THE IMPACT OF EXCHANGE RATE VARIATIONS ON AGGREGATE DEMAND IN NIGERA

CHAPTER ONE

INTROUDCTION

1.1.BACKGROUND OF THE STUDY

All over the world, policy makers have always been on the move to ensure that there is sustainable growth rate in the economies of the world.  As a result, a lot of economic factors have been brought to the fore to examine and investigate how they could be relevant in the achievement of their economic objectives.

In Nigeria, several government regimes have experimented on many economic factors (macroeconomic aggregates) to determine how economic growth could both be attained and sustained. Prior to the introduction of the structural adjustment programme (SAP) of 1986, that had exchange rate devaluation as  one of its policy measures, the economy of Nigeria ‘headed for the rocks’ and was highly distressed. This led to a decline in the country’s external reserves at a disturbing rate. The country’s debt stool was accumulated to an unfavorable level among others. In spite of this the naira exchange rate was overvalued leading to dexterous effect on the economy. It was opinioned  that exchange rate policy embarked upon by the Nigeria government, in August 1986,was to eliminate the observed distortions in the economy and bring about a sustainable growth in the economy.

 Since exchange influences the interaction of household, business firms, private financial institutions and the central bank, it implies that it could also affect aggregate demand in Nigeria. Knowing fully well that exchange rate is a real phenomenon; variations in relative prices affect both economic performance and aggregate demand. Hence, exchange rate is a relative price between domestic currency. For instance, if the exchange rate between British Pounds sterling and Nigeria Naira is N250 per Pound, it follows that one pound exchange for N250 in the world foreign (currency) exchange market.

Exchange rates are of two broad categories. They include:

1.       The fixed exchange rate and

2.       The flexible exchange rate

          The fixed exchange rates are pegged rates within narrow range of values by the central bank on trade of currencies while the flexible exchange also called FLOATING exchange rate is the rate that is determined by the forces of demand and supply.  Government has little direct control on the foreign exchange market that is flexible in nature.

          Variation of exchange rates over the years are known to have ripple effects on some other macroeconomic variables like aggregate demand.  This fact underscores the pertinence of exchange rate to the economic well being of countries that open their doors to international trade (Kombe, 2004). Due to the impact exchange rate regimes have on economies of the world, economists consider it vital to verify how their countries exchange rate are determined since different regimes of exchange rate show different economic effects (Kujis, 1998).

          Exchange rate determination varies from country to country. Part exchange rate regimes in Nigeria have been directed to control the use of foreign exchange at official determined rates. However, current policy options have shown an interest in market- determined exchange rate most current records show that the CBN has adapted an exchange rate regime that is neither pegged nor floating but a combination of both regimes called the MANAGED FLOAT exchange rate. This research work intends to look into the determinants of exchange rate in Nigeria and the impact exchange rate variations exert on aggregate demand in Nigeria.

1.2. STATEMENT OF PROBLEM

Economic and political analysts have reached a consensus on what a good exchange rate is as well as how it could both be operated and sustained. In most economic papers and literature, the major issues have been the need for competitive exchange rate stability and structural adjustments in the promotion of this competitiveness. However, since exchange rate reveals competitiveness of exports from domestic economies to the outside world, the economic implication of its variations need to be ascertained so that good exchange rate policies that will be realistic in consonance with aggregate demand could be formulated, adopted and operated.

Therefore, this study aims at providing answers to the questions stated below in order to ensure that viability reigns in the market.

1) Are exchange rate and aggregate demand variable stationary?

2) Does exchange rate variations have affect any impact on aggregate demand?

3) To what extent does exchange rate affect aggregate demand in Nigeria?

1.3. OBJECTIVES OF THE STUDY

The specific objective of this economic study are:

1. To ascertain the impact of exchange rate variations on aggregate demand.
2. To estimate if there exists any casual relationship between exchange rate and aggregate demand.

1.4. STATEMENT OF HYPOTHESIS

The following null hypothesis are to be stated for the statistical significance and non – significance of data.

Hi:    Exchange rate instability has no impact on aggregate demand in Nigeria.

H2:    There is no casual relationship between exchange rate and aggregate demand in Nigeria.

1.5    SCOPE AND LIMITATIONS OF THE STUDY

          The length of period within which this study covered is thirty years.  This falls between the periods of 1976 and 2006.  This essence of this is to enable the observation for the research work compensate for degree of freedom that could be cost.

1.6     SIGNIFICANCE OF THE STUDY

          Research work of this kind is usually treated directly with the variables lifted from their sources.  However, in this study, the directives of Philips (1986), which states that they are statutory, will be adopted to be assured that the result from this work is reliable for other policy works.

          Thus, the findings of this study will be of great importance to a lot of people.  Firstly, researchers carrying out research work on the influence of exchange rate in Nigeria would find this research work helpful. Secondly, policy makers who wish to formulate policies on the effects of exchange rate instability would find this research work handy. Thirdly, business firms and investors as well as exporters who need to know when it is convenient to operate in business and when it is not, would find this research work a present- help in their periods of economic decision- making. Again, the central bank of Nigeria, the monetary authorities (financial ministries and policy formulators would find this research work vital in regulating exchange rate regimes appropriately in terms of intervention of the government into the economic system through the central bank.  Finally, due to revolutionary steps taken in this research work, the end product of this study would add to knowledge, no matter how infinitesimal, as a contribution for a sustainable economic growth in Nigeria.