Asian Economic and Financial Review, 2013, 3(5):683-702

Asian Economic and Financial Review

journal homepage: http://aessweb.com/journal-detail.php?id=5002

OIL PRICE VOLATILITY AND ITS CONSEQUENCES ON THE GROWTH OF

THE NIGERIAN ECONOMY: AN EXAMINATION (1970-2010)

Oriakhi D.E
Department of Economics and Statistics, University of Benin Benin City
Iyoha Daniel Osaze
Department of Economics and Statistics,University of Benin Benin City

ABSTRACT
This study examines the consequences of oil price volatility on the growth of the Nigerian economy
within the period 1970 to 2010. Using quaterly data and employing the VAR methodology, the
study finds that of the six variables employed, oil price volatility impacted directly on real
government expenditure, real exchange rate and real import, while impacting on real GDP, real
money supply and inflation through other variables, notably real government expenditure. This
implies that oil price changes determines government expenditure level, which in turn determines
the growth of the Nigerian economy. This result seems to reflect the dominant role of government
in Nigeria. Considering the destabilizing effects of oil price fluctuations on economic activity and
government spending in Nigeria, the study makes some recommendations. Some of these include;
fiscal prudence, reform in budgetary operations, export diversification, revival of the non-oil
sector of the economy, accountability and corporate governance.
Keywords: Oil price volatility, Economic Growth, Impact Variables, Real Gross Domestic
Product, Government Expenditure.

INTRODUCTION

Issues in oil price volatility and how it impacts on economic growth have continued to generate
controversies among economic researchers and policy makers. While some (such as Akpan (2009),
Aliyu (2009), Olomola (2006), etc) argue that it can promote growth or has the potential of doing
so others (such as Darby (1982), Cerralo (2005) etc) are of the view that it can inhibit growth. The
former argue that for net-oil exporting countries, a price increase directly increases real national
income through higher export earnings, whereas, the latter cite the case of net-oil importing
countries (which experience inflation, increased input costs, reduced non-oil demand, lower

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investment, fall in tax revenues and ultimately an increase in budget deficit which will further
reduce welfare level) in advancing their argument.

Thus the impact (positive or negative) which oil price volatility could have on any economy,
depends on what part of the divide such economy falls into and of course the nature of such price
change (rise or fall). However, the Nigerian economy uniquely qualifies as both an oil exporting
and importing economy, by reason of the fact that she exports crude oil, but imports refined
petroleum products. Making a conclusive and authoritative statement on the impact of oil price
volatility on the Nigerian economy is therefore difficult.

Estimating the consequences of oil price shocks on growth is particularly relevant in the case of
Nigeria. As a small open economy, it has no real influence on the world price of oil, whereas, it is
greatly influenced by the effect of oil price volatility both as an exporter of crude oil and importer
of refined petroleum products. It thus implies by simple reasoning that oil price volatility whatever
the nature (either a rise or fall) can both benefit and hurt the economy at the same time.

Basically, the crux of the problem lies in the fact that the country has extremely relied on this
commodity over the years, making its economy a mono-product economy and this has triggered
severe structural difficulties for the economy. For example, in 2008 when oil price fell from a peak
of $147 to about $37.81 per barrel, the budget witnessed significant cuts in budgeted revenue and
expenditure. These cuts had attendant effect on all aspects of the Nigerian economy; apparently
budgetary operations in Nigeria are strongly linked to happenings (price, demand and supply) in
the international oil market.

Oil price volatility has been found to have had a more direct effect on the exchange rate of the
Naira than probably any other economic variable, this is because crude oil export earnings accounts
for a large chunk of Nigeria‘s foreign exchange (about 90%) and thus ultimately determines the
amount of foreign reserves of the country which is alarmingly low (about $30billion from over
$60billion in 2008) and continuously keeps depleting.

This paper has as its main objective, the examination of the consequences of oil price volatility on
the growth of the Nigerian economy within the period of 1970 and 2010 using quarterly time series
data sourced from the CBN Statistical Bulletin. In order to achieve this objective, the paper is
structured into five sections. The introduction makes up Section 1, Section 2 reviews related
literature (theoretical and empirical). Section 3 highlights the theoretical foundations of the study.
The model for our empirical work is also specified in this section. Empirical analysis and
discussion of the policy implication of the empirical results are presented in Section 4. Section 5
contains the recommendations and conclusion.

