EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

EFFECT OF ADDITIONAL MONETARY TIGHTENING ON EXCHANGE RATE VOLATILITY IN NIGERIA

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Abstract

CBN typically intervenes directly in the foreign exchange market to ensure that the value of the

Naira is stable. However, direct foreign exchange purchases and sales by the monetary

authorities could be very costly and are hardly effective in reducing exchange rate volatility

when the local currency is under pressure to depreciate. Researchers have found that this kind of

interventions have little or no desired effect, and may lead to undesired volatility in the exchange

rate. In an environment of tight monetary policy, additional monetary tightening could have

effect on the exchange rate. If this is so, then reserve loss in period of speculations can be

prevented. This study sets out to examine if Additional Monetary Tightening (AMT) can be used

to achieve exchange rate stability in Nigeria, as a potential substitute or complementary tool to

the direct intervention. The study identified the period of AMT from 2007- 2015, capturing the

periods by the use of dummy variable. The variables of the study includes Monetary Policy Rate

(MPR), Cash Reserve Requirement(CRR), Liquidity Ratio(LR), Upper interest rate Corridor

(UCORR), and Lower interest rate Corridor (LCORR), were estimated using GARCH (2,2) with

lag of one period for all the variables and was found to be appropriate. The result shows that

AMT is negative and statistically significant at 10% in reducing the exchange rate volatility in

the variance equation and also negative and significant at 1% in appreciating the exchange rate in

the mean equation. Although all variables were correctly signed in the variance equation except

CRR, only AMT, and LR, were statistically significant at 10% and 1% respectively in the

variance equation. This suggests that, AMT can be adopted as an alternative/complementary tool

in attaining exchange rate stability in Nigeria. From these findings, the study recommends that

where it is feasible, CBN should consider AMT as a useful tool for exchange rate management

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and prevent reserve loss. This also suggests that CBN must use this tool cautiously since AMT

can hurt the economy via investment and spending.


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