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TITLE PAGE
THE IMPACT OF EXCHANGE RATE VARIATIONS ON
AGGREGATE DEMAND IN NIGERA (1979 -2008)
SUMITTED IN PARTIAL FULFILMENT OF THE
REQUIREMENT FOR THE AWARD OF BACHELORS
DEREE (B.SC) IN ECONOMICS
BY
OCHENI AJUMA
EC/2006/247
DEPARTMENT OF ECONOMICS
FACULTY OF MANAGEMENT AND SOCIAL SCIENCES
CARITAS UNIVERSITY, AMORJI-NIKE, EMENE
ENUGU STATE
AUGUST, 2010.
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APPROVAL PAGE
I Certify that this research was carried out by Ocheni Ajuma, Reg
No: EC/2006/247 of the Department of Economics, Caritas University,
Amorji-Nike, Emene, Enugu state.
________________________
Date _________________________
UGWU JOHNSON
______________________
Date_________________________
PETER ONWUDINJO
H.O.D Economics
Department
_______________________
External Examiner
Date _________________________
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DEDICATION
This research work is dedicated to God Almightily, who has seen me
through to this point in my academic endeavors. To Him alone be
glory, honour and adoration (Amen).
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ACKNOWLEGEMENT
First and foremost, all thanks go to God Almighty for sparing my life
and seeing me through to the final stage of this project. My gratitude
also goes to my beloved parents, Hon. Mr. and Mrs. Ocheni for their
love, encouragement and support in all forms and to my ever loving
siblings.
I shall not forget my supervisor Mr. Ugwu Johnson whose friendly
and tireless effort contributes to making this project a reality.
Lastly to all my friends “Big thanks to you all”.
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ABSTRACT
The study is a critical Evaluation of the impact of Exchange rate
variation on Aggregate Demand in Nigeria. These study made use of
the ordinary least square (OLS) regression technique in analyzing the
impact of Exchange Rate Variation On Aggregate Demand in Nigeria.
There are also other variables that determine the impact of Exchange
Rate Variations on Aggregate Demand in Nigeria: 1979 -2008. Findings
from the paper show that all the variables included in the models
contributes in explaining the role of exchange rate on aggregate
demand in Nigeria. These massive contributions of these variables
may strongly depend on the circumstances in Nigerian economic
environment. The starting point in reclaiming and re-inventing project
in Nigeria is to squarely admit that oil and the manner we have
designed to utilize it have constituted a stumbling block in Nigeria’s
progress. Accordingly, there is need to pay specific attention to the
contest of action and the production relations in the various sections of
the economy.
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TABLE OF CONTENTS
Title Page =
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Approval Page
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Dedication
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Acknowledgement
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Abstract
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1.1
Background of the Study
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1.2
Statement of Problems =
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1.3
Objective of the Study =
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Table of Content
CHAPTER ONE
Introduction
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1.4
Statements of Hypothesis
1.5
1.6
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Scope and Limitations of the Study
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Significance of the Study
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CHAPTER TWO: LITERATURE REVIEW
2.1
Review of Theoretical Literature
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2.2
Exchange ate Determination Models
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2.2.1 Flexible Price Monetary Model
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2.2.2 Sticky Price Monetary Model
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2.2.3 Equilibrium Model and Liquidity Model
2.2.4 Portfolio Balance Model
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An Overview of Exchange Rate Regimes
2.3.1 The Gold Standard Regime =
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2.3.2 Flexible Exchange Rate Regime
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2.3.3 The Crawling Peg Regime
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2.3.4 The Managed Float Regime =
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2.3.5 The European Monetary System
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An Evaluation of Exchange Rate Regimes in Nigeria =
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2.4
2.4.1 The Pre – Sap ara
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2.4.2 The Post –Sapara
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2.5
Exchange Rate Determinants
2.5.1 Interest Rate
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2.5.2 Transaction Motive
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2.5.3 Volume of International Transaction
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2.5.4 Political Instability
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2.5.5 Policy Actions
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Review of Empirical Literature
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2.6
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2.6.1 Empirical Literature on the Study using Foreign
Data set = = = = = = = = = = = = = = = = = = = = = == =
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2.6.2 Empirical Literature on the Study Using
Nigerian Data set = = = = = = == = = = = = = = = = = =
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CHAPTER THREE: METHODOLOGY
3.1
An Overview of the Model = = = = = = = = = = = = = = = 49
3.2
Model Specification = = = = = = = = = == = = = = = = = = 50
3.3
Unit Root Test = = = = = = = = = = = = = = = = = = = = = = 52
3.4
Co Integration and Error Correction = = = = = = = = = = = 53
3.5.1 Economic Criteria = = = = = = = = = = = = = = = = = = = = 54
3.5.2 Statistical Criteria = = = = = = = = = = = = = = = = = = = = 54
3.5.3 Economics = = = = = = = = = = = = = = = = = = = = = = = = 54
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CHAPTER FOUR: PRESENTATION AND ANALYSIS OF RESULT
4.1
ADF Test for Stationary = = = == = = = = = = = = = == = 58
4.2
CO Integration Test = = = = = = = = = = = = = = = = = = = 60
4.3
Result from Modeling log of GDP by OLS = = = = = = = 62
4.4
Economic Interpretation = = = = = = = = = = = = = = = = =63
4.5
Statistical Criteria = = = = = = = = = = = = = = = = = = = = 69
4.5.1 T. Value = = = = = = = = = = = = = = = = = = = = = = = = = 70
4.5.2 F- Test = = = = = = = = = = = = = = = = = = = = = = = = = = 70
4.6
Evaluation based on econometric Criteria = = = = = = = = 71
4.6.2 Test for Hetrosedasticity = = = = = = = = = = = = = = = = =71
4.6.3 Test for Multicollinearity = = = = = = = = = = = = = = = = =73
4.6.4 Normality Test = = = = = = = = = = = = = = = = = == = = = 74
4.6.5 Test for Adequacy of the Model = = = = = = = = = = = = = 75
4.7 Evaluation of the Hypothesis = = = = = = = = = = = = = = = =76
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CHAPTER FIVE
5.1 Summary = = = = = = = = = = = = = = = = = = = = = = = = = 78
5.2 Conclusion = = = = = = = = = = = = = = = = = = = = = = = = = 79
5.3 Policy Implications = = = = = = = = = = = = = = = = = = = = = 81
Bibliography = = = = = = = = = = = = = = = = = = = = = = = = = = 85
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CHAPTER ONE
INTROUDCTION
1.1
BACKGROUND OF THE STUDY
All over the world, policy makers have always been on the
move to ensure that there is sustainable growth rate in the
economies of the world. As a result, a lot of economic factors
have been brought to the fore to examine and investigate how
they could be relevant in the achievement of their economic
objectives.
In Nigeria, several government regimes have experimented
on many economic factors (macroeconomic aggregates) to
determine how economic growth could both be attained and
sustained. Prior to the introduction of the structural adjustment
programme (SAP) of 1986, that had exchange rate devaluation as
one of its policy measures, the economy of Nigeria ‘headed for
the rocks’ and was highly distressed. This led to a decline in the
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country’s external reserves at a disturbing rate. The country’s
debt stool was accumulated to an unfavorable level among others.
In spite of this the naira exchange rate was overvalued leading to
dexterous effect on the economy. It was opinioned that exchange
rate policy embarked upon by the Nigeria government, in August
1986,was to eliminate the observed distortions in the economy
and bring about a sustainable growth in the economy.
Since exchange influences the interaction of household,
business firms, private financial institutions and the central bank,
it implies that it could also affect aggregate demand in Nigeria.
