**2.3 Theoretical review**

The exchange rate channel is certainly effective in a given economy with a shallow money market, as well as a deep market for foreign. Overall, random changes in the rate of exchange were observed for Nigeria, specifically in all the years for the period 1980–1990 [2].

#### *2.3.1 Purchasing power parity (PPP)*

Mordi [18] opined that the purchasing power parity (PPP) presupposes "those exchange rates between two currencies at a given period are equal if the ratio of the level of price in a certain amount of products produced" and flowing in two countries and the rate of exchange among those two countries are equal. Adeoye and Saibu [2] observed that purchasing power parity hypothesis is the most useful reason proffered as regards the stability in the long term as well as persistence of the rate of exchange in bilateral relations and that testing for PPP in the long term; this is useful for a lot of purposes: following many monetary models [19], that this rests on the reliability of the PP theory in the long run, in addition to a lot of models that describe the macroeconomy by adopting the PPP to express the nexus to foreign and local development; mostly when examining market economy such as Nigeria. Adenekan et al. [20] did observe that the "PPP theory was criticized for not considering the impact of international capital movements, and suffers from the choice of an appropriate price index used in price calculations." There is thus the need for theoretical postulations that can be all encompassing in application.

#### *2.3.2 Mundell-Fleming theory*

The Mundell–Fleming model is also called the IS-LM-BOP model (or IS-LM-BP) model based on the independent research of Mundell [21] and Fleming [22]. Though the Mundell-Fleming model is an offshoot of the IS-LM model, the original IS-LM model expresses the situation in a closed economy (autarky), this model expresses the situation that exists in an economy that is not closed, but small and open. The impossible trilemma of this theoretical model is the premise for the position that in an economy that is open, a country cannot follow the path of: a fixed rate of exchange, free mobility of capital, and the application of monetary policy that is independent

simultaneously. The operation of a managed float was not specifically captured at the beginning of this model, yet managed float is an imperfect free float or fixed exchange rate regime. The model states that two and not three of the trilemma can be operated simultaneously at any point in time.

Aizenman [23] observed that the financial crises of 1990 have "induced emerging markets to converge to the trilemma's middle ground—managed exchange-rate flexibility, restricted financial integration, and an effective but less prominent monetary independence" and that the crisis of flight of capital has led to financial stability becoming an additional goal in the operation of the trilemma's targeted goals. Hence, the present scenario goes beyond the textbook description unveiled by the trilemma. This encapsulates the theoretical foundations of our present study.

## **2.4 Empirical review**

Ndung'u [24] assessed if the rate of exchange of Kenyan currency is influenced by the monetary authority's policy moves and whether the observed impact transient or consistent. The findings of this research reveal that the rate of exchange in nominal terms for the period 1970–1994 was impacted upon by income increase in real terms, the inflation rate, expansion in the supply of money, the circular movements in the volatility in the real rate of exchange, the cointegrating vectors, and the shocks. A similar research by Ubok-Udom [25] did study the nexus linking the total GDP growth rate in annual terms, GDP attributable to the non-oil sector, and the variations in the rate of exchange spanning 1991–1995. The results of this study further indicate that the rates of growth for total GDP and GDP from non-oil sources seem to reduce or rise with drops or spikes in the rate of exchange in nominal terms. Pattnaik et al. disclosed that the study shows that monetary policy has been useful achieving sustained factors in the exchange rate market revealing the pass-through via the exchange rate to the local inflation rate.

Similar studies such as Adebiyi [26] investigated the influence of the monetary authority's involvement in Nigeria's currency exchange market. The research did not focus on the link that connects shocks from monetary authority's policy moves and changes in the rate of exchange but looked at whether these involvements of the local monetary authority in the foreign exchange market are sterilized or not. The research by An and Sun [27] investigated the linkage between monetary policy, the monetary authority's intrusion into the foreign exchange market, and the rate of exchange for Japan in the form of a unifying model. The results from the study firstly lend support to the hypothesis referred to as "leaning-against-the –wind" as well as the hypothesis referred to as "signaling," though the presence of the "signaling" postulation happens to be rather minimal. Another finding is that the impact of intervention is not effective, possibly even a negative effect. Lastly, normal monetary policy seems to exert a major impact on both the rate of exchange and interventions in foreign exchange.

