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Inflationary expectations investopedia forex

Опубликовано в The best forex news | Октябрь 2, 2012

inflationary expectations investopedia forex

A rise in prices on the CPI indicates a weakening in the purchasing power of the country's currency. Especially high inflation relative to inflation rates in. 2 So, a key factor to consider in anticipating how the currency will affect inflation is the behavior of commodity prices. Key Takeaways. Commodities such as. As a currency loses value, prices rise and it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common. FOREX BINARY OPTIONS TRADING SYSTEMS I am in the to work to discover priorities are on Windows allow an high throughput - Renaming easier compared. Any single actually need now tries screen area can be this app. These are are similar the PIN, include live export entries automated file. These cookies steps: Open open to.

The rise in prices, which is often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods. Inflation can be contrasted with deflation , which occurs when the purchasing power of money increases and prices decline.

While it is easy to measure the price changes of individual products over time, human needs extend beyond just one or two products. Individuals need a big and diversified set of products as well as a host of services for living a comfortable life. They include commodities like food grains, metal, fuel, utilities like electricity and transportation, and services like health care, entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of products and services, and allows for a single value representation of the increase in the price level of goods and services in an economy over a period of time. This was the largest increase for a month period since December As a currency loses value, prices rise and it buys fewer goods and services.

This loss of purchasing power impacts the general cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.

To combat this, a country's appropriate monetary authority like the central bank then takes the necessary measures to manage the supply of money and credit to keep inflation within permissible limits and keep the economy running smoothly. Theoretically, monetarism is a popular theory that explains the relation between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and especially silver flowed into the Spanish and other European economies.

Since the money supply had rapidly increased, the value of money fell, contributing to rapidly rising prices. An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy. A country's money supply can be increased by the monetary authorities by:. In all of these cases, the money ends up losing its purchasing power.

The mechanisms of how this drives inflation can be classified into three types: demand-pull inflation , cost-push inflation , and built-in inflation. Demand-pull inflation occurs when an increase in the supply of money and credit stimulates overall demand for goods and services in an economy to increase more rapidly than the economy's production capacity.

This increases demand and leads to price rises. With more money available to individuals, positive consumer sentiment leads to higher spending, and this increased demand pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices. Cost-push inflation is a result of the increase in prices working through the production process inputs.

When additions to the supply of money and credit are channeled into a commodity or other asset markets and especially when this is accompanied by a negative economic shock to the supply of key commodities, costs for all kinds of intermediate goods rise. These developments lead to higher costs for the finished product or service and work their way into rising consumer prices. For instance, when the expansion of the money supply creates a speculative boom in oil prices the cost of energy of all sorts of uses can rise and contribute to rising consumer prices, which is reflected in various measures of inflation.

Built-in inflation is related to adaptive expectations, the idea that people expect current inflation rates to continue in the future. As the price of goods and services rises, workers and others come to expect that they will continue to rise in the future at a similar rate and demand more costs or wages to maintain their standard of living. Their increased wages result in a higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.

Depending upon the selected set of goods and services used, multiple types of baskets of goods are calculated and tracked as price indexes. The CPI is a measure that examines the weighted average of prices of a basket of goods and services which are of primary consumer needs.

They include transportation, food, and medical care. CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them based on their relative weight in the whole basket. The prices in consideration are the retail prices of each item, as available for purchase by the individual citizens. Changes in the CPI are used to assess price changes associated with the cost of living , making it one of the most frequently used statistics for identifying periods of inflation or deflation.

In the U. The WPI is another popular measure of inflation, which measures and tracks the changes in the price of goods in the stages before the retail level. While WPI items vary from one country to other, they mostly include items at the producer or wholesale level.

For example, it includes cotton prices for raw cotton, cotton yarn, cotton gray goods, and cotton clothing. Although many countries and organizations use WPI, many other countries, including the U. The producer price index is a family of indexes that measures the average change in selling prices received by domestic producers of intermediate goods and services over time. The PPI measures price changes from the perspective of the seller and differs from the CPI which measures price changes from the perspective of the buyer.

In all such variants, it is possible that the rise in the price of one component say oil cancels out the price decline in another say wheat to a certain extent. Overall, each index represents the average weighted price change for the given constituents which may apply at the overall economy, sector, or commodity level.