Knowing fully well that exchange rate is a real phenomenon;
variations in relative prices affect both economic performance and
aggregate demand. Hence, exchange rate is a relative price
between domestic currency. For instance, if the exchange rate
between British Pounds sterling and Nigeria Naira is N250 per
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Pound, it follows that one pound exchange for N250 in the world
foreign (currency) exchange market.
Exchange rates are of two broad categories. They include:
1.
The fixed exchange rate and
2.
The flexible exchange rate
The fixed exchange rates are pegged rates within narrow
range of values by the central bank on trade of currencies while
the flexible exchange also called FLOATING exchange rate is the
rate that is determined by the forces of demand and supply.
Government has little direct control on the foreign exchange
market that is flexible in nature.
Variation of exchange rates over the years are known to
have ripple effects on some other macroeconomic variables like
aggregate demand.
This fact underscores the pertinence of
exchange rate to the economic well being of countries that open
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their doors to international trade (Kombe, 2004). Due to the
impact exchange rate regimes have on economies of the world,
economists consider it vital to verify how their countries
exchange rate are determined since different regimes of exchange
rate show different economic effects (Kujis, 1998).
Exchange rate determination varies from country to country.
Part exchange rate regimes in Nigeria have been directed to
control the use of foreign exchange at official determined rates.
However, current policy options have shown an interest in
market- determined exchange rate most current records show that
the CBN has adapted an exchange rate regime that is neither
pegged nor floating but a combination of both regimes called the
MANAGED FLOAT exchange rate. This research work intends to
look into the determinants of exchange rate in Nigeria and the
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impact exchange rate variations exert on aggregate demand in
Nigeria.
1.2
STATEMENT OF PROBLEM
Economic and political analysts have reached a consensus
on what a good exchange rate is as well as how it could both be
operated and sustained. In most economic papers and literature,
the major issues have been the need for competitive exchange rate
stability and structural adjustments in the promotion of this
competitiveness.
However,
since
exchange
rate
reveals
competitiveness of exports from domestic economies to the
outside world, the economic implication of its variations need to
be ascertained so that good exchange rate policies that will be
realistic in consonance with aggregate demand could be
formulated, adopted and operated.
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Therefore, this study aims at providing answers to the
questions stated below in order to ensure that viability reigns in
the market.
1) Are exchange rate and aggregate demand variable stationary?
2) Does exchange rate variations have affect any impact on
aggregate demand?
3) To what extent does exchange rate affect aggregate demand in
Nigeria?
1.3
OBJECTIVES OF THE STUDY
The specific objective of this economic study are:
1. To ascertain the impact of exchange rate variations on
aggregate demand.
2. To estimate if there exists any casual relationship between
exchange rate and aggregate demand.
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1.4
STATEMENT OF HYPOTHESIS
The following null hypothesis are to be stated for the statistical
significance and non – significance of data.
Hi:
Exchange rate instability has no impact on aggregate
demand in Nigeria.
H2: There is no casual relationship between exchange rate and
aggregate demand in Nigeria.
1.5
SCOPE AND LIMITATIONS OF THE STUDY
The length of period within which this study covered is
thirty years. This falls between the periods of 1976 and 2006. This
essence of this is to enable the observation for the research work
compensate for degree of freedom that could be cost.
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1.6
SIGNIFICANCE OF THE STUDY
Research work of this kind is usually treated directly with
the variables lifted from their sources. However, in this study,
the directives of Philips (1986), which states that they are
statutory, will be adopted to be assured that the result from this
work is reliable for other policy works.
Thus, the findings of this study will be of great importance
to a lot of people. Firstly, researchers carrying out research work
on the influence of exchange rate in Nigeria would find this
research work helpful. Secondly, policy makers who wish to
formulate policies on the effects of exchange rate instability
would find this research work handy. Thirdly, business firms and
investors as well as exporters who need to know when it is
convenient to operate in business and when it is not, would find
this research work a present- help in their periods of economic
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decision- making. Again, the central bank of Nigeria, the
monetary authorities (financial ministries and policy formulators
would find this research work vital in regulating exchange rate
regimes appropriately in terms of intervention of the government
into the economic system through the central bank. Finally, due
to revolutionary steps taken in this research work, the end
product of this study would add to knowledge, no matter how
infinitesimal, as a contribution for a sustainable economic growth
in Nigeria.
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CHAPTER TWO
LITERATURE REVIEW
2.1 REVIEW OF THEORETICAL LITERATURE
The importance of exchange rate policies in economic
adjustments cannot be overemphasized as it has become the
subject of considerable debate in many economies in the word
today.
Several economists in the world today have discovered that in the
bid to achieve certain objectives, that are economy wide in nature,
the issue of exchange rate cannot be handled lightly. They try to
see if exchange rate instabilities affect other macroeconomic
aggregates positively or negatively over time.
Efforts have also been made to see if the economic problems of
the Less Developed Countries (LDCs) could be tackled employing
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exchanging ate policy as a vital instrument. To this end, several
exchange rate models were propounded by different economies
in the world to suggest how exchange rate could, in the first
place, be determined.
2.2
EXCHANGE RATE DERMINIATION MODELS
exchange rate determination has been a crucial issue in economic
research. As a result, several schools of though propounded
different ways by which exchange ate could be determined.
Before the 1970’s the Keynesian model, which was developed by
James Meode (1951), dominated the scene. In 1962 and 1963, it
was
amended by
Marcus
Fleming
and
Robert
Murdell
respectively to be known as the Mudell-Fleming model. However
during the 1970s, other exchange rate models, which were based
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on considerations of stock equilibrium in the financial market
internationally, were developed.
2.2.1 FLEXIBLE PRICE MONETARY MODEL
The flexible price approach defines exchange rate as “The relative
price of two currencies”. It went ahead to model the relative price
in terms of the relative supply of and demand for the currencies.
The model assumed a continuous purchasing power parity (PPP).
It stipulates that since domestic money supply determines the
domestic price level, the exchange rate is, thus, determined by the
RELATIVE MONEY SUPPLY. Hence, a rise in domestic money
stock ceteris paribus. So, to increase their real money balances,
households reduce their expenditure which will cause general
price level to fall up to the point where equilibrium is established
in the money market, invariably, the domestic currency
apprecitates in terms of the foreign currency.
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From the fore-going this approach is a market clearing model of
the general equilibrium in which continuous purchasing power
parity is assumed However, the assumptions of the purchasing
power parity was altered due to the high volatility of real
exchange rate in the 1970’s. This led to the development of two
other classes of models, namely: the sticky-price monetary model
and the equilibrium model.
2.2.2 STICKY-PRICE MONETARY MODEL
The sticky-price monetary model is the exchange rate model that
allows for short term increases of the nominal and real exchange
rates over their long run equilibrium levels. Usually, the interest
rate compensates for stickiness in other aggregates that operate as
jump variables in the exchange rate system.
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The sticky nature of price in the shorten translate to an initial fall
in real money supply and a consequent rise in interest rate to
clear the money market. This increase in domestic interest rate
cause capital inflow and an appreciation of the nominal exchange
rate. A short run equilibrium would be sustained if the expected
rate of depreciation is equal to the interest rate differentials. To
alleviate pressure in the money market, in the medium run,
domestic prices begin to fall in response to fall in money supply,
and domestic interest rate also declines. This will invariably cause
exchange rate to gradually deprecate to the long run purchasing
power parity.
2.2.3 EQUILIBRIUM MODEL AND LIQUIDITY MODEL
The equilibrium exchange rate model was the model developed
by Alan Stockman and Robert Lucas in 1980 and 1982
respectively. The model analyses the general equilibrium of two
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countries by maximizing the expected present value of a
representative agent’s utility, subject to budget constraints. The
equilibrium models are an extension of the generalization of the
flexible price monetary model to give way for multiple-trade
goods and real stocks across the countries. In this model, a rise n
per capital output has two analytical effects, namely: The
REALISTIC PRICE effect and the MONEY DEMAND EFFECT.
