The Interaction of Oil Price Shocks, Exchange Rate Volatility and Inflation in Nigeria

This paper utilized monthly data to explore how oil price could affect exchange rate and inflation in Nigeria for the period of January 2010 to December 2023. The Granger causality test, Vector Autoregression (VAR), impulse response function, and variance decomposition were employed in analysing the data. The Granger causality test results are that oil price Granger causes exchange rate and inflation, and that exchange rate also Granger causes inflation in Nigeria. The VAR estimates indicated that the lags of oil price significantly affect the exchange rate of Nigeria, and that lags of exchange rate significantly influenced the rate of inflation in Nigeria. Thus, it is established that oil price shocks affect exchange rate which in turn affects the rate of inflation in the Nigerian economy. The impulse response function indicated that exchange rate responds positively to innovations in global oil price. The variance decomposition indicates that exchange rate accounts for up to 24.24% of the total forecasted error variance in the rate of inflation. The study resolved that oil price volatility affects the exchange rate of naira which therefore drives inflationary pressures in the domestic economy. Consequently, policies to strengthen the exchange rate should be intensified. This can involve boosting the non-oil export so as to augment export earnings from the oil sector.