An Examination of the Relationship Between Inflation and Exchange Rate Movements in Nigeria
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Background of the Study
Exchange rate dynamics are fundamental to a country’s economic stability, particularly in emerging markets such as Nigeria. Inflation, as a key macroeconomic variable, plays a significant role in influencing exchange rate movements. In Nigeria, persistent inflation has been closely linked to the depreciation of the naira, as rising domestic prices erode investor confidence and prompt a shift toward foreign currencies (Okafor, 2023). The interplay between inflation and exchange rate fluctuations is complex; high inflation often leads to a loss of purchasing power, triggering capital flight and further weakening the domestic currency. Conversely, a depreciating currency can exacerbate inflation by increasing the cost of imported goods, creating a cyclical effect that is challenging to break (Bello, 2024).
Economic policy measures, particularly those related to monetary policy, are deployed to manage these dynamics. However, the effectiveness of such measures is often hindered by structural challenges within the Nigerian economy, such as fiscal imbalances and a large informal sector. Moreover, external factors—such as global oil prices and international market conditions—also influence exchange rate movements, making it difficult to isolate the effects of domestic inflation (Chinwe, 2023). Recent empirical research has underscored the need for an integrated analytical framework to better understand how inflation contributes to exchange rate volatility and what policy interventions might stabilize the currency.
This study aims to bridge existing gaps in the literature by systematically examining the relationship between inflation and exchange rate movements in Nigeria. It will investigate the extent to which inflation drives currency depreciation and explore the moderating effects of government policies. By incorporating both qualitative and quantitative analyses, the study will offer insights into the mechanisms that link domestic price levels to international currency valuation (Okafor, 2025). Ultimately, the findings will inform policy debates and provide practical recommendations for achieving greater exchange rate stability.
Statement of the Problem
Nigeria’s persistent inflationary environment poses significant challenges to the stability of its exchange rate. Rising inflation diminishes the value of the naira, leading to increased volatility in foreign exchange markets (Bello, 2024). This instability disrupts international trade, increases the cost of imports, and places additional pressure on domestic producers who rely on imported raw materials. The complex relationship between inflation and exchange rate movements is further compounded by structural economic issues and external market pressures (Okafor, 2023).
The current monetary policy framework has struggled to effectively manage these challenges. Despite efforts to curb inflation and stabilize the currency, the naira continues to experience depreciation, which in turn fuels further inflation. This vicious cycle creates an uncertain business environment and undermines investor confidence. Furthermore, the lack of robust analytical tools to isolate the impact of inflation from other external factors makes it difficult for policymakers to design targeted interventions (Chinwe, 2023). The resulting volatility not only disrupts economic planning for businesses but also hinders sustainable economic development.
Given the centrality of exchange rate stability to Nigeria’s economic growth, it is imperative to understand the mechanisms through which inflation affects currency valuation. This study seeks to fill the gap in existing research by providing a comprehensive analysis of the inflation–exchange rate nexus, thereby offering actionable insights for policymakers tasked with stabilizing the domestic currency.
Objectives of the Study
- To analyze the relationship between inflation and exchange rate fluctuations in Nigeria.
- To investigate the impact of inflation on currency depreciation.
- To propose policy recommendations to stabilize exchange rate movements amid inflation.
Research Questions
- How does inflation influence exchange rate movements in Nigeria?
- What is the magnitude of the impact of inflation on currency depreciation?
- What policy measures can mitigate exchange rate volatility caused by inflation?
Research Hypotheses
- H1: Inflation is positively correlated with exchange rate depreciation.
- H2: Inflation significantly increases exchange rate volatility.
- H3: Effective monetary policies can reduce the adverse impact of inflation on the exchange rate.
Scope and Limitations of the Study
This study focuses on the Nigerian foreign exchange market and relies on data from central bank reports and international financial institutions. Limitations include the influence of global market conditions and potential data inconsistencies.
Definitions of Terms
- Exchange Rate: The value of one currency for the purpose of conversion to another.
- Inflation: A sustained increase in the overall price level of goods and services.
- Volatility: The degree of variation of a trading price series over time.
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