The realistic price effect involves a reduction in price of domestic
output while the money demand effect appreciates domestic
currency as the demand for money (of transaction) increases.
2.2.4 PORFOLIO BALANCE MODEL
The portfolio balance model is the exchange rate model that
assumed that between domestic and foreign assets three exists an
imperfect substitutability. In the model, a very basic model was
set out which stipulated that net financial wealth of private
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sectors can be split into three (3) namely: Money, Local Bonds
And Foreign Bonds. The concluded that domestically-issued
bonds could be viewed as government debts help by the local
private sector as well as the level of net claims on foreigners held
by the private sector. Under a free flat, a current account surplus
on the balance of payment must be matched equally by a capital
account deficit.
2.3
AN OVERVIEW OF EXCHANGE RATE REGIMES
All over the world today, several exchange rate regimes are being
operated to achieve a more realistic and sustainable economy.
Broadly speaking, two (2) major exchange rate regimes were
being operated before now. They include the PEGGED and
FLOATING exchange rate regimes.
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However, due to more attempts by the world economists to attain
a perfect or near perfect situation around the globe, three new
ones were developed. They include the crawling (adjustable) peg,
the managed float and the exchange rate bonds.
2.3.1 THE GOLD STANDRD REGIME
The regime preceded the establishment of the Britton wood (1988)
that involved the government fixing the price of gold in terms of
its domestic currency. The supply of domestic currency was
linked to the supply of gold. Domestic currencies of most
countries were maintained to be convertible into gold. Hence, the
exchange rate in the gold standard was pegged (fixed) causing
exchange to be stable. Moreover, the government abided by a rule
that linked domestic money creation to the governments holding
of gold.
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The regime was in vogue until 1971 when the convertible of the
Dollar into gold was suspended by the United States on account
of Balance of Payment problems. The regime became obsolete and
infective when the demand for foreign exchange reserves
outgrew the supply of gold. Thus, it could no longer sustain the
international demand for foreign exchange.
2.3.2 FLEXIBLE EXCHANGE RATE REGIME
This exchange rate regimes, also known as floating exchange rate
regime, involves the determination of the exchange rate through
the forces of demand for and supply of foreign exchange between
two countries. It evolved as a result of the global monetary crisis
withnessed in 1971 arising fro the decision by some countries to
float their currencies against the American Dollar and other
currencies.
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In this regime, equilibrium level is stained without government
intervention. That is, exchange rate is allow to establish it
equilibrium through the interplay of the market forces via the
PURCHASNG POWER PARITY (PPP) approach which stated
that “homogenous products should maintain equal prices in all
countries Alternatively, in general, the price of a bundle of goods
produced in two countries should be similar when expressed in a
common currency. Furthermore, it predicts that exchange rate
between two countries will adjust to reflect the price level
difference between the two countries in the longrum.
2.3.3 THE CRAWLING PEG REGIME
The crawling peg regime also called the adjustable peg or Dollar
standard, involved the agreement reached by counties to peg
their exchange rate against the Dollar and occasionally alter it
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until a planned point is attained in a pre-determined future. This
followed that exchange rate were fixed but countries could alter
them up to the desired rate. This regime evolved after the second
world war. It was quite different from the gold standard which
had a 100% backing for the domestic currency to be printed by
government at will.
2.3.4 THE MANAGED FLOAT REGIME
This exchange rate regime is the regime that blends the features of
freely floating exchange rate with Central Banks’ intervention to
ensure that governments’ objectives are attained. It was embraced
when more and more countries abandoned the fixed and floating
regimes. It stipulated that the market forces were allowed to
determined the exchange rate within defined bounds (minimum
and maximum). The exchange rate regime became useful to
several countries of the world as the government, through the
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monetary authorities, employ it as an effective instrument to
discourage demand on consumption of certain goods (eg
imports). Hence, the central ban intervenes in the market to either
cause stability or movement of the exchange rate in a predetermined direction. Currently in Nigeria, the managed float
regime
is
the
system
operated
to
achieve
government
predetermined goals.
2.3.5 THE EUROPEAN MONETARY SYSTEM
Following a resolution that the European currency unit (ECU)
would be used as a unit of account for specialized transactions
between governments of member states, the European monetary
cooperation fund and receives ECU’s in exchange was established
to create a link of monetary cooperation that was set out to bring
monetary stability in Europe.
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Some eight (8) European countries – Denmark, Belgium, Ireland,
Netherelands, Spain, Germany, France and Italy pegged their
currencies to each other and formed a system called the European
monetary system (EMS) Apart from the pegging between Spanish
and Italian currencies that allows a float of± 6%, no member
country was allowed to move or float by more than± 2.25.
2.4
AN EVALUATION OF EXCHANGE RATE REGIMES IN
NIGERIA
The exchange rage regimes in Nigeria dates back to 1959, when
the Nigerian currency maintained equal ranking with the British
pound sterling, until the devaluation of the pound sterling by
10% in 1967.
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2.4.1 THE PRE-SAP ERA
This period spanned between 1962 to 1986, also referred to as the
period of exchange control. The currency was allowed to move
independent of the sterling to include the US dollar in the basket
of currencies for determining the value of the naira after the
country’s currency was changed to Naira in 1973. The pond
sterling and the dollar had fixed exchange rates to the naira at
0.58 and 1.52 respectively.
In 1978, a basket method of calculating the exchange rate was
established in which the weights of both the pound sterling an the
US Dollar were alternatively high. In 1985, the US Dollar was
adopted as a currency intervention system where the naira linked
to it as an intervention currency in order to reduce the perennial
problem of high incidence of arbitrage in naira exchange rate.
35
Thus, the Nigeria exchange rate was quoted against the US dollar
as a single intervention currency.
2.42 THE POST – SAP ERA
In 1986, (September), the second-
tier foreign exchange
market (SFEM) decree was promulgated. It provided a flexible
(floating)
exchange rate system (a regime that involve two
separate rates operate in the foreign exchange market). They are
the FIRST – TIER and SECOND-TIER exchange rates. While the
first-tier exchange rate was the OFFICIL rate, the SECOND-tier
exchange rate was CENTRAL BANK-ORIENTED. Thus, it was
operated by the Central Bank to achieve government’s goals.
In 1987 (July), the first-tier and second-exchange rates were
merged into a single exchange rate-the FOREIGN EXCHANGE
MARKET (FEM) as a result of the lots of abuses and
36
multiplication of rates, which led to further depreciation of the
naira, that the exchange rate system had created.
In 1988, an autonomous rate was merged with the FEM to
produce the inter-bank foreign exchange market (IFEM) as the
exchange rate of the naira that experienced continuous
fluctuations. In a bid to bring up the value of the naira, the 1994.
in 1995, the dual exchange rate was re-introduced and this time
called GUIDED DREGULATION. The, the Autonomous Foreign
Exchange Market (AFEM) was establish through the Decree no 17
of 1995 on Foreign exchange for private source of foreign
exchange. In this case, while the exchange rate at the AFEM was
determined by the market, the CBN intervened occasionally to
stabilize the naira exchange rate.
Conclusively, in 1997 the official market maintained a fixed
exchange rate for genuine government transaction. Thus, the dual
37
exchange rate was retained of which the official selling rate was
pegged at N21.996 to the Dollar. This led to stability in the normal
exchange rate in the year 1995-1997 at the AFEM and the value of
the naira appreciated. However, in 1999 an inter-bank foreign
exchange market (IFEM) was introduced to replace the AFEM in
order to enhance transparency and allocative efficiency of the
foreign exchange market.