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REVIEW OF RELATED LITERATURE

The literature on oil price volatility and its attendant consequence on economic growth are quite
broad and continue to expand. As Adelman (2000) notes; ―crude oil prices have been more volatile
than any other commodity price [although in principle it ought to be less volatile]‖. He notes that
though oil price movements have always occurred mainly due to seasonal changes in demand, such
movements were small. For example, between 1948 and 1970, nominal prices fluctuated between
$2.50 and $3 per barrel. He notes that between 1998 and March 2000 international oil prices rose
from $10 to $31 per barrel, it further rose to $37 in September 2000, before declining to less than
$18 per barrel in November 2001. Since then there has been an upward movement in the prices of
crude oil reaching about $147 per barrel in 2008, before averaging $90 per barrel in 2010. He
adduces this volatility of crude oil prices to the fixation of prices by collusion in the OPEC cartel
and the unrest in the Middle East at various times. Kolawole (2002) seems to be in full agreement
with Adelman (2000), pointing out that disagreements on production quotas and members mistrust
have fuelled volatility. Ayadi (2005) does not think differently either, in his opinion, speculation
surrounding OPEC meetings can also induce volatility. He revealed that whenever OPEC meetings
approach, volatility drifts upwards and therefore blames the frequency of OPEC meetings and
quota adjustments in recent years as a crucial causal factor. Whatever the cause however, as Osije
(1983) remarks, oil prices like other market commodities is dictated fundamentally by market
trends and therefore subject to price volatility.

The fact that oil price volatility has significant impact on economic aggregates of any economy is
not in doubt; however, it is the channel through which the impact is transmitted and nature/severity
of the impact that has been argued by researchers. Gounder and Bartleet (2007) argue that the
demand-side impacts of energy crisis suggest that an energy price shock can result in higher
inflation and higher unemployment at the same time; this is known as ―stagflation‖. Their argument
finds support in the empirical work of Mork, Olsen and Flo (1992) on Oil price volatility and its
impact on key growth variables of economies. Their results indicate that oil price volatility may
trigger an external inflation spike, they assert that inflation results from oil price fluctuations and
not an increase in domestic money supply. Olaokun (2000), in a related study, arrived at some
interesting conclusions; He showed that oil price increases exerts a negative effect on the
economies of Ghana and Nigeria (although the later is an oil-producing country), but has a positive
effect on Russia, which like Nigeria is an oil producing country. This outcome raises a lot of
questions. Relating this volatility to the Nigerian economy, Olomola (2006) has argued that oil
price volatility is highly significant in explaining GNP growth and unemployment. Okonju (2009),
after a careful assessment of Nigeria‘s growth path in post oil discovery period, judged it as having
been very rough. He explained that during the oil boom era GDP grew positively by 6.2% annually,
but the growth rate turned negative through the larger part of the 80‘s when oil prices crashed; this

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period also saw inflation rate jump to 11.8% on average, with a period peak of 41% in 1989; Gross
Domestic Investment (GDI) as percentage of GDP fell from 16.3% to 14%. However GDP growth
rate managed to turn positive (averaging about 4%) between 1988 and 1997 as a result of structural
adjustment policies (SAP). Okonju concluded that oil price volatility has been a major contributory
factor to instability in GDP growth pattern in Nigeria.

Richard and Ronald (1980) lamented the continuous over reliance of the Nigerian budget on oil
revenue. They noted that periods of oil price upheavals especially price slumps have necessitated
significant alterations in budget figures, plans, targets and even allocations to states and
government-owned parastatals and agencies. Total abandonment of policies and projects have also
characterized such times, this they opined had serious growth implications for the Nigerian
economy. Damilola (1982), reasoned along same line, recalling the increase in income, savings,
employment, public and private investments in Nigeria during the 70‘s when global oil fortunes
looked good. The Nigerian economy was expected to grow rapidly, but as Olaokun (2000) pointed
out, events did not go this way; on the contrary a slump overtook the global economy and the years
between 1978 and 1982 witnessed the deepest global recession ever since the 1930‘s. Thus all the
expectations of continuous growth in the Nigerian economy were dashed as a result of the volatility
in international crude oil prices.

Obioma (2006) explained that Nigeria became more exposed to oil price fluctuations the moment
she started importing refined petroleum products due the collapse of local refineries in the late
1980‘s. Thus, the country could not grapple with the enormous subsidy it committed itself to, so
that between 1999 and 2010, the Federal Government had adjusted its subsidy on petroleum
products back and forth approximately 8 times. This has negatively affected production,
consumption, general welfare and hence the pace of economic growth.

