Download AN EVALUATION OF THE IMPACT OF OIL PRICE SHOCKS AND

AN EVALUATION OF THE IMPACT OF OIL PRICE SHOCKS AND EXCHANGE
RATE VOLATILITY IN NIGERIA (1986-2013)
I. Brief background of the Study
Crude oil is unarguably the single most important driving forces of the Nigeria’s economy, and
changes in the price of oil have significant effects on its economic growth. Oil price shocks (i.e.
sudden changes) can be transmitted into the macro-economy via various channels depending on
the structural characteristics of an economy (Rentschler, 2013); for a country like Nigeria, with
the double dilemma of being an oil exporting and oil-importing country, oil price shock will have
significant knock-on effects and repercussions throughout the economy, affecting macroindicators such as exchange rates, trade balance, inflation and public accounts, as well as stock
market prices and employment.
The stability of the exchange rate is formidable bedrock of all economic activities as it directly
affects domestic price level, profitability of traded goods and services, allocation of resources
and investment decision (Emerah, et al 2015). Getting the exchange rate right or maintaining
relative stability is important for both internal and external balance and consequently growth in
the economy. This is because of Exchange rate is the most important price variable in an
economy and performs the twin role of maintaining international competitiveness and serving as
nominal anchor to domestic price (Mordi 2006). Swings or fluctuations in the exchange rates
over a period of time, or deviations from equilibrium exchange rate are referred to exchange rate
volatility. Where there is multiplicity of markets parallel with the official market there could be
deviations from the equilibrium exchange rate. The exchange rate is subjected to variations when
it is not fixed, thus, since 1986 when SAP was introduced, Nigerians have watched helplessly
the unhindered and uncontrolled depreciation of the naira as floating exchange rate tends to be
more volatile. Economic essentials affect the level of volatility and the extent to which exchange
rate stability is maintained. Favorable economic circumstances and outcome which in turn would
appreciate the currency and maintain stability is caused by strong fundamentals (Mordi 2006)
The combine effect of fluctuations in oil prices and exchange rate instabilities on
macroeconomic stability is enormous. However, to what extent are these fluctuations affecting
the economic growth of Nigeria? Oriakhi and Osaze (2013), opine that estimating the
consequences of oil price shocks on growth is particularly relevant in the case of the Nigerian
economy which uniquely qualifies as both an oil exporting and importing economy, by reason of
the fact that she exports crude oil, but imports refined petroleum products. Hence, being a net
importer of oil, large shifts or fluctuations in oil prices should be a matter of serious concern to
the Nigerian government when taking policy decisions that affect her national economic growth.
II. Aims and Objectives/Purpose
Owing to the complex interaction of direct effects, knock-on effects, and repercussions induced
by oil price and exchange rate volatility, its consequences extend from government level to firms
and households, it is important to investigate their impacts on the economic growth of Nigeria.
This paper therefore, sets to empirically investigate the impact of oil volatility and exchange rate
volatility on economic growth of Nigeria within the period 1986 and 2013, using time series
sourced from the Central Bank of Nigeria.
III. Research Methodology
Economic growth in real life is influenced by a number of macroeconomic variables which may
equally be considered, beside oil price shock and exchange rate volatility, as one of the control
variables; investment, consumption and government spending, trade, foreign direct investment,
etc. Including these variables into the specification increases the fit of the model, but also
decreases the degrees of freedom (Shehu U. 2009).
For this reason the model is restricted to only the chosen variables and foreign direct investment
as a control variable. Real GDP is, therefore, regressed against the international oil price, the
naira exchange rate vis-à-vis the US dollar and foreign direct investment into the country.
Quarterly data obtained from the CBN (Central Bank of Nigeria) Statistical Bulletin from the
first quarter of 1986Q1 to the last quarter of 2007Q4 is used for all variables.
