An Empirical Assessment of the Real Exchange Rate and Poverty in Nigeria: Econometric ProcedureKempa identified two distinct sources driving exchange rates: one arising in financial markets and the other in the real economy. Nominal shocks were measured as changes in money supply and money demand and aggregate supply shocks were measured by a series on industrial production, while the rate of domestic absorption and elasticity of the current account were used as proxies for aggregate demand shocks. The decomposition suggested that nominal shocks accounted for less than 33 per cent of overall RER variability, aggregate supply shocks explained less than 10 per cent of overall variability and the remaining variability were accounted for by aggregate demand shocks, particularly at longer forecast horizons. Thus, the evidence in this study suggested that exchange rate fluctuations appeared to be predominantly equilibrium responses to real shocks, rather than volatility in financial markets. Oumar, assessed the relationship between the RER and poverty in a group of countries using panel data and the System General Method of Moments. He found that the RER depreciation favoured the poor, provided that income is fairly distributed and institutions are sound.
Akpan and Udoma investigated exchange rate policies and economic growth in Nigeria using annual time series data covering 1970 to 2006. They found no strong evidence of a significant relationship between exchange rate and gross domestic product (GDP). Rather, Nigerian economic growth has been influenced more by fiscal and monetary policies and other economic variables like export.
From the short review of literature undertaken here, we found that most of the studies focused on Latin America and other developed countries. Only few studies had been conducted on the issue in Sub-Sahara Africa, particularly Nigeria. The idea of reverting to intermediate policy indicators in this paper rather than final policy outcomes has two advantages. First it makes the model specification less cumbersome as the analysis relies on fewer factors. Second, the method helps to effectively address model uncertainty concerns and the parsimonious choice of explanatory variables because the approach is based on a theoretical model (Oumar, 2007). The relationship between the intermediate policy variables and poverty come to play through direct and indirect channels. Thus, in line with vast empirical literature on poverty reduction, economic growth is considered as the major indirect channel through which economic policies, RER and absorption in this paper influence poverty. Direct channels were also highlighted.
The Vector Error Correction Model (VECM) was used for the analysis because it restricts the long run behaviour of the endogeneous variables to converge to their cointegrating relationships while allowing for a short run adjustment (Gujaratti, 2003). The VECM is of the form: Where yt is a vector of endogenous variables which include exchange rate, domestic price, interest rate and money supply. The a parameters measures the speed of adjustment through which the variables adjust to their long run values and the P’ vectors are estimates of the long run cointegrating relationships among variables in the model. n is the drift parameter and is the matrix of the parameters associated with the exogenous variables. The stochastic error term is also included in the specification. read only