Systemic Estimation of Monetary Variables, Oil Price and Naira Real Exchange Rate Dynamics

Abstract

This paper estimates Naira real exchange rate equilibrium viz-a-viz the US Dollar and its determinants by examining the existence of a significant long –run relationship between exchange rate, money (M2) supply, interest rate differentials and external reserves on high frequency data series over a 4-year period from 2008-2011. Vector Error Correction model was used to generate threshold for misalignment of exchange rate in this study. Empirical findings reveal that a rise in oil price leads to a real appreciation of the Naira, while M2 growth and rise in real interest rate differentials undermine real Naira/Dollar rate.

Keywords: Real exchange rate, exchange rate misalignment, currency overvaluation, co-integration, unit roots test, vector error correction, the Balassa-Samuelson effect and causation tree.