Does the pass‐through of exchange rate and globalization validate the rockets and feathers hypothesis in Nigeria? Evidence from a nonlinear model

• Published date: 01 February 2021
• Author: Ojonugwa Usman
• Date: 01 February 2021
• DOI: http://doi.org/10.1002/pa.2151

ACADEMIC PAPER

Does the pass-through of exchange rate and globalization

validate the rockets and feathers hypothesis in Nigeria?

Evidence from a nonlinear model

Ojonugwa Usman

1,2

1

School of Business Education, Federal College

of Education (Technical) Potiskum, Potiskum,

Nigeria

2

Department of Economics, Faculty of

Business and Economics, Eastern

Mediterranean University, Famagusta, Turkey

Correspondence

Ojonugwa Usman, Department of Economics,

Faculty of Business and Economics, Eastern

Mediterranean University, Famagusta, North

Cyprus, via Mersin 10, Turkey.

Email: usmanojonugwa@gmail.com

The rapid shift in trade policy towards greater openness is theoretically pre-

sumed to leave domestic prices vulnerable to the change in exchange rate. This

study investigates not only the asymmetric pass-through of exchange rate but

also globalization to consumer price inflation (CPI) in Nigeria and determines

whether the pass-through is consistent with the rockets and feathers hypothesis.

Using the Nonlinear Autoregressive Distributed Lag (NARDL) model and the

monthlydatafrom1986 M01–2015M12, the results provide evidence that the

pass-through of exchange rate and globalization is asymmetric with depreciation

and negative shocks to globalization exerting a higher pass-through—aresultthat

validates the rockets and feathers hypothesis. The results further suggest that

the asymmetric pass-through of exchange rate and globalization is elastic in the

long run except for the positive shocks to exchange rate while in the short run,

it is inelastic except for the negative shocks to globalization. Overall, the pass-

through, in the long run, is higher compared to the pass-through in the

short run.

1|INTRODUCTION

Exchange rate pass-through (ERPT) is defined as the extent to

which a change in CPI is attributed to a change in exchangerate.

This issue has remained one of the key interests of the govern-

ments and policymakers especiallyin an open economy where the

bilateral exchange rate variation is high. From both theoretical and

empirical viewpoints, exchange rate variation is connected closely

to prices (see Adolfson, 2001; Balcilar, Roubaud, Usman, &

Wohar, 2019; Campa, Goldberg, & González-Mínguez, 2004; Dev-

ereux & Engel, 2003; Gagnon & Ihrig, 2004; Lariau, El-Said, &

Takebe, 2016; McCarthy, 2000; Taylor, 2000; Xu &

Bernhofen, 1999). In Nigeria, between 1985 and 1993, the currency

depreciated on average of 71%annually based on the official

exchange rate, while in the parallelmarket, the average depreciation

amounted to 114%. Similarly, the nominal effective exchange rate

(NEER) depreciated by approximately 41% on average between 1985

and 1989. These occurred at the time inflation was rising. For

example, the inflation rate rosefrom 7.69% in 1982 to 54.51% in

1988. It reached a peak of 79.9% in 1995 from 7.36% in 1990 (see

Bawa & Abdullahi, 2012; Oyinlola& Babatunde, 2009; Poloamina,

Babatunde, & Oyinlola, 2009).

A large body of the empirical literature on ERPT has flourished in

Nigeria's context, particularly in the new millennium. However, the

findings from most empirical studies sup port the proposition that the

pass-through of exchange rate to domesticprices is incomplete,

especially in the short term (Balcilar, Usman , & Agbede, 2019; Campa

et al., 2004; Gagnon & Ihrig, 2004; Lariau et al., 2016). The macro-

economic explanation to incomplete pass-through is linked to nomi-

nal rigidities, which cause prices notto respond to a change in

exchange rate in the short run (Bailliu & Fujii, 2004; Bhundia, 2002;

Campa & Goldberg, 2002; Choudhri & Hakura, 2003; Junttila &

Korhonen, 2012). More so, another argu ment in the recent literature

is whether there is an asymmetry in the transmission channels of

ERPT. In case there is, the estimation based on t he linear or symmet-

ric model may not be accurate and reliable for policy decisions and

Received: 20 November 2019Revised: 6 January 2020Accepted: 2 April 2020

DOI: 10.1002/pa.2151

J Public Affairs. 2021;21:e2151.wileyonlinelibrary.com/journal/pa© 2020 John Wiley & Sons, Ltd1of11

https://doi.org/10.1002/pa.2151