Overtime, Nigeria has experienced persistent depreciation in its exchange rate, with inflationincreasing at opposite direction, despite government’s exchange rate policies to stabilize prices. Exchange rate is key in foreign trade, as no country can satisfy demands of its population by operating close economy due to nations are endowed with varying natural resources. Thus, exchange rate and inflation constitute key determinants of economic performance of any economy.
This paper therefore investigates the relationship between exchange rate depreciation and inflation in Nigeria for the period 1980-2013, by applying Co-integration test, Vector Error Correction Model and Partial Correlation Coefficient analysis. Variables used in the study include inflation rate (INFR), exchange rate (EXCR), money supply (M2) and real gross domestic product (RGDP). The study conducted stationarity test, and found stationarity of the variables at second difference.
The results of co-integration test revealed that long run relationship exist among the variables. Thus, since negative weak correlation value of -0.143 exist between inflation and exchange rate; the study recommends that government should consider both official and parallel exchange rate markets in its exchange rate policies, as over reliance on official market alone in tackling inflation problem would be frustrated, if parallel exchange market remained unchecked.