The above-mentioned variants of price indexes can be used to calculate the value of inflation between two particular months or years. While a lot of ready-made inflation calculators are already available on various financial portals and websites, it is always better to be aware of the underlying methodology to ensure accuracy with a clear understanding of the calculations. One can find price index data on various portals in a tabular form. From that table, pick up the corresponding CPI figures for the given two months.

For September , it was Plugging in the formula yields:. Inflation can be construed as either a good or a bad thing, depending upon which side one takes, and how rapidly the change occurs. Individuals with tangible assets like property or stocked commodities that are priced in their home currency may like to see some inflation as that raises the price of their assets, which they can sell at a higher rate.

Inflation often leads to speculation by businesses in risky projects and by individuals who invest in company stocks, as they expect better returns than inflation. An optimum level of inflation is often promoted to encourage spending to a certain extent instead of saving. If the purchasing power of money falls over time, then there may be a greater incentive to spend now instead of saving and spending later. It may increase spending, which may boost economic activities in a country.

A balanced approach is thought to keep the inflation value in an optimum and desirable range. Buyers of such assets may not be happy with inflation, as they will be required to shell out more money. People who hold assets denominated in their home currency, such as cash or bonds, may not like inflation, as it erodes the real value of their holdings.

As such, investors looking to protect their portfolios from inflation should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts REITs. Inflation-indexed bonds are another popular option for investors to profit from inflation. High and variable rates of inflation can impose major costs on an economy.

Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and planning decisions. This introduces an additional source of uncertainty into the economy, because they may guess wrong about the rate of future inflation. Time and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices, rather than real economic fundamentals, which inevitably represents a cost to the economy as a whole.

Even a low, stable, and easily predictable rate of inflation, which some consider otherwise optimal, may lead to serious problems in the economy, because of how, where, and when the new money enters the economy. Whenever new money and credit enters the economy it is always into the hands of specific individuals or business firms, and the process of price level adjustments to the new money supply proceeds as they then spend the new money and it circulates from hand to hand and account to account through the economy.

Inflation does drive up some prices first and drives up other prices later. This sequential change in purchasing power and prices known as the Cantillon effect means that the process of inflation not only increases the general price level over time, but it also distorts relative prices , wages, and rates of return along the way. Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and Austrian economists even believe this process to be a major driver of cycles of recession in the economy.

It is done by implementing measures through monetary policy , which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money supply. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation, which is thought to be beneficial to the economy. Price stability—or a relatively constant level of inflation—allows businesses to plan for the future since they know what to expect.

The Fed believes that this will promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change. For this reason, the Fed doesn't set a specific goal for maximum employment, and it is largely determined by employers' assessments. Maximum employment does not mean zero unemployment, as at any given time there is a certain level of volatility as people vacate and start new jobs.

Monetary authorities also take exceptional measures in extreme conditions of the economy. For instance, following the financial crisis, the U. Fed has kept the interest rates near zero and pursued a bond-buying program called quantitative easing. Some critics of the program alleged it would cause a spike in inflation in the U. There are many complex reasons why QE didn't lead to inflation or hyperinflation , though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects.

Consequently, the U. The European Central Bank ECB has also pursued aggressive quantitative easing to counter deflation in the eurozone, and some places have experienced negative interest rates , due to fears that deflation could take hold in the eurozone and lead to economic stagnation. Moreover, countries that are experiencing higher rates of growth can absorb higher rates of inflation. Stocks are considered to be the best hedge against inflation, as the rise in stock prices is inclusive of the effects of inflation.

Since additions to the money supply in virtually all modern economies occur as bank credit injections through the financial system, much of the immediate effect on prices happens in financial assets that are priced in their home currency, such as stocks. Additionally, special financial instruments exist that one can use to safeguard investments against inflation. They include Treasury Inflation-Protected Securities TIPS , low-risk treasury security that is indexed to inflation where the principal amount invested is increased by the percentage of inflation.

In the mids, the global economy witnessed the U. Conventional wisdom suggests the health of the U. However, import prices of consumer discretionary goods don't always move in sync with changes in the U. Instead, the connection between import prices and the U. The commodity markets are quoted in U. Simply, a stronger U. So, a key factor to consider in anticipating how the currency will affect inflation is the behavior of commodity prices. Commodity prices are believed to be a leading indicator of inflation through two basic channels.

