IMPACT OF EXCHANGE RATE MISALIGNMENT ON MACROECONOMIC VARIABLES IN NIGERIA
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ABSTRACT
Since real exchange rate links domestic economy with the rest of the world, the determination of Equilibrium Exchange Rate is pivotal to ensuring macroeconomic stability, current account sustainability and effectiveness of monetary policy through implementation of policies to mitigate the impact of exchange rate shock. Based on this, a well-known view in international macroeconomics states that a misaligned exchange rate provokes costs to the domestic economy: an overvalued currency may cause loss of competitiveness in international trade, while an undervalued currency for an import dependent country like Nigeria may cause inflationary pressures there by hurting economic growth. This provides the premise to estimate the equilibrium exchange rate (as well as its misalignment) and its ensuing relationship to some macroeconomic variables. Therefore, the key objectives of this study are to interrogate the extent of exchange rate misalignment and the effect of such misalignment on Non-oil export, growth and current account imbalance. This study utilized four competing approaches namely, Fundamental Equilibrium Exchange Rate (FEER), Behavioural Equilibrium Exchange Rate (BEER), the Natural Equilibrium Exchange Rate (NATREX) approach and the Structural Vector Auto Regression approach (SVAR).The model selection criterion which has the least Root Mean Square Error (RMSE) and Mean Absolute Error (MAE) indicated that SVAR model is selected to achieve the objective of the study. The major findings of the study are as follows; the real effective exchange rate is misaligned from the four models estimated, based on the SVAR approach selected for this study, the result indicates about 47 episodes of misalignment. The result also indicates a negative relationship between REER misalignment and Non-oil export which implies that real overvaluation could adversely affect a country's Non-oil export performance via loss in competitiveness, while undervaluation is found to support Non-oil export. On the growth regression, the result indicates that exchange rate misalignment negatively affect growth. Also, overvaluation is found to affect growth negatively while undervaluation is found to have positive effect on growth. In both specifications (growth and non-oil export), flexible exchange rate is found to have disruptive effect compared to fixed exchange rate regime due to adjustment cost. The result also shows that there is causality running from exchange rate misalignment to current account imbalance. The policy recommendation that stems from this work is that policy makers should avoid periods of long lasting appreciation as it is inimical to growth rate of GDP, Non-oil export performance and could have disruptive effect on current account
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