This study revisited the issue of real exchange rate determination in Nigeria over the period 2000–2011 by extending the Behavioural Equilibrium Exchange Rate (BEER) approach by incorporating structural breaks in the specified naira real exchange rate model. Based on the results presented in section 5, the following conclusions are drawn. Firstly, the Bai and Perron
(1998) and Gregory-Hansen (1996) procedures identified three distinct endogenously determined structural break points located at 2002Q3, 2003Q2 and 2009Q2. These break points coincide with the periods of exchange rate policy changes and global financial crisis. Accounting for the identified structural breaks, an error correction model was set up to capture both the short and long run relationships between naira real exchange rate and its determinants. Secondly, model results showed that capital inflows (LFDI2), interest rate differential (LIRD), nominal exchange rate (LNER), productivity (LPRO), government size (LTGEGDP) and degree of openness (LDOO) were the major determinants of real exchange rate during the estimation period.
Overall, the estimated error correction model explained 86.7 per cent of variations in the naira real exchange rate.
Thirdly, on the average, the parsimonious model (with structural break) indicated that the naira real exchange rate was broadly in line with relevant economic fundamentals as the level of misalignment stood at 0.22 per cent. However, the model without structural breaks showed that the naira was misaligned by 0.29 per cent during the comparable period. This study therefore concludes that failure to account for structural breaks while modeling naira equilibrium real exchange rate leads to an overestimation of the misalignment level. This is consistent with the views of Aggarwal (1999), Andreou (2002) and Zainudin and Shaharudin (2011) who argued that ignoring structural breaks when they do exist leads to model misspecification. The parameter estimates are biased, thus leading to error in estimation and forecasts.
Fourthly, the sensitivity of the naira real exchange rate model to changes in exchange rate policy (as represented by movements in the nominal exchange rate) was tested by excluding the nominal exchange rate variable from the parsimonious error correction model. The results showed that exchange rate policies play a vital role in restoring the real exchange rate to its long run equilibrium following any shock. This was indicated by the deterioration in the explanatory power and speed of adjustment of the error correction model as a result of the exclusion of the nominal exchange rate variable.
Fifthly, even though the primary objective of this study was not to appraise the country’s various exchange rate policies over time, it provided some insights as to how realistic the naira real exchange rate values were during the estimation period. Results based on the model with structural breaks revealed that the average misalignment levels during the periods of IFEM, RDAS and WDAS stood at -1.3, -0.1 and 0.1 per cent, respectively. Thus, the naira was undervalued during the IFEM and RDAS and overvalued during the WDAS regime. For instance, the actual real exchange rate averaged N146. 50/US$ during the WDAS period. This underscores the role of nominal exchange rate (managed largely by the monetary authority), and by implication, the role of exchange rate policy in ensuring that the real exchange rate is in equilibrium.
In view of the consequences of persistent real exchange rate misalignments on the economy and the role of exchange rate policy in restoring equilibrium following a shock, this study
recommends that the current exchange rate determination arrangement (WDAS) should be retained. Also, in order to obtain realistic estimates of Naira equilibrium RER, the study strongly suggest that authors, researchers and policy economists should always endeavor to test for and accommodate possible structural breaks in their empirical models of real exchange rate determination.
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