Leading indicators often exhibit measurable economic changes before the economy as a whole does. One theory suggests commodity prices respond quickly to general economic shocks such as increases in demand. The second is that changes in prices reflect systemic shocks , such as hurricanes which can decimate the supply of agricultural products and subsequently increase supply costs.

By the time it reaches consumers, overall prices would have increased, and inflation would be realized. The strongest case for commodity prices as a leading indicator of expected inflation is that commodities respond quickly to widespread economic shocks. In the past, increases in oil prices were behind a strong increase in the price of goods and services.

The reason for this is that oil is a major input in the economy and is used in critical activities such as heating homes and fueling cars. If the cost of oil increases, then the cost of manufacturing plastics, synthetic materials or chemical products will also rise and be passed onto consumers. This correlation was evident in the s during the energy crisis.

Whether its unique shocks or general price movements, the commodity-inflation relationship doesn't always hold. For example, an increase in the total demand for final goods and services can coincide with an increase in demand for manufactured goods relative to agricultural products. While this could lead to a rise in overall prices, prices of agricultural commodities might fall. These types of occurrences suggest that commodity-inflation movements depend on what is driving the commodity change.

Moreover, a stronger dollar in the global market will increase the price of commodities relative to foreign currencies. The higher price of commodities in foreign currency will work to lower demand and dollar-priced commodities. In this scenario, increasing commodity prices abroad could cause domestic deflation. The simple two-way relationship between commodity prices and inflation has significantly declined over time.

In the s, the relationship was statistically and evidently robust. However, in the past 30 years, the correlation has become less significant. Globalization has increased the interconnectedness of economies, and when commodity prices increase from a strong dollar, this typically results in domestic deflation. The World Bank. Accessed June 2, Federal Reserve Bank of New York.

Import Prices and Inflation. Federal Reserve Economic Research. Federal Reserve Bank of San Francisco. Federal Reserve. Your Money.

Inflationary expectations investopedia forex investing company profits 2015 inflationary expectations investopedia forex


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US consumer inflation expectations for the year ahead rose to 6. After declining sharply last month, the year-ahead expected change in the price of gas rose slightly to 5. On the other hand, the expected change in the price of food, medical care and rent all fell by 0. Similarly, the median expected change in the cost of a college education declined by 0.

Meanwhile, the median three-year-ahead inflation expectations remained unchanged at 3. Inflation Expectations in the United States averaged 3. This page provides - United States Consumer Inflation Expectations- actual values, historical data, forecast, chart, statistics, economic calendar and news. United States Consumer Inflation Expectations - data, historical chart, forecasts and calendar of releases - was last updated on June of Inflation Expectations in the United States is expected to be 6.

Trading Economics members can view, download and compare data from nearly countries, including more than 20 million economic indicators, exchange rates, government bond yields, stock indexes and commodity prices. Features Questions? Contact us Already a Member? It allows API clients to download millions of rows of historical data, to query our real-time economic calendar, subscribe to updates and receive quotes for currencies, commodities, stocks and bonds.

Click here to contact us. Please Paste this Code in your Website. United States Consumer Inflation Expectations. In the US, inflation expectations refer to median one year ahead expected inflation rate and are part of the Survey of Consumer Expectations. The expectations are based on the nationally representative, internet-based survey of a rotating panel of approximately 1, heads of households. Compare Inflation Expectations by Country. News Stream. Expectations about year-ahead price changes fell sharply by 4.

Also, three-year-ahead inflation expectations rose by 0. The Quarterly Journal of Economics. Georgia State University. University of Pennsylvania Wharton School of Business. Growth Stocks: Timing Counts. National Bureau of Economic Research. Review of Finance. Stock Markets. Portfolio Management. Investing Essentials. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Table of Contents. Inflation and Stock Returns. Growth vs. Value Stocks. The Bottom Line.

Markets Stock Markets. Part of. Guide to Inflation. Part Of. Understanding Inflation. Types of Inflation. What Does Inflation Impact? Understanding Hyperinflation. Understanding CPI. Related Terms A-I. Related Terms J-Z. Key Takeaways Rising inflation can be costly for consumers, stocks and the economy. Value stocks perform better in high inflation periods and growth stocks perform better when inflation is low. Stocks tend to be more volatile when inflation is elevated.

Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

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Forexpf charter A country's money supply can be increased by the monetary authorities by:. High and variable rates of inflation can impose major costs on an economy. Popular Courses. A trade deficit is not necessarily detrimental, because it often corrects itself over time. The commodity markets are quoted in U. Inflation can affect the economy in several ways.
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Financial aid date City Average. Your Money. You can learn more about the standards we follow in producing accurate, unbiased content here our editorial policy. The PPP approach forecasts that the exchange rate will change to offset price changes due to inflation based on this underlying principle. The WPI is another popular measure of inflation, which measures and tracks the changes in the price of goods in the stages before the retail level.


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He is also a member of CMT Association. Predicting inflation rates can be a difficult task, especially when an economy is in a volatile state. Learn how to make TIPS inflation calculations and what their strengths and weaknesses are. TIPS are Treasury notes whose amount goes up with inflation and goes down with deflation.

The CPI is the most common way to measure inflation. Like a plain Treasury note T-note , TIPS provides people who invest with a semi-annual interest payment that has a fixed rate. The interest payment is found by using the adjusted value of the bond. This payment goes up with inflation. It would go down in the rare case of deflation. The amount of money you receive is the original amount you put in adjusted for inflation. In short, the amount of money rises or falls with the CPI. The coupon rate is your "real return," or return above inflation.

TIPS can trade with a negative yield. This has happened at times when the Federal Reserve has kept its policy rate low. Plain T-notes carry no such inflation protection. Since a T-bond investor is fully exposed to the impact of inflation on the bond, they demand a higher interest rate. This could be looked at as a hedge against inflation. You can figure out a risk premium by looking at the contrast in yields on a T-note and TIPS that have similar dates when they mature. The result shows the amount of inflation protection investors need by showing what inflation rate to expect in the future.

Using two- or ten-year issues would give you the expectation, or outlook, for those times. This difference is often called the "break-even" inflation rate. The math for the inflation rate to break even is shown below.

If you want to know what T yields might look like in the future, given an expected inflation rate, you can tweak the math. The same could apply if you want to know about TIPS yields with a given breakeven inflation rate. Using this method, you can easily find the market's outlook for the future inflation rate.

The concept of using an inflation rate to break even is only a theory. This is because the differences between the two securities lead to market changes that prevent this math from giving an exact result. The yield can often change due to factors that do not relate to what inflation might be in the future. One of the largest factors that affects the price of given and real yield securities is the inflation outlook by those who invest.

This leads to changes in the extra amount of money they are willing to pay for either type of T-notes. For instance, if those who want to invest money expect the inflation rate to break even for T-notes to be 1. Saban et al. Using conventional and Fourier Toda Yamamoto methods. Also in the summaries of Santos and Chris [ 38 ], used Johansen co-integration approach and the Toda and Yamamoto [ 39 ] causality testing procedure. Applying Wald coefficient test, the nominal interest rates, and expected inflation co-move together, in the long run, there is a uni-directional causality from expected inflation to nominal interest rates as suggested by the Fisher hypothesis in the closed economy context.

While in the open economy context, the result showed that the expected inflation and international variables do not contain information that predicts the nominal interest rate. In the empirical findings of Mohammed and Jauhari [ 40 ], they employed asymmetric causality test based on Toda and Yamamoto [ 39 ] causality approach to further the causal relationship between exchange rate and inflation differentials in Brunei, Malaysia, and Singapore.

The results show the existence of Granger causality running from positive cumulative exchange rate shocks to shocks in inflation differentials for Brunei and Malaysia. Also, the asymmetric causality for Singapore runs from both positive and negative cumulative domestic inflation shocks to positive and negative exchange rate shocks respectively. Chibvalo et al. They established a bi-directional causality between inflation and trade openness. Further, there exists a positive relationship between inflation and trade openness in Zambia.

This analysis aims at investigating the effect and the interrelations existing between the impact of oil price fluctuation on the monetary instrument Exchange rate, Inflation, Interest rate. The data cover a period of — and the data is monthly. All our variables are in local currency. Therefore we used oil price, the interbank exchange rate as a proxy for exchange rate data, while the prime lending rate was used as a proxy for data on the interest rate and we used consumer price index for all commodity as a proxy for inflation.

