Current Account Behavior, Real Exchange Rate Adjustment and Relative Output in Nigeria

Abstract

This paper examines the relationship between current account dynamics, relative output performance and real exchange rate adjustment in Nigeria. A structural vector autoregression model that imposes the long-run neutrality assumption of Blanchard and Quah was used to analyze data for the period 1981Q1-2017Q4. Findings show that fiscal shocks drive the dynamics of relative output and current account in Nigeria but do not explain real exchange rate adjustment. However, exchange rate shocks influence the path of relative output while a deterioration of the current account balance in response to a monetary contraction is observed, suggesting the existence of the expenditure-switching effect. The worsening of the current account in response to a fiscal expansion validates the twin-deficit hypothesis in Nigeria. The impact of shocks was found to be more pronounced under the fixed relative to a flexible exchange rate regime. The results make a case for policies that could improve the trade balance and boost productivity complemented by exchange rate flexibility to promote more efficient allocation of resources.