CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Exchange rate is a key variable that influences the international trade and economic performance of countries around the world. It determines the value of goods and services across borders and affects the prices of consumer and intermediate goods domestically. Exchange rate fluctuations, therefore, create uncertainty and risk for both producers and consumers, as well as policy makers and investors. Understanding the causes and consequences of exchange rate volatility is essential for designing effective macroeconomic policies and strategies.
One of the main effects of exchange rate fluctuations is on consumption, which is a major component of gross domestic product (GDP) and a determinant of welfare. Consumption reflects the preferences and behaviour of households, as well as their income and wealth. Consumption also affects the demand and supply of foreign exchange, which in turn influences the exchange rate movements. Therefore, there is a complex and dynamic relationship between consumption and exchange rate, especially in small open economies that rely heavily on imports.
Nigeria is one such economy that has experienced significant exchange rate fluctuations over the years, due to various factors such as oil price shocks, fiscal and monetary policies, external shocks, political instability, and structural reforms. These fluctuations have had implications for the consumption patterns of Nigerian households, who have to adjust their spending and saving decisions in response to changes in relative prices, income, and expectations. The impact of exchange rate fluctuations on consumption may vary depending on the degree of openness, the structure of the economy, the level of development, and the nature of the exchange rate regime.
The aim of this study is to examine the effect of exchange rate fluctuations on consumption in Nigeria, using both theoretical and empirical approaches. The study will also explore the factors that determine the exchange rate volatility in Nigeria, as well as the transmission channels through which it affects consumption. The study will contribute to the existing literature on exchange rate and consumption by providing evidence from a developing country context, using recent data and advanced methods. The study will also have policy implications for enhancing macroeconomic stability and welfare in Nigeria.
1.2 Statement of Research Problem
The foreign exchange market in Nigeria has evolved over time due to various factors. Some of these factors are the changes in international trade patterns, the economic institutions, and the production and consumption structures (CBN, 2016). Before the Central Bank of Nigeria (CBN) was established in 1958 and the Exchange Control Act was enacted in 1962, the private sector earned and held foreign exchange abroad through commercial banks that acted as their agents (CBN, 2011). At that time, most of the foreign exchange came from agricultural exports. Due to the high volatility of the market, several reforms were introduced. However, Nigeria still relies heavily on imports that are paid for by oil revenues. Many industries and households import raw materials and finished goods for production and consumption. This makes the economy vulnerable to exchange rate fluctuations that affect consumer prices of imports. The exchange rate of naira to the dollar and other major currencies has deteriorated because of the external sector challenges that reduced crude oil receipts (Mamman, 2017). This has implications for domestic consumption, which depends largely on consumer prices, and for the exchange rate itself.
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