Some researchers have wondered why Nigeria during times of hike in crude oil prices still reported
unimpressive growth performances (such as; double digit inflation rate, huge fiscal deficits, huge
external debt and so on). Duncan (2008) defined Nigeria as a crude oil exporter and importer of
refined petroleum products. He re-stated the fact that oil price volatility tends to exert a positive
effect on the GDP growth of a net-oil exporting country and a negative effect on a net-oil importing
country. On the basis of this, Nigeria‘s situation is clearly peculiar. The literature on the
relationship between oil price volatility and economic growth volatility keeps expanding as new
economic challenges unfold. Ademola (1998) in his work ―oil price volatility or economic
volatility?‖ which was necessitated by the economic crisis of the late 1990‘s particularly in the
Asian nations, introduced a twist in the argument, arguing that there exists a two-way causation
between oil price volatility and economic volatility. He made reference to the fall in crude oil
prices in the late 1990‘s, this he adduced to the economic collapse in the Asian countries which was

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more pronounced in the 2nd quarter of 1998. During this time the demand for crude oil by the Asian
countries which had been the major consumers had fallen considerably. Ademola‘s argument has
been supported by (Oyinola, 2001; Onoja, 2002; Ayisafe, 2005). The literature on oil price
volatility and its consequences on the growth of the Nigerian economy are expanding and will
continue to as long as oil revenue still predominantly drives the Nigerian economy. This paper is a
contribution to the existing literature.

Review of Empirical Studies

The first generation studies of the economic growth effect of oil price volatility dealt with the
experience of the developed countries. However, since the 1980‘s, a number of studies for some
developing economies have produced insightful results. Studies by Mork (1989), Lee and Ralti
(1995) and Hamilton (1983) for the Pakistani economy introduces non-linear transformation of oil
prices to provide evidence of a positive relationship between increases in oil prices and economic
growth. Gary and Sunoh (1994) had found similar evidence for the Gambia. A related study by
Mork (1989), specified increases and decreases in real prices of crude oil as separate variables, His
findings were that effects of an oil price increase are different from those of decreases and that oil
price decreases are not statistically significant. (Mork, 1989) in a study for Nigeria, also found an
asymmetric relationship between oil price changes and economic growth. Loungani (1996), found a
similar evidence for the Russian economy. Evidences from the study carried out for Norway by
Olsen and Flo (1992); indicate that positive non-normalized shocks in real oil price are strongly
related to negative real growth. In another study for Nigeria, Olomola (2006) found out that oil
price volatility is highly significant in explaining GNP growth and unemployment.

However evidences from other studies have not been as straightforward as those just reviewed.
Akide (2007) investigated the impact of oil price volatility on economic growth indicators in
Nigeria using quarterly data from 1970 to 2000. He found out that within the period of study oil
price shocks did not affect output and inflation in Nigeria, but significantly influenced real
exchange rate. Also Jimenez and Sanchez (2005) empirically assessed the effect of oil price
volatility on the real economic activity of the main industrialized countries using both linear and
non-linear models. Evidence of non-linear impact of oil price volatility on real GDP was
established.

Theoretical Framework
The standard growth theories focus on primary inputs such as; Capital, labour & land, while failing
to recognize the role of primary energy inputs such as; oil deposits. However, natural scientists and
some ecological economists have made efforts at evolving some theories which capture the role of
oil price volatility on economic growth, thus incorporating the linkage between energy resources;

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its availability and volatility and economic growth. The theories reviewed in this paper are
primarily reduced-form models, rather than a single theory.

The Mainstream theory of economic growth postulates that production is the most important
determinant of growth of any economy, and production which is the transformation of matter in
some way, requires energy. This theory categorizes capital, labour and land as primary factors of
production; these exist at the beginning of the production period and are not directly used up in
production (though they can be degraded or added to). While energy resources (such as; oil and
gas, fuels, coal) are categorized as intermediate inputs, these are created during the production
period and are entirely used up during the production process. In determining the marginal product
of oil as an energy resource useful in determining economic growth, this theory considers in one
part its capacity to do work, cleanliness, amenability to storage, flexibility of use, safety, cost of
conversion and so on, it also considers other attributes such as; what form of capital, labour or
materials it is used in conjunction with. The theory estimates the ideal price to be paid for crude oil
as one that should be proportional to its marginal product.

