Oil Price, Exchange Rate Volatility, And Inflation Dynamics In Nigeria: An ARCH/GARCH Modelling Approach

Abstract

This study investigates the volatility dynamics of inflation in Nigeria within the situation of oil price shocks, exchange rate fluctuations, money supply, interest rate, and trade openness over the period 1986- 2025. Employing the Autoregressive Conditional Heteroscedasticity (ARCH) and Generalized ARCH (GARCH) modelling framework, the study estimates the mean equation of inflation using a log-linear specification and models the conditional variance of the residuals to capture time-varying volatility. Preliminary diagnostics confirm ARCH effects in the inflation residuals (ARCH-LM test, p < 0.05). The GARCH(1,1) model, selected on the basis of the Akaike Information Criterion (AIC = 62.83), reveals a high volatility persistence (α + β = 0.957), implying that inflationary shocks decay slowly with an estimated half-life of approximately 15.8 years. Interest rate is found to exert a statistically significant positive effect on inflation (p < 0.01), while oil price and exchange rate exhibit negative but statistically insignificant direct effects in the conditional mean equation. Granger causality results confirm unidirectional causality from interest rate to inflation. The conditional volatility peaks coincide with Nigeria's structural adjustment programmes (1987-1993), the oil price crash (1998-1999), and the post-COVID devaluation episode (2023-2025). These findings carry important macroeconomic policy implications for the Central Bank of Nigeria regarding monetary transmission and exchange rate management.