2.5
EXCHANGE RATE DETERMINANTS
Exchange rate determination varies from one country to another
as well as from period to period. Past exchange rate policies in
Nigeria have often been directed at efforts to resist the use of
foreign exchange at officially determined exchange rate.
The main objective of a nations exchange rate policy is to have a
stable and realistic exchange rate that is in consonance with other
38
macroeconomic fundamentals. To attain this objective, a nation
may be compelled to shift the exchange ate level in line with what
the economy dictates.
In most countries of the world, exchange rates are marketdetermined without government intervention whereas in some
other economies, the exchange rate may be institutionally
determined where rate is pegged by fiat to one or more
convertible currencies. In between the two extreme cases of
exchange rate determination lines lies the dual exchange rate
determinations which is an admixture of both extreme systems of
FLAT and MARKET DETERMINED rates. Thus, exchange rate
regime determination is a function of the type of exchange rate
regime adopted. Major factors that affect exchange rate
determination and its shots are the policy stance of government
and the activities of the operators of foreign exchange market.
39
In conclusion, from experience internationally, no country leaves
it exchange rate determination completely to the market forces as
some level of intervention is applied occasionally. Exchange rate
stability will only be significant if it is measure in elation to
estimated equilibrium rate of the currency-the purchasing power
parity (PPP)
Generally, the exchange rate of an economy’s
currency could be determined by any of interest rate, transaction
motive, volume of international transaction, political instability,
policy action, etc.
2.5.1 INTEREST RATE
Interest rate can be seen as the price paid for money borrowed.
When interest rate rises in one country, people in and around the
country will be interested to invest in the country. Hence, an
increase in the exchange rate of the country. If there is a fall, on
40
the other hand, in interest rate the volume of investment will be
lowered. Hence, a depreciation in the country’s currency.
2.5.2 TRANSACTION MOTIVE
This handles motives for holding money for purchases. W hen
there is a rise in the level of demand for a country’s currency for
purchase of goods and services obtained in a country, the
exchange rate for that country will rise. However, if there is a fall
in the level of demand for a countries currency for transaction
motive, the exchange rate of the country’s currency will fall.
2.5.3 VOLUME OF INTERNATIONAL TRANSACTIONS
This refers to the movement of goods and services across the
borders of a country in relation to other countries. If the volume
of goods and services moving out of a country (export) is ,more
than the volume of goods and services into the country (import),
41
there wil be an inflow of foreign exchange. Hence, a rise in
exchange rate. However, if the volume of import of the country is
higher that the volume of export, then will be an outflow of
foreign exchange and consequently a fall in exchange rate. Hence,
a depreciation in the country’s currency.
2.5.4 POLITICAL INSTABILITY
This refers to the political situation of a country as it relates to
governance and socioeconomic circumstances. If the political
situation of a country is table and void of political disturbances,
investors will be encouraged to invest in the economy. Hence, rise
in the exchange rate due to capital inflow for investment.
However, when the political situation of the country is unstable
and full of disturbance, it results in the folding up of firms and
transferring of funds out of the country causing a drain in the
foreign reserves an discourage investors firm investing in the
42
country. Hence, a fall in the exchange rate of the country’s
currency.
2.5.5 POLICY ACTIONS
This refers to the monetary and fiscal policy adopted by a
particular country. The monetary and fiscal policies adopted by a
country results in capital flows between countries. If a country
adopts a tight monetary policy, this will cause the interest rate to
trise and cause investors to invest in the country. Hence, inflow of
capital and a rise in the country’s exchange rate. However, if a
country adopts a loose monetary policy, the interest rate will fall
and cause investors to shy away to invest elsewhere. This will
cause an outflow of capital and lead to a fall in exchange rate.
43
2.6
REVIEW OF EXPIRICAL LITERATRE
Several empirical researches have exhibited strong proofs of the
impact of exchange rate variations on other macro-economic
aggregates. Mitechell (2006) observed that economic theory is
vital in providing a model for comprehending the workings of the
globe, however, evidence helps to determine which economic
theory is correct.
2.6.1 EMPIRICAL LITERATURE ON THE STUDY USING
FOREIGN DATA SET.
Gyltasm and Schmid (1983) constructed a small macroeconomic
model with intermediate goods having two conflicting effects
generating an expansion through aggregate demand on one hand
and having a devaluation result through its effect on the cost of
imported inputs on the other hand. The parameter estimate of
44
countries were used to show that the demand effect dominates
the cost effect in most cases (i.e in industrial and developing
economies).
Kombe Oswld M (2004) showed the movement of Zambia’s real
effective exchange rate using the vector error correction model
and quarterly time series data between 1973 and 1997 and
concluded that exchange rate is different from models based on
international monetary fund statistics.
Branson (1980) constructed specific simulation model for Kenya
which suggested that devaluation will have vital contraction
effect in the
Kenyan
economy.
Taylor and Rozensweig (1984) stimulated the effect of a
number of policy measures including devaluation on economic
growth
for
Thailand
and
suggested
that
exchange
rate
devaluation will have expansionary effect and generate an
45
increase in real GDP in the economy in a bid to provide solutions
to the controversy whether exchange rate devaluation was
concretionary or expansionary Edward (1986) brought out an
empirical analysis which showed that devaluation has a negative
shorten effect on output and expansionary effect in output
growth in the medium term. Using the data in Latin America
(1962-1982) he suggested that the observed decline in output
growth in the period may not be a consequence of exchange rate
changes but may rather reflect the effect of an imposition of
restrictions and other policies that accompanied devaluation in
that country. He concluded that it was the same case in the LDCs
as it was pretty difficult to separate the effects of devaluation
from macroeconomic policies after implemented pari-passu.
Agenir (1991) showed that an anticipated depreciation of
real exchange rate has a negative effect on economic activities
46
while an unanticipated depreciation has a positive impact on
output, contrary to Edward’s result in 1986. According to Karl
Marx [1992] . Devaluation tends to be contractionary in nature
, the lower the Elasticity Of Substitution between imported
inputs and domestic value added, the higher the degree of
wage indexation coefficient, Morley [1992] conducted a cross
sectional study on the impact of real devaluation on capacity
utilization, during stabilization programme in the LDCs when
significant nominal devaluation was above 15%. The outcome
showed that while real devaluation tended to reduce output, it
took at least two years to have their full effect. He also revealed
that devaluation was not linked with significant rise in private
savings as only investment declined. Hence, factors such as terms
of trade and the capacity to import has a positive significant
effect.
47
Moving from exchange rate impact on output level to the
impact of exchange rate impact on inflation (domestic price level).
Billson, Bon, Kenen and Pack (1980) postulated that exchange rate
and foreign price level affect the domestic price level whereas the
vicious cycle hypothesis maintained that exchange rate changes
constitute an independent source of inflationary pressure where
exchange rate and price
level drive each other
.
Ndunga (1996) conducted
a study to determine the degree of
correlation between the
exchange rate and inflation covering a period of twenty-three
years (1970-1993) when accelerated money supply growth, fiscal
difficulty, foreign exchange squeezes, etc were witnessed in
Kenya.
He found out that the rate of inflation and exchange rate changes
drove each other while the foreign rate of inflation and the real
48
effective exchange rate drove the nominal effective exchange rate
changes. When a study on the link between devaluation and
inflation was done in Ghana by Younger (1992), the study showed
that a 100% increase in exchange rate led to rise in prices by –
10%.
