EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

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EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

Abstract:

CBN typically intervenes directly in the foreign exchange market to ensure that the value of the Naira is stable. However, direct foreign exchange purchases and sales by the monetary authorities could be very costly and are hardly effective in reducing exchange rate volatility when the local currency is under pressure to depreciate. Researchers have found that this kind of interventions have little or no desired effect, and may lead to undesired volatility in the exchange rate. In an environment of tight monetary policy, additional monetary tightening could have effect on the exchange rate. If this is so, then reserve loss in period of speculations can be prevented. This study sets out to examine if Additional Monetary Tightening (AMT) can be used to achieve exchange rate stability in Nigeria, as a potential substitute or complementary tool to the direct intervention. The study identified the period of AMT from 2007- 2015, capturing the periods by the use of dummy variable. The variables of the study includes Monetary Policy Rate (MPR), Cash Reserve Requirement(CRR), Liquidity Ratio(LR), Upper interest rate Corridor (UCORR), and Lower interest rate Corridor (LCORR), were estimated using GARCH (2,2) with lag of one period for all the variables and was found to be appropriate. The result shows that AMT is negative and statistically significant at 10% in reducing the exchange rate volatility in the variance equation and also negative and significant at 1% in appreciating the exchange rate in the mean equation. Although all variables were correctly signed in the variance equation except CRR, only AMT, and LR, were statistically significant at 10% and 1% respectively in the variance equation. This suggests that, AMT can be adopted as an alternative/complementary tool in attaining exchange rate stability in Nigeria. From these findings, the study recommends that where it is feasible, CBN should consider AMT as a useful tool for exchange rate management vii and prevent reserve loss. This also suggests that CBN must use this tool cautiously since AMT can hurt the economy via investment and spending.

EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

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