Nonlinear and Asymmetric Exchange Rate Pass-Through to Consumer Prices In Nigeria: Evidence from a Smooth Transition Autoregressive Model

This paper examines the nonlinearities and asymmetries in the exchange rate pass-through (ERPT) to consumer prices in Nigeria using quarterly time series data from 1986 to 2013 and the nonlinear smooth transition autoregressive (STAR) method. The standard literature assumes linearity and symmetry in the ERPT to consumer prices in a developing country, despite the importance and presence of potential asymmetries and nonlinearities which are generated by the presence of various factors such as menu costs, capacity constraints, market share objectives and production switching. This study develops a partial equilibrium microeconomic mark-up model to investigate asymmetric and nonlinear behaviour in the ERPT. The study confirms the presence of nonlinear ERPTs due to different inflation levels. The results also show asymmetric ERPTs in the appreciation and depreciation of exchange rates. The magnitude of the ERPT also depends on the size of the exchange rate change. The ERPT is higher during depreciation than during the appreciation episodes of the Naira; nonlinearity is more prevalent during the high inflationary period of the 1990s than in other periods. The policy implication of the results is that the government, despite temptations to do so, should avoid the devaluation of the Naira during high inflation periods in order to reduce the impact on consumer prices and the associated costs.