A small open economy model for Nigeria: A DSGE framework

We estimate a small open economy (SOE) model for Nigeria with a view to understanding how the Nigerian economy should be managed in the face of business cycle such as the recent global meltdown. Our SOE model is used to generate dummy observation priors for the VAR in line with the BVAR-DSGE technique. We consider four monetary policy rules and estimate each of the resulting models using DYNARE platform. We find that the Central Bank of Nigeria (CBN) places little weight on the exchange rate behaviour in reacting to the cycles, resulting in overshooting and persistence in the exchange rate but strongly reacts to the behaviour of inflation and, to a lesser degree, of output, output gap or its growth following the shocks. We conclude that it will be important for the CBN to pursue a guided exchange rate policy by actively responding to the exchange rate movement to avoid overshooting and persistence, that the terms of trade should be endogenized and that there is scope for the CBN to learn from past policy outcome by building a much stronger feedback.