenge to the Nigerian economy, Many studies have examined several factors that lead to high inflation rate yet the figures keep incrensing according to empirical data. Against this background, this study examined the effect of exchange rate depreciation on inflation rate in Nigeria. The study seeks to (1) examine the granger causality between exchange rate depreciation and inflation rate in Nigeria, (2) determine the impact of exchange rate depreciation on inflation rate in Nigeria, and (3) evaluate the response of inflation rate to shocks from exchange rate depreciation in Nigeria. Annual time series data for 35 years (1981 - 2016) were gathered from the Central Bank of Nigeria statistical bulletin to examine the objectives. Also, the Augmented Dickey-Fuller unit root test, Johansen test for co-integration, Impulse Response, Pairwise granger causality test, and Fully Modified OLS and Error Correction Mechanism were used to analyze the data. This study found that the response of inflation rate to exchange rate depreciation shock is stable showing two reversal turning points within ten consecutive periods as the probability value of exchange rate depreciation (LEXCR) and value of 0.0016 was positively significant at 5% level of significance in impacting inflation (INFR), Also, lagged-one inflation (INFR-1), government expenditure (LGEXP), and money supply (LMS) were also stable in impacting inflation (INFR) with probability values of 0.0000, 0.0004, and 0.0081 respectively and were all positively significant at 5% level of significance in impacting inflation (INFR). However, only real gross domestic product (LRGDP) was positively insignificant in impacting inflation (INFR) as its probability value of 0.1073 was not significant at 5% level of significance in impacting inflation (INFR). Furthermore, there exists unidirectional granger causality from exchange rate to inflation rate as the probability value of 0.0041 was significant at 5% level of significance. Finally, in the long run, exchange rate depreciation induces incremental effects on inflation rate in Nigeria during the period examined with probability values of 0,3063 and 0.7008 respectively for lagged-one and lagged-two exchange rate. The study thus recommended, amongst others, that the Central Bank of Nigeria should stop the practice of managed exchange rate where few gains from crude oil price increase were used to cushion the naira at the foreign exchange market. The study thus contributed to existing knowledge in literature by using the Fully Modified OLS econometric technique which corrects the major shortcomings associated with time series data analysis and also employing modified model version of Imimole and Enoma (201 1).