Impact of Exchange Rate Volatility Regime Switching on Inflation in Nigeria

Abstract

This study utilises a markov switching model, and quarterly data spanning from 1980 to 2023 to analyse the regime-switching responses of inflation in relation to exchange rate volatility. Findings show a greater possibility of transitioning from less volatile to high volatile system, the model stays in the low volatility system for an average of 4 quarters and the high volatility for 7 quarters. In addition, volatility
in the exchange rate indicates unfavourable influence on output, as evidenced by the statistically significant negative influence observed in each regime. Additionally, interest rates are negatively impacted by exchange rate fluctuations in the two regimes; this relationship is glaring when volatility is low but not when it is high. Moreover, there is a favourable correlation—albeit not a statistically significant one—between inflation and exchange rate volatility in the low and high volatility systems, respectively. Finally, the Toda-Yamamoto  demonstrate a unidirectional influence running from exchange rate volatility to economic growth and inflation but no causal relation with the interest rate in either direction. The study highlights the importance of exchange rate stabilisation, curbing inflationary trends, and the promotion of sustainable growth.