The Effect of Foreign Exchange on Economic Growth

INTRODUCTION
 1.1 Background to the Study
The foreign exchange market intervention phenomenon is obviously not a recent development, quite a number of governments across the globe have intervened in foreign exchange markets. 
The essence has mostly been to try to dampen volatility and to slow or reverse currency movements. This is usually borne out of concern that excessive short-term volatility and longer-term swings in exchange rates that "overshoot" values justified by fundamental conditions may hurt their economies, especially sectors heavily involved in international trade. And this concern has increase both in scale as well as in dimension with the foreign exchange market certainly becoming more volatile in recent times. 
In Nigeria, while exchange rate interventions were an expected feature when the Dutch system was in introduced, they are still an issue today, more than two decades after the adoption of the float regime. 
The Central Bank of Nigeria introduced explicit intervention in response to what were considered exceptional circumstances that put the exchange rate market under significant stress. In fact according to Tapia and Tokman (2004), the “two-corner hypothesis” (Eichengreen (1994), Obstfeld and Rogoff (1995), which suggests that currency regimes worldwide are either shifting towards extremely tight commitments or to floating regimes, has brought new attention to exchange rate intervention. When an explicit currency commitment exists, the central bank has an obvious role to play, naturally using its tools (i.e. reserves, interest rates) to validate such commitment. 
However, things become fuzzier when analyzing the adequate role to play under flexible exchange rate arrangements. Even in free-floating countries, where the market in principle determines the parity by itself, interventions are frequent. Clean float is a rarity and almost every regime that is labeled as floating intervenes in the exchange market to some degree (Tapia & Tokman, 2004). 
The Central Bank of Nigeria (CBN) has periodically intervened in the foreign exchange market since 1986. As part of the International Monetary Fund (IMF) conditions under the structural adjustment package, the CBN has also intervened in the form of foreign exchange purchases in order to accumulate foreign reserves for the government. 
In a liberalized and market directed economic and financial system in which the exchange rate is floated, exchange rate management becomes an important component in the transmission mechanism. 
The more open the economy, the greater the importance of the exchange rate in the economic policy process and the more important this variable becomes as an optional policy conduit. Thus, the stability of the exchange rate is very important for macroeconomic stabilization. To ensure this, Adebayo (2007) opined that most central banks intervene in foreign exchange markets to smooth out short run fluctuations of the exchange rate. 
However, the effects of central bank intervention in the foreign exchange market are not straightforward. The efficiency of the foreign exchange market matters coupled with the nature and credibility of the interventions. The effect of such interventions, therefore, is an empirical question, which this paper attempts to address.  
The main concern of this research work is to determine whether foreign exchange intervention has an effect on exchange rates, foreign reserve and economic growth in Nigeria and to also determine whether or not intervention in Nigeria is indeed sterilized. This is of importance because stabilization policy in Nigeria is based on the control of money supply with M2 as an intermediate target and base money as the policy instrument. Policy implementation is conducted by minimizing deviations of M2 from target. If intervention is not sterilized, then interventions are likely to affect money supply growth and this becomes a part of monetary policy issues. 
However, the effectiveness of sterilized intervention in foreign exchange management is still controversial (see Danker et al., 1996; Lewis, 1988b; Humpage, 1989; Baillie & Humpage, 1994; and Dominguez, 1998). In fact according to Adebayo (2007), conventional academic wisdom holds that "sterilized" interventions have little impact on the exchange rate and are a waste of time and of the government's foreign exchange reserves. 
Despite academic skepticism, many central banks intervene in foreign exchange markets. The significance and validity of this study principally lie in both research and policy interests. 
The research interest is founded on the fact that very few of such studies, if any, have been done on Africa (conducted by Simatele, 2003). It is of policy interest because, if it is eventually found that sterilized intervention has an effect on the exchange rate in Nigeria, then this will undoubtedly present to the monetary authority in Nigeria and beyond an additional policy tool independent from general monetary policy for the purpose of achieving macroeconomic stability.

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APA

Oluwasegun, I. (2018). The Effect of Foreign Exchange on Economic Growth. Afribary. Retrieved from https://afribary.com/works/the-effect-of-foreign-exchange-on-economic-growth-5213

MLA 8th

Oluwasegun, Ilesanmi "The Effect of Foreign Exchange on Economic Growth" Afribary. Afribary, 29 Jan. 2018, https://afribary.com/works/the-effect-of-foreign-exchange-on-economic-growth-5213. Accessed 21 Jul. 2024.

MLA7

Oluwasegun, Ilesanmi . "The Effect of Foreign Exchange on Economic Growth". Afribary, Afribary, 29 Jan. 2018. Web. 21 Jul. 2024. < https://afribary.com/works/the-effect-of-foreign-exchange-on-economic-growth-5213 >.

Chicago

Oluwasegun, Ilesanmi . "The Effect of Foreign Exchange on Economic Growth" Afribary (2018). Accessed July 21, 2024. https://afribary.com/works/the-effect-of-foreign-exchange-on-economic-growth-5213