Do Trade Imbalances Drive Inflation? A Nonlinear and Asymmetric Analysis of Nigeria’s Economy (1981–2023)

Abstract

The study examines the relationship between trade imbalances and inflation in Nigeria from 1981 to 2023, using the Nonlinear Autoregressive Distributed Lag (NARDL) model. It finds that positive trade imbalances (PTI) have a short-term deflationary effect on inflation, while negative trade imbalances (NTI) show delayed inflationary effects due to currency depreciation and increased import costs. The study highlights the asymmetric nature of trade imbalances' influence on Nigeria's economy. The study also reveals that macroeconomic variables like money supply, trade openness, foreign direct investment, and real GDP influence inflationary pressures. Increased money supply exacerbates inflation in the short and long run, while trade openness contributes to short-term inflation due to global price volatility. Foreign direct investment offsets short-term inflationary pressures with long-term economic benefits, and real GDP growth contributes to demand-pull inflation in the short term. Diagnostic tests confirm the model's robustness, despite residual autocorrelation. The findings also align with Balance of Payments theory, Monetary Theory of Inflation, and Structuralist perspectives. The study recommends policy measures to manage trade imbalances, stabilize inflation, and promote sustainable economic growth in developing economies, including diversifying exports, enhancing domestic production, and implementing effective monetary and fiscal policies.

Keywords: Trade Imbalance, Inflation, Asymmetric Effects, NARDL Model, Monetary Policy