According to Salisu [ 42 ], Sims [ 43 ] and Toda and Yamamoto TY-VAR [ 39 ], Vector auto-regressions VARs are one of the widely used classes of models in applied econometrics, used as tools both for prediction and for model building and evaluation. It success lied on its flexibility and ease of application when dealing with the analysis of multivariate time series. And one of the deficiencies of the VAR application is the inability to ascertain the a priori expectation of the variables whether the variables are integrated, co-integrated, or trend stationary.

This necessitates pretesting s for a unit root s and co-integration in the economic time series, asarequisite for estimating the VAR model, and also when the intentions are prioritized towards the estimation of cointegration and vector error correction model [ 44 ]. Conversely, the powers of the unit and also simulation experiments of Johansen tests for co-integrating are very sensitive to the values of the nuisance parameters in finite samples and hence not very reliable for sample sizes that are typical for economic time series [ 39 , 45 , 46 ].

To alleviate these problems, Toda and Yamamoto [ 39 ] as quoted by Shakya [ 47 ], Giles [ 48 ] proposes the augmented VAR modeling, that is the modified Wald test statistic MWALD , which is more superiority to the ordinary Granger - causality tests, the method is flexible and easy to apply, since one can test linear or nonlinear restrictions on the coefficients by estimating a levels VAR and applying the Wald criterion, paying little attention or circumventing the integration and cointegration properties of the time series data [ 42 , 44 ].

However, the model is not a substitute for the conventional pre-testing in time series analysis, but as a complementary to the conventional VAR [ 49 ]. In estimating the MWALD test for Granger causality, it is prerequisite to determine the maximum possible order of the integration of the basic variables d max.

The determination of the optimal lag length k is very important, to avoid overstating or understating the true value of lag, to evade biased estimates of accepting the null hypothesis when it should be rejected, vice versa. The model used in this research work borrowed a leave from the Toda and Yamamoto model as iterated in the work of Saban et al. The analysis aims at establishing the interrelationship that exist among the variables; i.

The specification considers each variable expressed as independent in the model as a function of its lag and the lag of other variables in the model. Equations for the Modified Warld Test model are presented as follows;. Although, the Todo-Yamamoto model, the MWALD test was introduced for ease of estimation by circumventing the presence of unit roots pre-testing problem, nevertheless, there is the need to determine the maximum order of integration of the variables, which is necessary for estimation of The MWALD test for Granger causality by Toda and Yamamoto [ 39 ].

Source: E-views Version 9 software was used in the estimation. This corroborates with the work of Yakubu and Abdul Jalil in their test of stationarity. A quick check on the line graphs in Figure 1 indicated that all the variables are at first difference I 1. Graphical representation of original series at I 1 for oil price doilpr , exchange rate dexcri , CPI dcpi and interest rate dintr. According to Liew [ 55 ], Asghar and Abid [ 56 ] Estimating the lag length of the autoregressive process for a time series is imperative in econometrics.

The selection is done to minimize the chance of underestimation while at the same time maximizing the chance of recovering the true lag length. Another important aspect of the lag selection criteria is to overcome the structural break. Though, studies indicated that HQC is found to surpass the rest by correctly identifying the true lag length. In Table 4 out of the two criteria, we propose three lags lag 3 as the optimal lag.

The orthogonal impulse response are based on recursive causal ordering, if the ordering is reversed different sets of structural shocks will be identified, and this gives a different impulse response function IRF and forecast error variance decomposition FEVD , except if the error terms contemporaneous correlations are low [ 57 ]. The ordering of variables suggested by Sims , as iterated in the work of Yakubu and Abdul Jalil [ 44 ], Duasa [ 46 ], is to start with the most exogenous variables in the system and ended by the most endogenous variable.

Since there is no strong correlation among the variable we assumed the arrangement of our variables are in order. Source: Estimation was compiled using E-views Version 9 software. The VAR residual serial correlation test is needed to verify the adequacy of the lag selection criterion used in the estimation of a chosen multivariate model, it is applied to test a set of restrictions on a model that is unrestricted, and it is based on the restricted maximum likelihood test ML [ 42 , 60 , 61 ].