Lonelon (1989) examined the role of money
supply and exchange rate in the inflationary process in twenty
three African countries and found out that during the period,
money supply, expected inflation, real income and exchange rate
devaluation were all vital determinants of inflation in the
sampled countries.
Carbo (1985) employed a macro model to explain the dynamics of
the Chilean inflation during the periods 197-1982 it was
unraveled that inflation rate was precipitated by exchange rate
variations and wage indexation.
49
Liviation (1980) in his contribution stated inflation as highly
linked to exchange rate changes (prompted by balance of
payment crisis). He opinioned that exchange rate depreciation
increases the underlying rate of inflation either through measures
in inflationary expectation which will be accommodated by the
monetary authorities or the wage indexation mechanism.
Chiber (1991), concluded a study on the causes of inflation in
African countries. It was discovered that there exists a correlation
between exchange rate regimes and inflation. He stipulated that
the country with floating exchange rate regimes tend to
experience higher inflation than those with pegged exchange rate.
However, he stressed that the underlying cause of inflation was
the high fiscal deficits financed primarily by money creation.
Goldstein (1974) constructed a simple 2-equation wage price
model to estimate the impact of exchange rate on the United
50
Kingdom’s wage and inflation level. He discovered that thee were
some vital changes in wage behaviour. But, it was difficult to
relate the changes directly to the devaluation as other factors and
economy policies acted on wages and prices simultaneously.
Thus, it was difficult to assign to any policy action arising from
observed changes in wage-price behaviour after devaluation.
Finally, considering exchange rate impact on import demand
Grafot (1980) in his study examined various approaches to the
balance of balance of payment adjustments, using Jamaica as a
case study. After employing the ordinary least square for sample
periods (1954-1973), he found out that relative prices and income
are vital factors that influence the demand for imports when he
estimated the import and export demand function. It was also
discovered that disaggregates of imports led to better and more
reliable estimates the import demand. Akakaiyi (1985) did an
51
investigation on the situation under which devaluation may
really function in the short run as an adjustment instrument. He
found out that if the elasticity is such that the relevant import
structure does not hold, devaluation should be accompanied by a
form of import re-structuring. Thus, before a country embarks on
such a policy, it should obtain estimates of the price elasticity of
demand for at least two categories of imports namely:
competitive imports and non-competitive
imports.
Bhagwat and Orutsuka (1974) attempted to assess the importexport response upon devaluation with the help of selected
quantitative indicators that are designed to be applicable to a
varied cross-section of countries. They discovered that higher
domestic prices of imports upon devaluation affect demand
adversely and encouraged substitution of domestic goods for
imported ones both in production and consumption. Thus, the
52
rise in demand for import sterming from the export-led level of
domestic economic activity and from import- liberalization
measures was stronger than the price effect of devaluation in the
opposite direction. It was also discovered that the behaviour of
imports after devaluation depends on the monetary-fiscal and
wage policies of the period in consideration.
2.6.2 EMPIRICAL LITERATURE ON THE STUDY USING
NIGERIAN DATA SET
Olofin et al (1986) made a study in connection with the
devaluation of the naira. It simulated different devaluation
scenarios of the Nigerian economy within the framework of a
macro model. Their discovery suggested that devaluation will
neither improve external balance position nor would it succeed in
effecting major internal adjustments at least in the short-run even
53
when combined with fiscal measures of expenditure. Also, the
study showed that the cost of any amount of devaluation would
far out-weigh any benefit that might be expected through internal
and external adjustments.
Egwaikhide (1993), built a macro-
model of the Nigerian economy an evaluated the historical impact
of devaluation on the indicators of growth like LGD, investment,
inflation, etc. He discovered, after employing a simulation
procedure of a 50% devaluation of exchange rate that while GDP
fell, the balance of payment improved marginally. He added that
the situation will lead to an increase in money supply which
propels inflation. Hence, it stipulates that devaluation may
necessarily be inflationary. He concluded that in order to
maintain both internal and external balance, devaluation must
necessarily be completed with the appropriate money and fiscal
measures.
54
Fakiyesi (1996), employed OLS technique on data covering 19601994 and discovered that exchange rate depreciation, monetary
expansion, inadequate output, inflation expectation etc are the
major determination of inflation in Nigeria. He concluded that
effective fiscal and money tools will stimulate productivity in the
real sector and proper management of exchange rate might limit
the growth of inflation.
Moser (1995), carried out a research on the factors that real
exchange rate and money supply are major determinants of
inflationary pressure in Nigeria. Dprbusch and Fischer (1993)
after studying, presented the study on moderate inflation
occurences because of external shocks in commodity prices,
increased production costs, fiscal deficits and exchange rate.
55
Their study also confirmed that inflation can be reduced to
low levels through a combination of light fiscal policy, income
policy and some exchange rate commitments.
Ukpolo (1987) examined what the effect of a combination of
devaluation policy with trade liberalization he discovered that
BOP situation of the LDCs will improve with enormous trade
imbalance using Nigerian data as a case study to assess the
impact of devaluation on the net foreign exchange earnings and
on the economy. The devaluation of the naira was unique with
implications for being a one sector dominant economy. Thus, the
elasticity of the value of imports was relatively inelastic. The
proportionate drop in the quantity of imports was out weighed
by the proportionate rise in the domestic price of imports in the
country. In effect, Nigeria could not take advantage of the
competitive edge that was gained through devaluation due to the
56
lack
of
short
term responsiveness to import-substitution
production.
Ayodele (1985) demonstrated that exchange rate changes
have significant impact on Nigeria external account. In his stuy,
the concept of effective exchange rate data was employed so as to
capture the effective changes in the cost of imports that are
occasional by changes in the exchange rate along Nigeria major
trading partners. The study adopted the flow of funds approach
for modeling the foreign sector of the Nigerian economy. He
discovered that an increase by a naira in the effective price of
foreign exchange would result in increases of N403.73, N71.88
and N475.61 million in the net capital inflow, current account
balances and the foreign reserve positions respectively after two
years. According to him, this favourable effect wee not well
captured by previous studies because the researchers often failed
57
to employ the correct measures of exchange rate between Nigeria
and the rest of the word. Also, he added that he allowed enough
time for the discounting of the currency by 2% on the parallel
(non-official)market. A standby arrangement was adopted as a
solution to the gap that existed between the official and parallel
markets exchange rates. Inflation which had fallen to 0% in April
2000 reached 14.5% by the end of that ear and 18.7% in August,
2001. In 2000, higher world oil prices resulted in government
revenue of over 16 billion dollars (about double the 1999 level).
Looking into the import-export relation, in 2004, importation
of goods was to the tune of 26 billion US dollars. The leading
sources included China (9.4%) the United States (8.4%), the
United Kingdom (7.8%), the Netherlands (5.9%), France (5.4%),
Germany (4.8%), and Italy (4.0%). The imported goods
constituted:
manufactured
goods
machinery
,
transport
58
equipment, chemicals, foods, and live animals. Exports of foods,
on the other hand, was to the tune of 52 billion US dollars. The
leading destination of exports were the United States (47.4%),
Brazil (10.7%) and Spain (7.1%). In the 2004 also, oil accounted for
about 95% of merchandise export while cocoa and rubber
accounted for 60% of the remainder.
