Exchange Rate Dynamics and Monetary Fundamentals: A Cointegrated SVAR Approach for Nigeria

Are monetary fundamentals important determinants of the exchange rate behaviour in Nigeria? This article examines the validity of both short- and long-run versions of the monetary exchange rate model for the Nigerian naira–US dollar exchange rate from 1987:1 to 2011:4 within a cointegrated SVAR framework. Apart from the long-run relationship, the short-run contemporaneous interactions are examined for the monetary exchange rate model. The results show the existence of a unique long-run relationship between the exchange rate and monetary fundamental, which is theoretically consistent with the monetary model. The short-run evidence is not entirely consistent with the monetary exchange rate model, although the impulse response of the exchange rate to shocks in the monetary fundamentals mirrors the predictions of the monetary model. However, only the interest rate differential is significant and explains most of the variations in the nominal exchange rate in the short run.