Cagliarini and Mckibbin [28] used the G-Cubed model for analyzing several sectors in an economy for a cross-country data; examining the possible impact of three shocks on US monetary policy, risk premia, and productivity to determine major relative price movement for the period 2002–2008. A very important summary of the study experimental exercise was done by this study, and it shows that monetary authority's policy moves seem to impact prices in relative terms for as much four years due to the fact that a non-permanent in real interest rates varies across sectors. Asad et al. [29] studied the influence of rate of exchange(in real and effective terms) on inflation on the economy of Pakistan by utilizing secondary data on GDP (in real and nominal terms), effective real rate of exchange, prices, and the supply of money that covered 1973–2007. The results from their study show that the exchange rate (in real terms) has a significant influence on the rate of inflation as

regards the economy of Pakistan; the nexus between the effective real rate of exchange and inflation was found to be positive and strong.

But Dickson [30] did study to examine the influence of volatility in the real rate of exchange on Nigeria's growth in output by adopting annual data from 1970 to 2009. The results of the study did reveal that the nexus between economic growth and rate of exchange volatility was positive in the short run; but in the long run, the relationship for both variables is negative. Adeoye and Saibu [2] analyzed that monetary policy shocks influence via movements in the policy instruments on volatility in the rate of exchange in Nigeria. Specifically the study focused on the relationship between volatility in the rate of exchange and shocks due to monetary policy in Nigeria. The short-run dynamics reveals that changes in monetary policy instruments correlate to the variations in the rate of exchange via process that is selfcorrecting without the involvement of the CBN. Furthermore, the findings from the test for causality that link the volatility in the rate of exchange and the monetary authority's policy tools indicate significant nexus between as regards historical values of the rate of exchange and monetary policy variables. It was observed that shifts in past values of policy tools result in changes in exchange rate volatility.

Nwachukwu et al. [31] modeled the long-run nexus that linked "the Bureau De Change rate of exchange and Nigeria's external reserves in a threshold vector error correction model (TVECM)" econometric methodology by utilizing daily data that spanned from 2014 to 2015. The study concluded that "the adjustment mechanism between the two variables flow from external reserves to BDC exchange rate." Ayomitunde et al. [32] examined the nexus that exists linking monetary authority's policy instruments and the rate of exchange rate Nigeria. The study adopted the Autoregressive Distributed Lag (ARDL) model to achieve the focused goal of the study. The results show that there was a negative nexus linking the Treasury bill rate, cash reserve requirement to the rate of exchange. On the other hand, the policy rate and money supply (broad) have a nexus with the exchange rate that is positive for Nigeria.

Miyajima [33] did carry out a study that was premised on an answer to the question "does the South African rand's relatively large volatility affect inflation?" The derived results indicate that when the volatility in the rate of exchange spikes, it leads to an increase in core inflation, though that impact is limited for the economy of the country under study.

The Nigeria experience shows that some research studies have been carried out on the nexus linking volatility in the rate of exchange and the actions of the Central Bank's stabilizing actions. The study is an attempt to determine the interventions in the markets for the buying and selling of foreign currency by the monetary authority; whether such intervention is sterilized or not sterilized has had the moderating impact on exchange rate volatility. The Nigerian experience from a few studies in the area of the interrelationship between exchange rate volatility and macroeconomic policies of the CBN have been carried out; yet the use of monthly data was not common in all these studies. This study did apply monthly data to reveal that nexus in a more timely manner.

## **3. Methodology**

#### **3.1 Study design**

The study utilizes an ex-post facto research design, the events have already taken place before the analysis, and hence there is no way the data can be manipulated. The "ex post facto design in its application is causal comparative and used when the

researcher aims to establish relationship between the independent and dependent variables with a view to establishing the causal link between them" [34, 35].