In 2005, Nigeria posted a 26 billion US dollar trade surplus
corresponding to almost 20% of GDP, achieving a posted current
account balance of 9.6 billion US dollars. Moreover, a major
breakthrough was achieved by Nigeria in the same year. An
agreement was reached with the Paris Club to eliminate the
country’s bilateral debt through a combination of write down and
buy-backs. In mid-June of 2006, the exchange rate was pegged at
128.4 naira to the US dollar. Data shows that External debt with
the London Club is 12 billon US dollars with external reserves of
59
49 billion dollars (December 2oo6). The exchange rate trend
between 2000 and 2006 follows thus:
2005 – 128 naira to the Us dollar
2004 – 132.89 naira to the US dollar
2003 – 129.22 naira to the US dollar
2002 – 120.58 naira to the US dollar
2001 – 111. 23 naira to the Us dollar
60
CHAPTER THREE
METHODOLOGY
3.1
An Overview of the Model
The study shall follow a linear specification via the partial
adjustment approach.
At the broadest level of generalization,
theories and empirical studies have established strong evidence of
a correlation between exchange rate variation and aggregate
demand as proxy by gross domestic product. Informal activities
such as variations in broad money supply instruments,
government expenditure, inflation rate, foreign reserve, interest
rate and real exchange rate, are generally highly dynamic and
their influence transmits into other macroeconomic variables.
The relationship between variations in exchange rate is therefore
likely to be dynamic in nature and therefore has influence on the
aggregate demand in an economy.
61
Apart from the impact analysis component of this study, the
degree of responsiveness of macroeconomic instability to changes
in these instruments shall be measured. A point to note here is
that the variables would be in their log forms in order for scaling
purposes. Also, the Error Correction Model, if co-integration
exists, will help to correct the deviation from the long term
equilibrium (Gujarati, 2004; Greene, 2000).
3.2
Model Specification
Following from our research objectives 1, and 2, we develop a
compact functional form of our variables follows:
ADt = f (GEt, INFt, M2t FRt, INTt,) …………………………………. (
Where
AD =
Aggregate Demand
GE
Government Expenditure
=
62
M2 =
Broad Money Supply
FR
=
Foreign Reserves
INTR=
Real Interest Rate
INF =
Inflation Rate
For empirical computation, equation (1) transforms to:
AD =
0
+
1
+ GE +
2
+ M2 +
3
+ FR +
4
INTR +
5
INF +
µ1…..(2)
= parameters to be estimated
µ = error term
For the purpose of scaling the variation in model (2), we
shall present the model in a log form, hence:
LOFAD =
0+ 1+LOGGE+ 2+ 3LODFR+ 4 LOGINTR
+ 5LOGINF+µ1…………………………………………………………
….(3)
63
Usually in econometric modeling, the response of the dependent
variable to the explanatory variables is rarely instantaneous. Very
often the dependent variable responds to the explanatory
variables with a lapse of time (See Gujarati, 2004).
3.3
Unit Root Test
The assumption so far is that variables are well behaved that is to
say they do not possess any of the time series problems.
However, literature has shown that most macroeconomic data are
confined to time so that their mean is time-dependent making
them non-stationary and co integrated (Granger and Newbold,
1974; Dickey and Fuller, 1981; Enders, 1995; Sims, 1990; Pindyck
and Rubinfeld, 1998).
We shall therefore subject the entire
variables to a unit roots stationarity test using Augmented
Dickey-Fuller (ADF) test.
64
3.4
Co Integration and Error Correction
In order to bring the short run dynamic specification
relationship to their long run specification, the co integration test
becomes necessary. In the event that GDP has an identical order
of integration with any of the explanatory variable(s), we
therefore suspect co-integration. Hence, we estimate their linear
combination without the constant and subject the residual to unit
root test using the following equations respectively:
µt = (r-Zt-1)…………………………… (7)
Where
z
=
vector of the co integrated factor(s) and
y is the vector of al the dependent variables.
If the residual is stationary there is co-integration. Under
this scenario, the long-run multiplier of the explained variable
will be highly dependent on the impulse of the explanatory
variables in question.
Hence the appropriate model for
65
estimation will be the Error Correction Model, (Engle and
Granger, 1987).
3.5.1 Economic Criteria:
The economic a prior expectations will evaluate the parameters
whether they meet standard economic theory expectations both in
signs and sizes.
3.5.2 Statistical Criteria:
Statistical tests of significance will be based on the t-tests. The Fstatistic will be used to assess the significance of the overall
regression.
3.5.3 Econometrics Criteria
Econometric criterion involves conducting several tests to
evaluate the true position of the model. They are secondary tests
which will be perform in order to further attest to the reliability of
66
the expected result.
conducted
include
Specific econometric tests that will be
autocorrelation,
model
mis-specification
muticollinearity and the residual normality.
Autocorrelation Test
This test will be performed to see whether the errors terms
corresponding to different observations of the series are
correlated. Since the classical OLS assumption assumes that the
disturbance term relating to any observation is not influenced by
the disturbance term relating to any other observation. (Gujarati
204). The popular Durbin Watson d statistics shall be used for
this test.
Model Mis-Specification Test
To find out if the model is well specified, the Ramsey reset test is
used. This follows the F-test such that if F-critical exceeds F-
67
observed, then the model is well specified and the variables truly
fit the equation.
Residual Normality Test
This tests whether the residuals are normally distributed.
The Jacque-Bera statistic will be used for the test.
Multi-co linearity test
When multicollinearity exists, it becomes difficult to
separate the individual influences of the explanatory variables. If
any of the partial R2 exceeds the overall R2, then there is serious
multi-co linearity (Petterson, 2000). This test will therefore be
conducted so as to measure the level of correlation between any
two of the variables holding all other variables constant.
Sources of the Data
68
The data to be employed for this analysis are secondary in
nature. They shall be obtained from the Central Bank Nigeria
Statistical Bulletin Vol. 17, December 2006 publication.
Econometric Software
We shall load the data initially into Microsoft Excel Worksheet
and the imported into the PC-GIVE software for the analysis.
69
CHAPTER FOUR
PRESENTATON AND ANALYSIS OF RESULT
4.0
INTRODUCTON
This sector first of all, will evaluate the fundamental properties of
OLS. Thus each of the variables would be examined for unit root
and co-integration.
Consequently, the Augmented Dickey –
Fuller (ADF), defines the equations for these tests.
4.1
ADF Test for Stationary
Employing the Augmented Dickey-Fuller test, unit roots test
was run on the variables up to their 2nd differences with the
following result:
70
Table 4.1
Variable
Unit Root Test (ADF-test)
DDLAD
DDLM2
DDLFR
DDLRINT
DLINF
DDLEXR
DLGE
 (d)
2
2
2
2
1
2
2
Lag
2,1,0
2,1,0
2,1,0
2,1,0
2,1,0
2,1,0
2,1,0
-5.2289**
-2.8153**
-5.8783**
-5.8783**
-43590**
-4.2305**
-5.2319**
-7.2001**
-3.7223**
-7.0095**
-8.5220**
-5.5715**
-5.7156**
-6.7060**
-10.525**
-7.8906**
-8.3571**
-10.717**
-5.1802**
-7.7639**
-11.394
Critical Values -1.955
-1.955
-1.955
-1.955
-1.955
-1.955
-1.955
5% & 1%
-2.66
-2.66
-2.66
-2.66
-2.66
-2.66
-ADF
-2.66
NB** Indicate significance at the 5% & 1% levels.
In the table above, the level of integration or the significance
(5% & 1%). Of each of the variables is shown by the **. This result
revealed that some variables (explanatory variables) were of the
same order with the dependent variable. That is, they were made
stationary after second difference.
integrated of order 1  (2).
Thus we can say they are
Therefore, the evidence of co-
71
integration was shown from the order of integration presented
above, which proves that the dependent variable has the same
order with some explanatory variables, and for this reasons, we
conduct co-integration test as shown below.
4.2
Co Integration test
Given the unit root properties of the variables, we
proceeded to implement the Engle-Granger co-integration
procedure. Since the dependent variable have the same order of
integration with some of the explanatory variables. In doing this,
we first of all estimate their combination at level form without the
intercept and obtain their residual which is then subjected to cointegration test as show in the table below.