The Linear/Symmetric relationship theory of growth which has as its proponents, Hamilton (1983),
Gisser (1985), Goodwin (1985), Hooker (1986) and Laser (1987) postulated that volatility in GNP
growth is driven by oil price volatility. They hinged their theory on the happenings in the oil
market between 1948 and 1972 and its impact on the economies of oil-exporting and importing
countries respectively. Hooker (2002), after rigorous empirical studies demonstrated that between
1948 and 1972 oil price level and its changes exerted influence on GDP growth significantly. Laser
(1987), who was a late entrant into the symmetric school of thought, confirms the symmetric
relationship between oil price volatility and economic growth. After an empirical study of her own,
she submitted that an increase in oil prices necessitates a decrease in GDP, while the effect of an oil
price decrease on GDP is ambiguous, because its effects varied in different countries.

The Asymmetry-in-effects theory of economic growth used the U.S economy as a case study. The
theory posits that the correlation between crude oil price decreases and economic activities in the
U.S economy is significantly different and perhaps zero. Mark et al. (1994), members of this
school in a study of some African countries, confirmed the asymmetry in effect of oil price
volatility on economic growth. Ferderer (1996) another member of this school explained the
asymmetric mechanism between the influence of oil price volatility and economic growth by
focusing on three possible ways: Counter-inflationary monetary policy, sectoral shocks and
uncertainty. He finds a significant relationship between oil price increases and counter-inflationary
policy responses. Balke (1996) supports Federer‘s position/submission. He posited that monetary
policy alone cannot sufficiently explain real effects of oil price volatility on real GDP.

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The Renaissance growth theory/model was an off-shoot of the symmetric and asymmetry in effect
schools. Lee (1998) who was a leading proponent of this school focused her theoretical work on
attempting to distinguish between oil price changes and oil price volatility. Lee (1998) defined
volatility as the standard deviation in a given period. She submitted that both have negative impacts
on economic growth, but in different ways: Volatility has a negative and significant impact on
economic growth immediately, while the impact of oil price changes delays until after a year. She
concludes by stating that ―it is volatility/change in crude oil prices rather than oil price level that
has a significant influence on economic growth‖.

There exist other theories on the oil price volatility effect on economic growth in the literature,
such as; the Decoupling theory, Income transfer model of growth etc. The theories reviewed are
still at their crude stage, this is vivid from the quality of their analysis, ambiguity in conclusions
and submissions and a clear absence of an econometric face. This is not unconnected to the
background of the proponents of these theories, many of whom are scientists, ecological and
environmental economists. The submissions of these theories however provide analytical
foundations on which to compose our empirical investigations.

Model Specification
From the review of literature, the discussion and examination of the theoretical framework we
specify our model. The model uses oil prices and real GDP figures, since our main objective is to
analyze the effects of change in the former on the later. This research study uses real GDP as the
measure of economic growth. The unrestricted VAR model of order P is presented in equation 1;

Yt = AiYt +…..+ ApYt-p + Bzt+Et ---------------------------------------1

Zt = [constant, D1, D2, D3, D4, D5, D6, D7]

Where;
Yt is the vector of endogenous variables
Zt is the vector of exogenous variables
Ai and B are coefficient matrices
p is the lag length
Et is an unobservable zero-mean white noise process.
D1 – D7 are the variables chosen from 1970-2010 for the VAR model.
OPRV is measured by deriving the standard deviation of international oil prices between 1970 and
2010 over four quarters.

Using Cholesky (1977), this research work assumes the following ordering of the seven variables
used in the VAR: Oil Price Volatility (OPRV), Real GDP (RGDP), Real government expenditure

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(RGOVEX), Real exchange rate (REEX), Inflation rate (INFL), Real money supply (RMS), Real
imports (RIMP), (real money supply represents the monetary sector, while real imports represents
the external sector, so that the three broad sectors of the economy are captured in the model) This is
necessary because the orthogonalization method involves the assignment of contemporaneous
correlations only to specific series.

Data employed for the analysis are obtained from the Central Bank of Nigeria (CBN). The VAR
method allows us assess the relative importance of a particular variable in the changes of other
variables. Another advantage of this technique is that it circumvents the problem involved with the
specification and estimation of structural simultaneous equations. This is because the VAR model
considers all variables as endogenous. Our empirical analysis will involve 3 steps; Unit root test for
the variables, Granger causality test and Forecast Error Variance Decomposition (FEVD).