The Model
We specify the model as follows:
RGDP= (Oil_shock, RER_Volt, FDI,)
(1)
We convert all variables into logarithmic form and specify the econometrics representation as in
linear function as follows:
lrgdpt = α0 + β1 loil_shockt + β2 lrer_volt + lfd i+ εt
(2)
Where:
Lrgdpt = the log of real GDP is a linear function of
loil_shockt = the log of oil price shock;
lrer_volt = the log of real exchange rate volatility
lfdi = the log of foreign direct investment; and
εt = the error term.
The first step in the empirical analysis involves testing the time series characteristics of the data
series using ADF and PP tests and running the pairwise Granger causality test. This was
followed by applying the Johansen cointegration test and the estimation of the long run
cointegrating vectors. The analysis was capped with the estimation of short run vector error
correction model.
Furthermore, we will carry out the Granger causality test where Granger (1969) proposed a time
series data based approach in order to determine causality. Since the main objective of this paper
is to assess not only the pairwise nature of causality among the variables, but, also the short run
and long run dynamic impact as well, we will also test for cointegration using two well known
approaches: the one developed by Engle and Granger (1987) and the other one by Johansen
(1988) and Johansen and Juselius (1990). In addition, vector error correction methodology
(VECM) will be applied.
Expected Outcomes
The main purpose of this work is to empirically investigate the impact of oil volatility and exchange rate
volatility on economic growth of Nigeria; thus Oil price shock and exchange rate volatility each
should have a significant impact on the economic growth of Nigeria within the period of study.
Again, oil price shock and exchange rate volatility each should Granger cause real GDP in
Nigeria within the period of the study. This is due to the fact that international oil prices and real
exchange rate volatility are two key variables that have influenced economic growth in Nigeria
within the sample period.
Finally, the sensitivity of real GDP in Nigeria to shock in international oil prices and the real
exchange rate volatility using the long run vector coefficients is expected to show that Nigeria’s
GDP increases more by oil price increase than by exchange rate appreciation. It is also expected
that economic growth in Nigeria has an automatic adjustment mechanism and that the economy
responds to deviations from equilibrium in a balancing manner.
References
1.
Emerah A.A, Adeleke E. and David J.O (2015); “Exchange Rate Volatility and Economic
Growth in Nigeria (1986-2013)’’; Research Academy of Social Sciences Journal of
Empirical Economics Vol. 4, No. 2, 2015, 109-115. Accessed online at:
http://www.rassweb.com on August 7, 2015.
2.
Engle, Robert F. and C. W. J. Granger (1987) “Co-integration and Error Correction:
Representation, Estimation, and Testing,” Econometrica, 55, 251–276.
3.
Johansen, S., (1988) “Statistical Analysis of Cointegration Vectors”, Journal of Economic
Dynamics and Control, Vol. 2 (June-September), pp. 231-54.
4.
Johansen, Soren, Juselius, Katarina (1990), “Maximum Likelihood Estimation and
Inferences on Cointegration – With Application to the Demand for Money”, Oxford
Bulletin of Economics and Statistics, Vol. 52, No. 2, pp. 169-210
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Mordi, C. N. O. (2006). Challenges of Exchange Rate Volatility in Economic Management
in
Nigeria.Central Bank of Nigeria Bullion, 30(3).
6.
Oriakhi DE, Osaze D (2013). “Oil Price Volatility and Its ConsequencesOn the Growth of
the Nigerian Economy: An Examination (1970-2010)”, Asian Econ. Finan. Rev. 3(5):683702.
7.
Rentschler. J.E. (2013); “Oil Price Volatility, Economic Growth and the Hedging Role of
Renewable Energy”: The World Bank, Sustainable Development Network, Office of the
Chief Economist, Washington D.C., USA
8.
Shehu Usman Rano Aliyu (2009); “Impact of Oil Price Shock and Exchange Rate
Volatility on Economic Growth in Nigeria: An Empirical Investigation”. Accessed Online
at http://mpra.ub.uni-muenchen.de/16319/ MPRA Paper No. 16319, posted 18. July 2009
11:43 UTC on August 7, 2015.