A SVEC model of monetary policy and international trade in Nigeria

Abstract

The development of the monetary theory of balance of payment was from the balance of payment theory which is mainly in the context of a closed economy. Whereas, the Mundel-Fleming model was coined from the IS-LM model for an open economy. Mundel- Fleming model argues that to achieve economic stabilization by adopting fiscal or monetary policies can be done based on the exchange system adopted. This study examines the effects of monetary policy shocks, aggregate demands, and exchange rate shocks on international trade in Nigeria with monthly data from 2008m1 to 2019m12 sourced from the Central Bank of Nigeria (CBN). The study adopts a SVEC model to examine the short-run, long-run, and contemporaneous relationships that exist among trade, interest rates, consumer price index (CPI), and exchange rate. Having confirmed evidence of two co-integrating vectors in the system by adopting the Johansen tests, the study further finds that a rise in domestic price brings about a rise in international trade, the study also shows that loosing of naira power against dollar discourages international trade in the long-run and charging of one percent additional rate of interest will drastically reduce international trade in the long-run. In a nutshell, the study shows that monetary policy shock could not significantly explain the proportion of the forecast error variance of international trade in Nigeria compared to the aggregate and exchange rate shocks. Based on the findings, the study recommends that the government should ensure the implementation of monetary policies that will assist in improving international trade.