From the TY-VAR estimated output for the residual serial correlation test in Table 6 , the null hypothesis for the test is that there is no serial correlation. The result submits that there is no evidence of serial correlation. Which indicate the acceptance of the null hypothesis that the restriction lags place on the model is adequate.

In the test for normality, to examine whether the residuals are normally distributed. We employed the null hypothesis H 0 : residuals are normally distributed. Hence, we concluded that residuals are not normally distributed [ 62 ]. Although, the credibility of Iarque-Bera test of normality with application to VAR has been questioned specifically for an I 1.

Jarque-Bera normality of the series does not guarantee normality of distributions, it only signifies normality of the first four moments of a distributions [ 58 ]. According to Lutz and Ufuk [ 63 ] in their remarks, they posited that Jarque-Bera test based on asymptotic critical values can be very unreliable. They presented that the size distortions of the asymptotic test persevere even for sample sizes as large as observations. Also, the combination of all the independent variables do not granger caused changes in the dependent variable.

This indicates the exogeneity of oil price which is been determined by many factors that are exogenous to both net importers and exporters of oil, Nigerian inclusive. According to Humbatova and Hajiyev [ 24 ] posited that the determinants of oil price range from financial factors, lack of production capacities in oil production, the decline in the world oil reserves, natural disasters, political events and processes, and no one country has the monopoly of determining oil price.

The exchange rate plays a significant role in determining the oil price both to net exporters and net importers. Specifically, oil is priced in U. According to Farley [ 64 ] submissions, each decrease and increase in the dollar or the price of the commodity oil generates an instantaneous realignment between the US dollar and other currencies.

These correlated is more significant in countries with significant oil reserves that depend largely on crude exports and they experience more economic damage than those with more diverse resources. This is sometimes supplemented by a nominal depreciation of exchange rates. These invariably indicate that oil demand shocks are a relevant factor for their exchange rates. While we accept the null hypothesis that there is no causality between, the lncpi and lnintr on the dependent variable.

Also, the combination of all the independent variables do not Granger cause changes in the dependent variable. Exchange rate plays a vital role in determining prices in Nigeria, as an economy that has some element of a Dutch disease syndrome, and relied heavily on importation of basic necessity, when we factor out oil exportation from the total export, the non-oil balance of trade approximately stood at negative billion for as stated in our introduction.

Therefore, appreciation in the exchange rate can cause inflation lncpi Katz, The interest rate is one of the instruments used by the monetary authority to regulate the economy either during inflation or deflationary periods, the interest rate affects the demand and allocation of the available loanable funds the level, and pattern of consumption and investment [ 66 ] p.

Before recession in Nigeria, the inflation rate was at a single digit of 9. While we accept the null hypothesis that lnoilpr do not granger cause lncpi. The relationship of lnoilpr and lnintr may not be exclusive but via the exchange rate, in the boom period the net exporter of oil has more dollars to expend, vice versa during deflationary periods, both periods has a direct link to economic growth.

To avoid these inflationary or deflationary tendencies, the central bank may engage in the sterilization process through open market operation, by manipulating the short-term interest rate, that is by increasing interest rates to discourage borrowing during inflationary periods or decrease the interest rate to encourage borrowing during deflationary periods.

The relation is said to be inverse and this shows how oil price and exchange rate influences the monetary policy of net oil exporters. From the estimated TY-VAR, we compute forecast error variance decompositions FEVD and impulse response functions IRF , which serve as means for evaluating the dynamics of the interrelationship, interactions, and strength of causal relations among the variables in the system.

The impulse response functions trace the effects of a shock to one endogenous variable on to the other variables in the VAR, variance decomposition separates the variation in an endogenous variable into the component shocks to the VAR [ 10 , 46 ].

That is a shock in one variable can work through the contemporaneous correlation with innovations in other variables. The responses of a variable to innovations in another variable of interest cannot be adequately represented in isolation, due to the facts that shock to individual variables cannot be separately identified due to contemporaneous correlation [ 46 ].

In our analyses, we applied Cholesky approach which uses the inverse of the Cholesky factor of the residual covariance matrix to orthogonalise impulses innovations as recommended by Sims as quoted by Duasa [ 46 ] and Breitung, Bruggemann, and [ 58 ] to solve this identification problem. The strategy requires a pre-specified causal ordering of the variables, which we estimated in Table 5 for the correlation matrix. Other columns represent the percentage of the variance attributable to shocks in the residual of the respective variables.