72
Table 4.2: Co-Integration Test
t-adf
Lag
5% Critical Val
1% Critical Val
Residual
-1.3661
2
-1.954
-2.652
Residual
-1.0778
1
-1954
-2.652
Residual
-1.0129
0
-1.954
-2.652
The result presented in table 4.2 shows that there is actually no
presence of co-integration among the variables. This is so because
the residual obtained from the linear combination of the nonstationary variables in question were not statistically significant at
both 55% and 1% critical value. However, this led us to adopting
out formal model as specified in chapter three above.
73
4.3
Results from Modeling Log of GDP by OLS
The result of our OLS model is presented in Table 4.3
Table 4.3 Result Summary
Variable Coefficient Std Error
t-value
t-prob
Part R2
Constant
-3.0599
3.0749
0.995
.03300
0.0413
LGEX
-0.33315
0.48298
-4.690
0.0002
0.5203
LINF
0.21855
0.13839
3.579
0.0079
0.3178
LM2
1.2726
0.42427
2.999
0.0064
0.2812
LFR
0.26111
0.16654
2.568
0.0025
0.2566
LINT
0.74797
0.53928
3.387
0.0017
0.2972
LEXR
-0.35983
0.31599
-2.139
0.0065
0.1934
R2 = 0.960745
F(6,23) = 93.818,
DW = 1.75
74
4.4
Economic Interpretation
Government Expenditure (GEX)
The variation shown by the coefficient of government
expenditure in the model has a negative value of -033315. This
finding implies that the value of government expenditure indicate
a negative trend to the aggregate demand in the economy. That is
a unit increase in government expenditure variation will lead to a
decrease in the aggregate demand by -0.33315 units. In other
words as variation in government expenditure is increasing,
aggregate demand in the economy is declining. Also, using the
2-t Rule of thumb, variation in government expenditure is
statistically significant judging from the t-value of -4.690 which is
greater than 2 in absolute value at 5% level of significance. This
result suggests that the variation in government expenditure as a
growth instrument appeared to have a meaningful impact on the
aggregate demand in the Nigerian economy.
75
Rate of Inflation (RI)
The value of the coefficient of inflation rate is 0.21855 and it did
not conform to the “a priori” expectation. It implies that a unit
increase in inflation rate will cause aggregate demand to increase
by 0.21855 units. However, the value of inflation is statistically
significant, and the result renders inflation control as major
instrument for maintaining the growth of aggregate demand,
though inflation rate contributes negatively to aggregate demand
growth in Nigeria and as well to the aggregate growth of the
economy (GDP).
Again, using the 2-t rule of thumb, variation in rate of
inflation is statistically significant judging from the t-value of 3.579 which is greater than 2 in absolute value at 5% level of
significance.
This result suggests that the variation in rate
76
inflation appears to have a meaningful impact on the growth of
aggregate demand in the Nigerian economy.
Broad Money Supply (M2)
The coefficient of broad money supply is 1.2726. This implies a
positive relationship between broad money supply and aggregate
demand growth. This positive sign conform to our economic “a
priori” expectation because increase in the rate of broad money
supply is expected to boost the level of economic activities and as
well increase the aggregate demand.
In other words a unit
increase n broad money supply will cause economic output and
aggregate demand to increase by 1.2726 units, thereby increase
the aggregate growth of the economy.
Also, using the 2-t rule of thumb, variation in the rate of
broad money supply is statistically significant judging from the t-
77
value of -2.999 which is greater than 2 in absolute value at 5%
level of significance. This result suggests that the variation in
broad money supply appears to have a meaningful impact on the
growth of aggregate demand in the Nigerian economy.
Foreign Reserves (FR)
The coefficient of foreign reserves is 0.26111.
This implies a
positive relationship between foreign reserves and the growth in
aggregate demand in Nigeria. This positive sign conform to our
economic “a priori” expectation because increase in the rate of
foreign reserves is expected to boost the level of aggregate
demand in the economy.
In other words, a unit increase in
foreign reserves will cause aggregate demand to increase by
0.26111 units, thereby increase the aggregate growth of the
economy.
78
Using the 2-t rule of thumb, variation in the rate of foreign
reserves is statistically significant judgng from the t-value of 2.568 which is greater than 2 in absolute value at 5% level of
significance. This result suggests that the variation in foreign
reserve appears to have a meaningful impact on the growth of
aggregate demand in the Nigerian economy.
Real Interest Rate (INT)
The variation in the rate of interest possesses robust
coefficient of 0.74797. This implies that a unit increase in the rate
of interest causes aggregate demand in the economy to increase
by 0.74797 units, all things being equal. The robust responds of
this results is further confirmed by its t-value of 3.387 which is
greater than 2 in absolute value at 5% level of significance
following 2-t Rule of Thumb. Though the finding here imply that
79
positive variation exist between rate of interest and the aggregate
demand in Nigeria, it can be observes not to be in conformity
with some theories and no conformity to others. As high interest
rate reduces the incentive to borrow as well as investment which
transmits to low demand in an economy.
Real Exchange Rate (RER)
Real exchange rate displays a negative coefficient of -0.35983.
This result suggests that a unit increase in real exchange rate
cause aggregate demand growth to decline by 0.35983 units.
Notwithstanding, Real exchange rate is statistically significance
inn showing positive fiscal instrument of maintaining aggregate
demand growth in Nigerian economy. The negative signs and
strong size of the variable show how frequent changes in real
exchange rate precipitate in macroeconomic growth.
80
4.5
Statistical Criteria (First – Order Test)
These tests are determined by statistical theory and aims at
evaluating the statistical reliability of the estimates and
parameters of the model (Koutsoyiannis, 1977). From the sample
observation, the first order test is carried out based on the
following R2, t – probability (t-prob) and F-test.
Coefficient of Determination (R2)
In our model, R2 = 0.960745, which implies that approximately
96% of the variation in the dependent variable (AD) is explained
by the variations in the explanatory variables. Judging by the size
of the coefficient of determination (R2), 96% shows a good fit for
the model. Meaning that 96% variations is explained in the model
leaving around 4% variations in the model unexplained.
81
4.5.2 t value
Following a 2-t Rule of Thumb, a variable is statistically
significant if its t-value is greater than 2 in absolute value at any
% level of significance. In other hand, it statistically insignificant
if its t-value is less than 2 in absolute value at any % level of
significance; (Gujarati, 2004).
Consequently, from the t-values
generated in the regression as shown in Table 4.3, all of them
were statistically significant since at 5% level of significance their
various t-values were greater than 2 in absolute value.
4.5.3 F-test
Following Gujarati (2004), to find out whether the model is
adequate and well specified, we use the F-test such that if the Fcalculated are F(6,23) = 93.818, which exceeds F-tabulated of 2.53,
at 5% level of significance implying that the model is well
specified and adequate for forecasting and policy analysis.
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4.6
Evaluation based on Econometric Criteria (Second Order
Test)
These tests are based on econometric theory and are aimed at
finding out whether the underlying assumptions of OLS
regarding the estimation of time series data is satisfied.
Test for Auto Correction
The DW rule value of 1.75 suggested no presence of positive
serial autocorrelation. This was derived from the Rule the Thumb
which decision was made in guide from the table presented
below.
D-W Statistic
Positive Autocorrelation
Between 1.5 and 2.5
No positive serial autocorrelation
Below 1.5
Positive serial autocorrelation
Above 2.5
Negative serial autocorrelation
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The above table shows that our DW statistical value of 1.75
falls between 1.5 and 2.5 and for this; we conclude that there is no
positive serial autocorrelation in the error terms.
