Real Exchange Rate and Economic Growth: The Interacting Role of Financial Development in Nigeria

Abstract

This article gives empirical evidence that the real exchange rate can significantly affect sustainable productivity growth, which confirms the hypothesis that the effect critically depends on the degree of the economy’s financial development. Following the relatively underdeveloped financial system in Nigeria, its exchange rate reduces the productivity growth of the economy. In this article, we consider the interacting effect of exchange rate fluctuation and the level of financial development instead of analyzing the exchange rate fluctuation in isolation. The empirical estimation is based on the Nigerian data set covering the years 1980-2019; through the application of threshold autoregressive non-linear co-integration and the non-linear ARDL estimation. We further deploy a test of causality using the frequency domain that enables us to differentiate a temporal as well as a permanent causality. The findings appear that financial development amplifies the positive effects of the real exchange rate on Nigeria’s economic growth. It also records that the uncertainty in foreign capital flows adversely affects Nigeria’s output growth. The paper recommends that the Nigerian policymakers should in their attempt to diversify and improve the future growth of the economy, promote adequate financial sector development since financial shocks are amplified with poorly implemented credit markets.