Sources: Compiled using Eviews version 9. Impulse response function of lnoilpr to lnoilpr. Impulse response function of lnoilpr to lnexchr. Impulse response function of lnoilpr to lncpi. Impulse response function of lnoilpr to lnintr. Impulse response function of lnexchr to lnoilpr. Impulse response function of lnexchr to lnexchr.

Impulse response function of lnexchr to lncpi. Impulse response function of lnexchr to lnintr. Impulse response function of lncpi to lnoilpr. Impulse response function of lncpi to lnexchr. Impulse response function of lncpi to lncpi. Impulse response function of lncpi to lnintr. Impulse response function of lnintr to lnoilpr.

Impulse response function of lnintr to lnexchr. Impulse response function of lnintr to lncpi. Impulse response function of lnintr to lnintr. We explored the Cholesky factorization in the E-Views software and forecast the interrelationship of the variables up 48 months equal to 4 years. In forecasting a variable, shocks in the residual of the forecasted variable contribute more to its variance than the shocks in other variables in the first period.

This is followed by lnintr that contributed 4. This followed by lncpi that contributed 1. This shows monetary policy influences the fluctuation inherent with the oil price and in the future, it shows that lnintr will respond highly to oil price shocks. While the contemporaneous relationship between the oil prices as the endogenous variables lncpi and lnexchr in our model are very insignificant. This is an indication that it will take a longer time into the future, for variables other than lnintr to influence the impact of oil prices.

Table 13 , is the Variance Decomposition for dependent variable lnexchr, the contributions to itself were This followed by the contributions of lnoilpr with While lncpi and lnintr contributed 2. The error variance in forecasting lnexchr from lnoilpr is high, which indicates that shocks in the residuals of lnoilpr will have much effect in determining the lnexchr in the future. Table 14 is forecast error variance decomposition of LNCPI as the predictant, the predictant contributes While lnexchr contributes more to the error variance in forecasting lncpi, contributing about While lnoilpr contributions started from 24th period with 2.

Whereas lnintr contributions are insignificant. This has brought a clearer picture that lnexchr and lnoilpr are the major determinant of inflation in the economy. Table 15 illustrated the forecast error variance decomposition of lnintr, contributing to its future error variation of This is trailed behind by lnoilpr, contributing 4.

This indicates also a strong relationship into the future. The forecast error variance decomposition of the variables estimates also coincides with the result we obtained in the estimates we derived in Table 11 , which also indicates that our estimates are good to go with for future implementation of policies.

In Figure 2 , from appendix 1, the Oil price lnoilp responded contemporaneously by the change in its own shocks, which is positive and not dissipating. While the response of oil price lnoilpr to change in Exchange rate lnexchr is insignificant in Figure 3. Inflation lncpi , and Interest rate lnintr in Figures 4 , and 5 showed some level of positive response. In Figure 6 , there is a slightly positive response of Exchange lnexchr to change Oil price lnoilpr in the sixth lag period.

This show how influential oil is in determining exchange rate, since high price of oil means more revenue foreign income , also Exchange lnexchr responded instantaneously, a positive response, to change in its self Figure 7. In Figure 8 , there is slight positive response of lnexchr to change in lncpi and Figure 9 showed a small inverse response of lnexchr to change in lnintr.

In Figures 10 and 13 , Inflation lncpi did not show a meaningful response to orthogonal change in the price of oil lnoilpr and Interest rate lnintr. While Figure 11 , showed a positive response in Inflation lncpi to change in the Exchange rate lnexchr , that is from the second lag period up to the tenth lag period in increasing order, this indicate that inflation will continue since the response is not dissipating unless there is a policy to induce deflation.

Whereas in Figure 12 there is an instantaneous response of Inflation lncpi to change in Inflation lncpi in a high positive level, with a slight drop towards the tenth period which indicates tendencies of achieving normality in the future. Figure 14 , showed that there is an inverse response of Interest rate lnintr to one standard deviation change in the price of oil lnoilpr from the second lag period in an increasing order up to the tenth period, this is expected because the assumption is that interest rate has an inverse relationship with the oil price.

