Persistence of Terms of Trade Shocks and Real Exchange Rate Volatility in Nigeria

Abstract

This study is undertaken to determine the duration of terms of trade shocks, estimate its impact on real exchange rate volatility and proffer policies that may help dampen its volatility. The study adopted the median unbiased estimation procedure to calculate the duration of terms of trade shocks in Nigeria. This procedure follows a first order autoregressive AR (1)/unit root model. Thereafter, the impact of terms of trade shocks on real exchange rate volatility was estimated using the distributed lag model based on an Error Correction Model (ECM). This study reveals that terms of trade shocks is not a very serious case in Nigeria due to its temporal effect, notwithstanding its positive impact on real exchange rate volatility. The study discovers that terms of trade shocks have an immediate high magnitude of impact in the current period than after one year in Nigeria. The study recommends that the non-oil exports be diversified to include a huge percentage of manufacturing products so as to add value to raw materials which hitherto constituted the major component of non-oil exports. Also, depreciating the real exchange rate a little will create a more conducive atmosphere for investors in the economy.

Keywords: Terms of Trade Shocks, Persistence, Real Exchange Rate Volatility, Median-Unbiased Estimation, Distributed Lag Model and Error Correction Model (ECM).