Exchange Rate Variation and Inflation in Nigeria

We analysed the trend of inflation and exchange rate in the last 38 years by evaluating the relationship between government expenditure, money supply, Oil revenue, exchange rate and inflation as the dependent variables.

We adopted the Augmented Dickey- Fuller to carry out the unit root test and cointegration with Johansen test. Our result shows that the individual variables are integrated order one, that is a unit root exist. This means that each variable tends to follow a random walk.On the other hand, inflation rate, exchange rate, oil revenue, government spending and money supply are cointegrated. This revealed a strong relationship among the variables though inflation rate and exchange rate show no long term relationship, but short term relationship seems to exist between them. 1 Acknowledgements We would like to express our gratitude to all those who gave us the possibility to complete this thesis.

We want to thank the Department of Financial Economics for giving our opportunity to commence his program and the thesis in the first instance, to do the necessary research work. We are deeply indebted to my supervisorSimply put, inflation depicts an economist situation where there is a general rise in prices of goods and services, continuously. It could be defined as ‘a continue rise in prices as measured by an index such as the consumer price index (CPI) or by the implicit price deflator for Gross National Product (GNP). Inflation is frequently described as a state where “too much money is chasing too few goods”.

When there is inflation, the currency losses purchasing power. The purchasing power of a given amount of naira (currency) will be smaller over time when there is inflation in the economy. For instance, assuming N10. 0 (Nigeria unit currency) can purchase 10 shirts in the current period, if the price of shirts double in the next period, the same N10. 00 can only afford 5 shirts.

In the definition of inflation, two key words must be borne in mind. First, is aggregate or general, which implies the rise in prices that constitutes inflation must cover the entire basket of goods in the economy as distinct from an isolated rise in the prices of a single commodity or group of commodities? The implication here is that changes in the individual prices or any combination of the prices cannot be considered as the occurrence of inflation.However, a situation may arise such that a change in an individual price could cause the other prices to rise. An example is petroleum product prices in Nigeria.

This again does not signal inflation unless the price adjustment in the basket is such that the aggregate price level is induced to rise. Second, the rise in the aggregate level of price must be continuous for inflation to be said to have occurred. Broadly, inflation can be grouped into four types, according to its magnitude: 1. Creeping inflation: This occurs when the rise in price is very slow, a sustained annual rise in price of less than 3% per annum falls under this category.Such an increase in prices is regarded safe and essential for economic growth.

2. Walking Inflation: Occurs when prices rise moderately and annual rate is a single digit. It has a range of between 3% and less than 10%. Inflation of this kind is a warning signal for government or policy 5 makers to control it before it turns into running inflation. 3.

Running Inflation: When prices rise rapidly at the rate of between 10 percent and 20 percent per annum, it is called running inflation. The middle class and the poor feel the bite.Only strong monetary and fiscal measures can control such inflation. This is where the Nigeria economy finds her self in the last two and half decades which to this moment is still an issue in the economy.

4. Hyper Inflation: When prices double or triple in digit rates, that could result in a situation where inflation rate can no longer be measured or controlled. Prices could rise many times everyday. For instance, the current Zimbabwe inflation rate is at 37131. 9%.

Basically, two identified causes are Demand pull and Cost push inflation.This would be discussed in later chapters. Inflation generally is a worldwide phenomenon; it is not peculiar to Nigeria only. The major four factor that have been identified as the causes of inflation in Nigeria are the money supply, nature of government spending, exchange rate, price of energy product and the oil revenue hence the wealth of the country depend largely on the oil price. Why is inflation a must fight issue with central bank? Central banks world over are obsessed about inflation and therefore, devote a significant amount of resources at their disposal.