Dynamic Interaction between Capital Flows, Exchange Rates and Growth: Evidence From Nigeria

Abstract

This paper examines the relationship between capital flows, exchange rate, and growth for the Nigerian economy for the periods 1986-2014. Employing the vector autoregressive (VAR) approach, empirical findings from the impulse response reveals that capital inflows respond negatively to changes in exchange rate. Also, the results show that capital inflows react positively to growth suggesting that the higher the economic growth the more the capital inflows. The study also shows that exchange rate response positively to shock in capital inflows suggesting that the more the capital inflows the more the Nigeria currency appreciates. Furthermore, it was found that growth responds positively to shock in capital inflows indicating that the higher the capital inflows the higher the rate of economic growth. The variance decomposition of capital inflows shows that variation in capital inflows is greatly influenced by growth. Also, the variance decomposition of exchange rate suggests that capital inflow plays a significant role in the variation of the exchange rate. Furthermore, the outcome of the study also shows that both the capital inflows and exchange rate produce almost the same influence on economic growth. Finally, employing the Granger causality in determining the causal relationship between the variables, it was found that there is a unidirectional causal relationship between growth and capital inflows in Nigeria. The implication of this study is that government should design and implement policies towards enhancing economic growth to stimulate capital inflow.