Exchange Rate Dynamics and Inflation Targeting Monetary Policy in Nigeria: Evidence from Normalized Co-Integration Analysis

Abstract

In Nigeria, monetary targeting has been a major strategy of the Central Bank of Nigeria (CBN) to control inflation. This strategy involved adjusting the various monetary tools to reign in the growth of the money supply and subdue inflationary pressure. This paper examined exchange rate dynamics and inflation targeting monetary policy in Nigeria from 1986 to 2023 under the Mundel-Fleming and inflation targeting frameworks. The variables used in this paper are inflation rate, exchange rate premium, nominal interest rate, oil price, government debt and broad money supply, food price. From the results, exchange rate premium had a positive but insignificant relationship with inflation targeting policy, nominal interest rate is negatively related to inflation rate. Oil price and inflation targeting are negatively related, while, the relationship between food prices and inflation targeting was negative and insignificant and the relationship between food prices and inflation targeting was negative and insignificant. It can be concluded that inflation targeting of the Central Bank of Nigeria has not contributed to exchange rate stability in Nigeria in the contemporaneous period, as a result, the volatility of the exchange soars with much depreciation of the domestic currency. Hence, the implication is that exchange rate stability and inflation targeting are both monetary policy strategies that can be used to manage an economy's price stability. Therefore, the combination of inflation targeting and exchange rate targeting, with a priority on the exchange rate, can be an optimal monetary strategy for the Nigerian economy.