4.6.2 Test for Hetroscedasticity
We shall employ the White’s hetroscedasticity test see
Gujarati (2004) third Edition.
Hypothesis
Ho: (There is no hetoscedasticity; i.e. homoscedasticity)
H1: (There is hetroscedasticity)
Decision Rule: Reject Ho if the calculated hetroscedasticity valye
which follows the Chi Square distribution with 12 degree of
freedom, otherwise accept Ho.
following the above formula,
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calculated value of 7.3859 is less that tabulated value of 21.0 we
accept Ho of homoscedasticity or equal variance of the error
terms.
4.6.3 Test for Multicollinearity
Multicollinearity test shall be used to ascertain the violation
of the tenth assumption of classical linear regression model. In
carrying out the test, we shall investigate the R2 and t-test. A
classical symptom of multicollinearity is that a model with R2
which is high, say in excess of 0.8, and most of the t-value are not
statistically significant, we say that the model has multicolliearity
problem. We conclude based on empirical findings as guided by
the above decision rule, that the model is free of multicollinearity
problem having all the variables except one statistically
significant.
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4.6.4 Normality Test
The normality test adopted is the Jarque Bera (JB) Test of
Normality. The JB test of normality is an asymptotic, or largesample, and it is based on the OLS residuals. This test computes
the skewness and Kurtosis measures of the OLS residuals and it
follows the Chi-square distribution (Gujarati, 2004:148).
Hypothesis
H0 1 = 0 (the error term follows a normal distribution)
H0 1 = 0 (the error term does not follows a normal distribution)
At  = 5% with 2 degree of freedom.
Decision Rule: Reject Ho if X2cal > X2(0.05)
(2 df), and accept Ho and
tab
reject if otherwise.
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From the result obtained from Jarque-Bera (JB) test of
normality, JB = 1.084 (See appendix), which is less than chi-square
of X2(0.05) (2 df), and accept H0 and reject if otherwise.
tab
From the result obtained from Jarque-Bera (JB) test of
normality, JB = 1.084 (See appendix), which is less than chi-square
2
table of Xtab
= 5.99147. therefore, we accept H0 and conclude that
the error term follows a normal distribution.
4.4.5 Test for Adequacy of the Model
This test was conducted to test whether the model was well
specified. In this test, the Reset Test was adopted. The test follows
t – distribution, at 5% level of significance.
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Statement of Hypothesis
H0: Normal specification of the model
H1: Wrong specification of the model
Reset F* = 0.83331
Decision rule: Reject H0 if F* > F – tab, and accept if otherwise
where F0.05, (1,22) = 4.30.
Conclusion; Since F* = 0.8331 < F –tab = 4.30 we accept the null
hypothesis and conclude that the model used is well specified.
4.7
Evaluation of the hypothesis
The hypotheses have earlier been stated as:
H0: Exchange rate instability has no significant impact on
aggregate dement in Nigeria.
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H1: There is not causal relationship between exchange rate and
aggregate demand in Nigeria.
Going strictly by the result of the tables presented above, all
the variables conformed to the “a priori” expectation, and also, all
the variables were statistically significant. Furthermore, the f –
test shows that the regression is significant and the adjusted R2 is
completely a good fit. The result is also shown to be robust to
possible sources of specification test, the hetroscedasticity, which
shows that the error term have equal variance. From the
observation above, we noted that exchange rate instability has an
appreciable impact on the aggregate demand of the Nigerian
Economy.
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CHAPTER FIVE
SUMMARY, POLICY IMPLICATIONS AND CONCLUSION
5.1 Summary
This study examines the impact of exchange rate variation on the
aggregate demand in the Nigerian economy over the period of
1979-2008. The study explores simple regression models with the
adoption of Ordinary Least Square (OLS) method of estimation in
examining these variables. This work, amongst other things,
found out that all the variables included in the models contributes
in explaining the role of exchange rate on aggregate demand in
Nigeria. These massive contributions of these variables may
strongly depend on the circumstances in the Nigerian economic
environment. Major empirical studies have investigated the
relationship between exchange rate and economic growth and the
role played by the exchange rate volatility is confronted in the
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domestic economy. This study further believed that for the actual
developmental impact of aggregate demand to be felt in Nigeria
there
should
be
large
local
markets,
natural
resource
endowments, good infrastructure, low inflation, an efficient legal
system and a good investment frame work promotion. In
contrast, corruption and political instability have the opposite
effect. These finding are consistent with the reports of
multinational companies that operate in Nigeria.
5.2
Conclusion
The paper empirically investigates the role of exchange rate
variability on aggregate demand in Nigeria. The empirical
investigation presented in the work strongly suggests that Nigeria
needs to sufficiently develop it’s financial system in order to let a
well formulated exchange rate policy contribute positively to
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aggregate demand growth. The outcomes of the empirical
investigation suggest that Nigeria should first reform their
domestic financial system before liberalizing the capital account
to allow for a favorable exchange and as a result enlarged FDI
inflows.
However, be that as it may, we draw the final conclusion by
calling on the Nigerian government to note that exchange rate
variation is expected to have positive impact on aggregate
demand growth. However, due to insufficient data, we can not
confirm this expectation in this work. We suggest that further
empirical analysis should be performed with more detail
information on the determinant of exchange rate variation and it’s
impact on aggregate demand to verify their theory backings.
However, the interrelationship between exchange rate in
promoting economic growth appears to be quite complex and for
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this, further investigation is needed so that an appropriate
explanation for this phenomenon can be given.
5.3
Policy Implication
The starting point in reclaiming and re-inventing projects in
Nigeria is to squarely admit that oil and the manner we have
designed to utilize it have constituted a stumbling block to
Nigeria’s progress.
For the vision 20:2020 not to end up as an empty sloganeering in
Nigeria, the economy has to be growing annually at the rate of 15
per cent or more. To achieve this, we must therefore begin by
breaking down the institutional arrangements around oil and
reconstruction Nigeria’s with each of the federating units being
fiscally viable regions. The emphasis is to orchestrate a new
politics that is aimed at cake-baking ather than cake sharing, one
93
which aims to mobilize the creative energies of Nigerians and
their endowed resources to unleash one of the economic miracles
of the 21st Century.
For sustainable democracy to emerge, fundamental changes are
required in the constitution, the electoral system, the fiscal
federalism and operations, as well as a gamut of legalinstitutional reforms that are developmental and capable of
promoting private enterprise and competition” (Soludo, 2005:11).
There is need to devise effective mechanisms for coordination and
cooperation between federal government and federating subnationals in such a way as to make it possible to agree on
economy-wide macroeconomic objectives and targets, and ways
of achieving same. This could entail legally enforceable fiscal
rules that ensure that individual governments pursue goals and
targets that are consistent with overall national objectives.
94
The policy options for Nigeria’s growth and stability go far
beyond a few macroeconomic reforms, into the transformation of
the very basis of production and exchange in the Nigerian
economy. Accordingly, there is need to pay specific and
systematic attention to the context of action and the production
relations in the various sector of the economy (Ukwu, et al 2003).
It must be understood that Nigeria cannot develop on a
sustainable basis without restoring the umbilical cord between
government and business (private sector) thus bringing back
competition among the regions/states to create wealth. When
government revenue depends on whether or not private
businesses thrive, it will become the primary business of
government to ensure that businesses survive and boom.
Currently, there is no such an incentive and Nigeria cannot go
forward without it. Citizens’ participation and demand for
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accountability increases when government depends on them for
revenue. Nigeria must unleash a production investment boom
and competition/revolution in most sector (Soludo, 2010).
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