Determinants of Real Exchange rate in Nigeria (1970-2011): A Behavioral Equilibrium Exchange Rate Approach

Abstract

Real exchange rate (RER) is an important index that measures the competitiveness of an economy and provides a useful guide on the conduct of monetary and exchange rate policy of a nation. Persistent misalignment of RER could generate various undesirable effects on the economy. This paper investigated the drivers of RER in Nigeria under the Behavioral Equilibrium Exchange Rate (BEER) framework using annual data from 1970 to 2011. Deploying the Hodrick-Prescott (HP) Filter, the long-run values of the fundamentals of the RER were decomposed to obtain and estimate the misalignment in the RER. Our results showed that increase in trade openness, technological progress and government expenditure depreciate Nigeria’s RER in the long –run. Increase in oil prices and net foreign asset were found to boast the RER. Index of RER misalignment in Nigeria reveals that it was overvalued between the periods: 1980-86 and 1994-98. Undervaluation was noticed between the period: 1975-78 and 1986-94, while relative stability was found in the later period: 1999-2011. Some policy lessons have been drawn, including the need to diversify the
economy from crude oil as a major export commodity to the non-oil sector, adoption of an inter-temporal fiscal plan for the management of oil wealth, cautious trade liberalization and improving the productivity of government expenditure, especially in the tradable sector.