ASYMMETRIC AND PASS-THROUGH EFFECTS OF OIL PRICE SHOCKS ON INFLATION IN NIGERIA

Abstract

Oil price shocks due to its direct and significant impact on inflation play an important role in the Nigerian economy given her dependence on oil revenue. While substantial studies exist on the effect of oil price shocks on aggregate output, exchange rate and stock market performance, few empirical studies have focused on the pass-through from oil price shocks to inflation. More importantly, the asymmetric effects of oil price shocks on inflation in Nigeria remained largely unexplored. This study, was therefore, designed to investigate the effects of oil price shocks on inflation in Nigeria.

The New Keynesian Phillips Curve Model provided the framework for this study. Quarterly data sourced from Central Bank of Nigeria Statistical Bulletin from 1986 to 2017 was used given that the period corresponds with significant oil price shocks. The Dickey-Fuller with Generalised Least Squares Detrending (DFGLS) and NG Perron (NP) tests were used to investigate the order of integration of the variables. The Auto-Regressive Distributed Lag (ARDL) and Non-Linear Auto-Regressive Distributed Lag (NARDL) techniques that measured short run and long run relationships were employed. The ARDL and NARDL models were estimated with structural breaks and without structural breaks. The asymmetric effects of oil price shocks on inflation was analysed by differentiating between partial sums of positive and negative oil price shocks using the Wald tests. Coefficients were analysed at 5 per cent level of significance.

The DFGLS and NP tests revealed a mixed order of integration of variables. While some variables were stationary at levels, others were stationary at first difference. The symmetric result without structural breaks showed that higher oil price reduced inflation in the short run ( = -0.21) and long run ( = -0.96).The asymmetric result without breaks showed that positive oil price shocks reduced inflation in the short run ( = -0.21) and long run ( = -0.91). In addition, negative oil price shocks abated inflation in the short run ( = -0.21) and long run ( = -0.91). The Wald test revealed absence of asymmetries in the oil price-inflation nexus without breaks (WSR=0.9; WLR=0.18). The symmetric result with structural breaks showed that higher oil price was responsible for lower inflation in the short run ( = -0.28) and long run ( = -0.96). This indicates a negative and incomplete pass-through from oil price to inflation. For the asymmetric relationship with breaks, positive oil price shocks reduced inflation in the short run ( = -0.28) and long run ( = -0.96). Similarly, negative oil price shocks reduced inflation in the short run ( = -0.29) and long run ( = -1.01). The Wald test revealed absence of asymmetries in the oil price-inflation nexus with structural breaks (WSR=0.8; WLR=0.14). Employing the Wald test, structural breaks was found to be significant at 10 per cent (WSB=0.08).

Oil price shocks had negative significant effects on inflation in Nigeria. Government should therefore adopt domestic policies that promote price stability during oil price shocks.