Exchange Rate Volatility and Inflation Dynamics in Nigeria: A Structural VAR Approach

Abstract

Exchange rate volatility poses significant challenges to macroeconomic stability in emerging economies, particularly those like Nigeria that rely heavily on imports and primary commodity exports. This study investigates the impact of exchange rate fluctuations on inflation in Nigeria using a Structural Vector Autoregression (SVAR) model, which allows for the identification of structural shocks and their dynamic interactions with macroeconomic variables. Utilizing monthly time-series data spanning 2000–2023, the analysis incorporates key indicators such as the nominal exchange rate, consumer price index, money supply, interest rates, and government expenditure. The impulse response analysis reveals that exchange rate shocks exert a strong and immediate inflationary impact, which persists in the medium term, underscoring a significant exchange rate pass-through effect. However, Granger causality tests show no predictive causality from exchange rate volatility to inflation, suggesting the presence of other dominant inflation drivers. Variance decomposition results further affirm that exchange rate volatility accounts for a considerable share of inflation variance, especially over the medium term. The findings highlight the critical role of credible exchange rate management, coherent monetary-fiscal policy coordination, and economic diversification in mitigating inflationary pressures. This study contributes to the literature by offering a more structurally grounded, data-driven analysis of Nigeria’s inflation dynamics and provides actionable insights for inflation-targeting frameworks in similarly volatile economies.