Oil Price Shocks and Macroeconomic Adjustment: Evidence on Exchange Rate, Inflation, and Interest Rate Dynamics in Nigeria
Abstract
This study examines the short-run and long-run impact of oil price shocks on three major macroeconomic variables of Nigeria, which are the exchange rate, the inflation rate, and the interest rate for the period of 1974 to 2022. Nigeria is an interesting case study because it is a large crude oil exporter and a net importer of refined petroleum products, resulting in complex and asymmetric macroeconomic responses to global oil price fluctuations. This study adopts the Autoregressive Distributed Lag (ARDL) bounds approach and the Error Correction Mechanism (ECM) after applying the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) unit root tests. The ARDL bounds test results indicate that the oil price fluctuations are long run cointegrated with all three dependent variables in all three models. The long-run estimates show that oil price change has a statistically significant and negative impact on exchange rate (β = −0.4455, p < 0.01), which suggests that oil price increase is correlated with naira appreciation in line with the Dutch Disease mechanism. Oil price shocks, on the other hand, have statistically insignificant long run effects on inflation (β = 2.4298, p = 0.249) and the interest rate (β = 0.1063, p = 0.519). The ECM coefficients are negative and statistically significant in all three models, which indicates that the adjustment process toward the stable LR equilibrium is taking place at a rate of 47%, 76% and 56% per year for the exchange rate, inflation, and interest rate models, respectively. The results of the CUSUM and CUSUM-of-squares stability tests indicate that the parameters are constant in Models 1 and 2 but that some parameters are not constant in Model 3. The results indicate that Nigeria's monetary and fiscal policy should consider tackling the structural oil reliance, which makes the exchange rate highly vulnerable to oil market shocks, but also that the non-oil domestic factors are the main drivers of inflation and interest rate movements. The policy recommendations are focused on economic diversification, a rules-based exchange rate management framework and coordination between the monetary and fiscal authorities.