The Determinants of Real Exchange Rate Volatility in Nigeria

Abstract

The purpose of this paper is to describe and investigate the factors which determine the equilibrium real exchange rate (ERER) and affect its volatility in the Syrian economy over the period 1980-2008, using two estimation techniques, the Vector Error Correction Mode (VECM) and ARCH Model. According to the theoretical literature, there are many elements causing the (RER) volatility (relative productivity, government expenditure, terms of trade, trade openness and net foreign assets). The estimation excluded the last three non-significant variables and included gross capital formation and oil prices which are considered to be important factors in capturing the effect of these non-significant variables. The empirical results confirm the theoretical links between (RER) volatility and its determinants in the Syrian economy. Three main results are derived from the analysis: first, the actual Syrian (RER) has been volatile around its equilibrium level; in contrast, the speed of adjustment is relatively slow. Results from ARCH model estimation shows that the real shocks volatility will persist, so that shocks will die out rather slowly, and lasting misalignment seems to have occurred; second, the expected decline in Syrian oil production would require a significant depreciation of (RER), since its impact is relatively important; third, to address the challenges of the Syrian economy and to allow (RER) to converge easily to its equilibrium level, a more flexible exchange rate system will be needed. Therefore, the Central Bank of Syria (CBS) should move regularly towards greater flexibility in the exchange rate regime, which would also facilitate a gradual increase in central bank independence and promote indirect monetary policy instruments.