Monetary Policy and Exchange Rate Dynamics in Nigeria: Evidence from Official and Parallel Market Rates.

Abstract

This study examines the impact of the monetary policy rate (MPR) on exchange rate fluctuations in both the official and parallel (black) foreign exchange markets in Nigeria using the autoregressive distributed lag (ARDL) and threshold regression techniques from 2001Q1 to 2025Q4. Two long-run models are estimated for the official and parallel foreign exchange markets to assess both the short-run and long-run responses to monetary policy adjustments. Also, the threshold regression technique proposed by Tong H.(1978) is adopted to evaluate policy effectiveness across different macroeconomic regimes and to identify critical interest rate levels at which monetary tightening becomes effective. The ARDL results for both markets show that tight monetary policy adopted by the Central Bank of Nigeria leads to an appreciation of the local currency (Naira). However, the findings indicate that increases in headline inflation and Treasury bill rates do not have a significant impact on exchange rate fluctuations in both markets. The results further show that credit to the private sector has a negative significant effect on the foreign exchange rate. It suggests that an increase in credit to productive sectors can boost local investment and reduce demand for foreign exchange. The threshold regression results indicate that monetary tightening becomes effective in stabilizing the exchange rate in both markets only when the monetary policy rate and the Treasury bill rate exceed threshold levels of 22.75% and 23%, respectively. The results also indicate that maintaining headline inflation at a single-digit level below the threshold of 8.2%, and increasing credit to the private sector up to the threshold level of 5.8% contributes significantly to exchange rate stability in both markets. The study concludes that both the official foreign exchange market and the parallel market exchange rate respond significantly to monetary policy and credit policy measures of the Central Bank of Nigeria.