EMPIRICAL ANALYSIS AND POLICY IMPLICATIONS OF EMPIRICAL

RESULT

This section presents the empirical results of the analysis beginning with the time series properties
of the variables used for the estimation.

Unit Root Test for variables

The analysis is based on time series data. This therefore requires some specific approaches to the
analysis. It is generally known that the econometric estimation of a model based on time series data
demands that the series be stationary, as non-stationary series usually results in mis-leading
inferences. Engle and Granger (1987) provide a standard technique to deal with this problem. This
involves testing the variables of an equation for stationarity by running the regressions for all the
series at both first difference and levels and, with constant and trend in the equation employing the
Augmented Dickey and Fuller (1979) (ADF) tests. The ADF-tests are reported in table 1 appendix.

The result of the ADF unit root test presented in table 1 appendix establishes the existence of non-
stationarity in all the data series (except inflation) in level, as the absolute values of ADF test
statistic of the variables (in level) were less than the absolute (values of the) 95% critical value of
the ADF statistic, thus signaling the non-stationarity of six (6) of the variables. However, upon 1st
differencing non-stationarity in the data series of these 6 variables is gotten rid of and stationarity
was attained. Meaning the hypothesis of unit root could not be rejected at the 1% level.

Having established the foregoing, we proceeded to establish the causality tests;

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Testing for Significance and Granger-Causality

This research study investigates the relationship between oil price volatility and the
macroeconomic variables selected in the model. Table 2 appendix reports the results of the
Pairwise Granger Causality Tests. The first line results display the Granger causality test of the
response of inflation to oil price volatility. The results from the table indicate that at an F-ratio of
4.201, the null hypothesis cannot be accepted. Thus oil price volatility significantly granger causes
inflation rate even at the conservative 1% level of significance. Similarly, the 7 th line results follow
similar analysis. With the F-ratio of 4.071, it is difficult for us to accept the given null hypothesis,
leaving us with the option of accepting the implied alternative hypothesis that oil price volatility
granger causes real exchange rate in Nigeria. Focusing on the direction of causality between oil
price volatility and real government expenditure, the 9 th line of this result reports this causality. At
1% significant level, the F-statistic value of 3.74 passes the significant test and gives us enough
evidence to accept the alternative hypothesis that oil price volatility granger causes government
expenditure. Expectedly, line 18 indicates that with an F-value of 4.99, causality running from real
money supply to real GDP is significant, thus real money supply granger causes real GDP in
Nigeria. By way of summing up, the results show that the interaction between oil price volatility
and major macroeconomic variables in Nigeria is generally significant with the direction of
causality going in at least one direction across all the oil price specifications. Interestingly however,
the results reveal that we cannot reject the hypothesis of non-causality running from oil price
volatility to real GDP.

Forecast Error Variance Decomposition

The series of analysis in the VAR methodology is the Forecast Error Variance Decomposition
(FEVD). Here, we determine the percentage of variances in each endogenous variable that is
determined by the other variables. This can help provide the amount of influence the endogenous
factors exert on each other. The Forecast Error Variance Decomposition results are reported in
table 3 appendix.

The variance decomposition suggests that shocks to oil prices as presented in table 3 (appendix)
had the greatest impact on real exchange rate throughout the period of the analysis. It increased
steadily and significantly overtime. Oil price volatility accounted for about 4% of shocks to real
exchange rate in the first quarter, increasing in effect to about 15% in the tenth quarter and further
to about 19% in the fifteenth quarter. It increased further to about 22% in the twentieth quarter and
peaked at about 24% in the twenty-fifth quarter. Other variables which had significant impacts on
variations in real exchange rate were; real government expenditure and change in commodity prices
(inflation). Real government expenditure accounted for about 10% of variations in real exchange
rate in the first quarter; it however declined minimally to about 9% in the fifth quarter and further
to about 7% in the tenth quarter. By the fifteenth quarter its contribution had fallen further to about