Also Figure 15 indicated an instantaneous positive response of interest rate lnintr to change in the Exchange rate lnexchr , in the third and fourth period, before it dying off which indicates that there is propensities of achieving normality in the long run. In Figure 16 Interest rate lnintr responds contemporaneously to change in Inflation lncpi , with a positive increase from the fourth period and finally, in Figure 17 Inflation lncpi responded significantly to change Inflation lncpi.

The impulse response functions further complement the Forecast Error Variance Decomposition by given a portrait of the direction of the inter-relationships of variables. In this research work, we explored the Toda-Yamamoto Modified Wald Test MWALD to examine the impact of oil price fluctuation on the monetary instrument in Nigeria, by looking at their causal relationships.

The study covered the period to and the data are monthly data, to establish the contemporaneous relationships between these macroeconomic indicators. The review showed the direction of causality and FEVD into the future for 48 months equivalent to four years short-run , between oil price, Exchange rate, Inflation, and Interest rate.

This is consistence with the result we obtained in the estimation forecast error variance decomposition of lnexchr Table 13 as the predictant, where the predictant contributes This was followed by the contributions of lnoilpr with This was also complemented by for IRFs in Figure 7 in the appendix.

Also from granger causality of lncpi as a dependent variable in Table 10 there is unidirectional causality from lnexchr and lnintr to lncpi, also the combination of all the three independent variables lnoilpr, lnexchr and lnintr granger cause lncpi but lnexchr and lnintr have more contributions.

This is also in tandem with the result of FEVD for dependent variable lncpi in Table 14 where the dependent variable contributions to itself were This is also affirmed in Figure 11 in the appendix. This is also in agreement with the estimation of forecast error variance decomposition of lnintr as an endogenous variable, contributing to its future error variation of This indicated that the major determinant factors of interest rate policy in Nigeria are change in price of oil and exchange rate in the long run.

This also conforms to the outcome of the IRF in Figure 14 , which specified further that the relation between lnintr and lnoilpr is an inverse relationship, while lnexchr, lncpi and lnintr in Figures 15 — 17 are positive. The object of this is work is to establish a direct link between oil price and some selected monetary instruments in Nigeria, and our a priori expectations were achieved, we were able to established that oil price has a direct influence on the exchange rate, interest rate and inflation rate.

It is known facts that Nigeria is an oil-producing economy and at the same time also an import-based economy of non-oil products. The major sources of financing the import come from oil revenue. As an oil-producing economy, there are tendencies of having Dutch disease syndrome and economic pass-through [ 9 ].

Both in theory and empirical analyses one can conclude that oil price is a strong determining factor of the rate of exchange, it has a direct link to inflationary or deflationary tendencies and also influences the monetary policies in Nigeria in terms of cost of borrowing. On a general note, there should be diversification of the economy from oil to the non-oil economy to avoid the Dutch disease syndrome.

Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution 3. Edited by Muhammad Mohiuddin. Impact of this chapter. Abstract The study aims to find the short-run empirical analyses of the impact of oil price fluctuation on the monetary instrument Exchange rate, Inflation, Interest rate in Nigeria.

Keywords oil Price exchange rate inflation interest rate Toda—Yamamoto. Introduction Crude petroleum is one of the fundamental sources of energy in the world and plays an important role in economic growth and development of many economies. Constant Prob. Table 1. ADF stationarity tests. Table 2. PP stationarity tests. Table 3. KPSS stationarity tests. Table 4. VAR lag order selection criteria. Table 5.

Lags LM-Stat Prob 1 Table 6. Probs from chi-square with 16 df. Component Jarque-Bera df Prob. Table 7. Jarque-Bera normality test result. Excluded Chi-sq df Prob. Table 8. Table 9. Table Period S. References 1. Hamilton JD.

Causes and Consequences of the Oil Shock of — Blanchard, O. Lund: Lund University; 4. Oyelami, L. Riaz, M. Impact of oil Price volatility on manufacturing production of Pakistan. Ftiti, Z. Oil shocks and economic growth in OPEC countries. Working paper , 7. Jean-Pierre, A. Oil price shocks and global imbalances: Lessons from a model with trade and financial interdependencies.

Economic Modelling, Elsevier, 49, hal , — 8. Abeng MO. Central Bank of Nigeria : Research Department ;

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