Mathematical Modeling of Inflation and Exchange Rate Dynamics in Nigeria

ABSTRACTThis research investigate the intricate relationship between inflation and exchange rates in Nigeria using advanced mathematical modeling techniques. The primary purpose is to determine the effects of exchange rate changes on the inflation rate over the short and long terms in order to provide empirical insights for appropriate macroeconomic policy. The period between 2015 and 2024 is the basis for the research which forms the annual time series data. The research uses the VECM model to relate inflation to the exchange rate in the short-run and long-run dynamics. The unit root tests show that the series on inflation as well as the exchange rates for Nigeria is integrated of order one. This justifies the application of cointegration techniques. The Johansen cointegration test indicates that there is a significant long-run equilibrium relationship between the variables and the depreciation of the exchange rate accounted for about 35% of the changes in long-run inflation. It was observed from the short-run dynamics that, inflation is 42% responsive to equilibrium deviations which is why persistence in both variables is evident. The results affirmed an expectation that exchange rate depreciation has a positive and, in relative terms, significant impact an inflation in Nigeria, and that the impact is pass-through in nature. However, the short-term pass-through effects are rather constrained, probably due to the structural rigidities, the economy-wide heavy-handedness, and the belt-tightening policies from government. This study highlights the need to reduce volatility in the exchange rate as an inflation control policy which, on its own, is insufficient. It also points to the need for additional supply-side structural adjustments and discipline on government spending to achieve enduring stability in the level of prices. The tightening of fiscal monetary policy warrants the proposals set out in this work. The monetary and exchange rate policies should, as a foremost primary objective, be framed to control the inflationary targets which are relevant for the economy’s diversification