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6% and then averaged about 5% through the twenty-fifth quarter. However, inflation rate had an
increasing effect on real exchange rate. Its contribution increased from 0 in the first quarter to about
2% in the fifth quarter, this increased to about 5% in the fifteenth quarter. From the fifteenth
quarter to the twenty-fifth quarter the contribution of inflation to variations in real exchange rate
averaged about 7%. The error decomposition of real government expenditure shows that through
the first ten quarter period of the analysis, real government expenditure variations were mostly
explained by itself, after which the effect declined over time. The two other variables that had
considerable impact on its variations were real exchange rate and oil price volatility. Real exchange
rate contributed about 3% to variations in real government expenditure in the tenth quarter after
having not contributed in the first and fifth quarters. This rise continued to about 6% in the fifteenth
quarter and then about 10% in the twentieth quarter, its contribution finally peaked at about 15% in
the twenty-fifth quarter. Expectedly, the result shows that the response of real government
expenditure to shocks in oil prices was significantly different from zero. In the fifth quarter it
accounted for about 1% this increased considerably to about 4% in the tenth quarter and then
declined to about 3% in the fifteenth quarter, by the twentieth quarter its effect had risen to about
4%, with a further rise to about 6% in the twenty-fifth quarter.

However, the empirical result indicates that real GDP largely explains itself for the first ten quarter
period of the analysis, after which its explanatory power declines substantially. Specifically, the
empirical result indicates that real government expenditure accounted for the largest variations in
real GDP. For instance about 3% of the shocks in real GDP in the fifth quarter were as a result of
variations in real government expenditure. This rose to about 12% in the tenth quarter and then
about 15% by the fifteenth quarter, by the twentieth quarter it accounted for about 17% of
variations and finally, 19% in the twenty-fifth quarter. The contribution of oil price volatility was
insignificant over the period of the analysis, averaging just 1%. Furthermore, the contributions of
real exchange rate, inflation rate and real imports were also significant. While real exchange rate
accounted for about 15%, 16% and 18% of variations in real GDP in the fifteenth, twentieth and
twenty-fifth quarters respectively, inflation rate persistently increased its contribution to variations
in real GDP from about 6% in the fifteenth quarter to about 7% in the twentieth quarter and then
about 9% in the twenty-fifth quarter. The contribution of real import to variations in real GDP was
not different, averaging about 9% through the fifteenth to twenty-fifth quarters of the analysis. The
real import response to a shock in oil prices is positive and significantly different from zero. This
positive response of real imports to oil price volatility lasts until the end of the period of analysis.
As indicated by the table its contribution declined to about 2% in the fifth quarter from about 3% in
the first quarter. It deepened further to about 1% in the fifteenth quarter, but rises to about 3% in
the twentieth quarter and further to 5% in the twenty-fifth quarter. Government expenditure
accounted largely for variations in real imports. It accounted for about 16% of variations in the first
quarter, and then about 24% in the fifth quarter, this rise continued to about 45% in the fifteenth

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quarter, by the twenty-fifth quarter, real government expenditure accounted for about half of the
variations in real imports. Real exchange rate also had a significant impact on real imports,
accounting for about 11% of variations in the fifteenth quarter and about 22% in the twenty-fifth
quarter. This confirms the strong linkage between government, real exchange rate and real imports
in the Nigerian economy. Finally, real GDP and oil price volatility accounts for the largest share of
variations in inflation rate. Real GDP accounted for about 6% of changes in commodity prices in
the first quarter, increasing to about 10% in the fifth quarter and then to about 14% through the
twenty-fifth quarter. Oil price volatility explained only 0.88% of changes in inflation rate in the
first quarter; it however rose to about 13% in the tenth quarter, its contribution to variations in
inflation rate averaged about 13% through the twenty-fifth quarter. Similarly, real government
expenditure also had significant impact on variations in inflation rate within the period of analysis.
It accounted for about 2% of total variations in the first quarter and then about 3% in the fifth
quarter. It steadily increased to about 10% in the fifteenth quarter, and then averaged at about 11%
through the twenty-fifth quarter. Other variables were not significant in explaining variations in
inflation rate in Nigeria within the period of analysis.

An interesting aspect of the result is that variations in real money supply were almost totally
explained by real government expenditure. Government expenditure accounted for about 30% of
variations in money supply in the first quarter, this rose to about 44% in the fifth quarter, this
further increased to about 67% in the fifteenth quarter. Through the twenty-fifth quarter, its
contribution averaged 69%. Also the contribution of oil price volatility was significantly different
from zero. Oil price volatility accounted for 0.02% of variations in real money supply in the first
quarter; this increased to about 2% in the tenth quarter and then accounted for about 6% in the
twentieth quarter, through the twenty-fifth quarter. Inflation also contributed significantly,
fluctuating between 3% and about 6% within the first and tenth quarter. It then settled at about 3%
through the twenty-fifth quarter. The contributions of the other variables were insignificant.

