AN ANALYSIS OF THE RELATIONSHIP BETWEEN REAL EXCHANGE RATE AND DOMESTIC CONSUMPTION IN NIGERIA (1981-2016)

ABSTRACT

This dissertation analyses the real exchange rate-domestic consumption relationship in Nigeria using the Smooth Transition Autoregressive (STAR) model from 1981 to 2016. Findings shows that domestic consumption determines the regime shift in real exchange rate suggesting a nonlinear linkage of real exchange rate and domestic consumption with clearly distinct regimes. Exchange rate is shown to have significant linear effect from previous exchange rate. On the other hand, current foreign consumption is positive but has no significant impact on the exchange rate in the linear part of the model. In the nonlinear part of the model, we found evidence of a significant negative relationship between real exchange rate and domestic consumption, thus supporting the proposition by standard International Real Business Cycle (IRBC) Model. In the face of the wide disparity in literature trying to establish the prediction of IRBC model, we found evidence of bi-directional nonlinear granger causality between real exchange rate and domestic consumption. The study concludes that the relationship between real exchange rate and domestic consumption is indeed nonlinear and that fiscal and monetary authorities should develop policies that will help strengthen domestic production to further reduce import component in domestic consumption.