Policy Implications of Regression Results

The estimates of the models that are outlined in the previous sub-sections give us results that are
instructive and far-reaching in policy implications. Firstly, the Forecast Error Decomposition result
suggests that shocks to real exchange rate in all twenty-five quarters were accounted considerably
for by oil price volatility. As a net-oil exporter, Nigeria‘s real exchange rate appreciates when oil
price hike facilitates higher inflow of foreign exchange into the economy. Although, this may
sound good for the economy, it, however, has serious implications on real economic activities and
the foreign scene due to the heavy reliance of the economy on foreign inputs. This finding is
consistent with (Amano and Norden, 1998; Olomola, 2006). Specifically, the introduction of SAP
in the 1980‘s marked a new era in Nigeria‘s exchange rate policy—it was deregulated. Post-SAP
period has witnessed a steady depreciation of the Naira exchange rate. Cost of production in

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Nigeria has been very high relative to other countries. Simply because amongst other reasons, the
dollar value of imported (both intermediate and final) technology required for production in terms
of the Naira is extremely high. As a result the country has become a dumping ground for foreign
goods which are far cheaper than the Nigerian made goods. Considering this fact, the country has
rolled out a number of policies aimed at protecting and promoting locally made products, these
policies however have been academic, as the imported goods predominantly ‗China goods‘ have
continued to flourish in our markets, basically because of their affordability. Secondly, the result
showed that oil price volatility had a significant effect on real government expenditure. Increase in
oil prices had the effect of increasing government expenditure. The result confirms the huge
monetization of crude oil receipts and subsequent increase in government expenditure explained
earlier. This finding however, contradicts that of Farzanegan and Markwardt (2007) where positive
oil shocks accounted for an insignificant variation in government expenditure. Another finding
from the result was that real exchange rate impacted heavily on real government expenditure; this
might not be unconnected with the over-dependence of the government budget on oil prices (oil
benchmarking). Hence, the prevailing exchange rate of the dollar to the Naira on receipt of the
dollar value of its oil, influences government ability to well meet its domestic capital and re-current
expenditure obligations. The implication of this result is that oil price volatility has a direct as well
as indirect effect on government expenditure, with the later effect been through real exchange rate.

The third aspect of the result is the indirect and marginal impact of oil price volatility on real GDP
in Nigeria. This contradicts the expectations that oil price shocks tend to lower real GDP (Gordon,
1989) and impacts significantly on it (Farzanegan and Markwardt, 2007), rather it confirms the
findings of (Barsky and Kilian, 2004) as well as (Akpan, 2009), that oil price shocks had marginal
impact on real GDP. An explanation for the rather weak causality between oil price volatility and
real GDP as demonstrated by the result is suggested. Oil price volatility may not have a direct
impact on real GDP in Nigeria; rather it works through real government expenditure and real
exchange rate as indicated by the result. Characteristically, government has remained the major
driver of the Nigerian economy; therefore through its expenditure it dictates the growth trend and
speed of the economy. The implication of this result therefore is that at the prevailing exchange
rate, oil prices determine government’s expenditure which in turn determines growth in Nigeria.

Another explanation which can be put forth is the difference in estimation periods. Some related
studies such as; (Akpan, 2009; Aliyu, 2009), which employed estimation periods of 1980-2009 and
1981-2008 respectively, reported a direct significant impact on real GDP by oil price volatility. But
the studies of (Olomola, 2006) that used an estimation period similar to this study, reported a
weakly significant impact of oil price volatility on real GDP. This implies that the period chosen
for the analysis could be considered as a likely factor. Another likely explanation is the recent
economic diversification goal being pursued by policy makers at all levels in the country. There has

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been a lot of effort geared towards reducing the dependence on oil. Some state governments have
improved their tax collection mechanisms so as to reduce their reliance on the oil determined
revenue allocations from the Federal government. If these efforts are anything to go by, the
implication ordinarily will be that the direct causality between oil price volatility and real GDP
should expectedly fade away. A fourth consideration in this direction is the significant impact of oil
price volatility on inflation rate. The results of the VDC showed an increasing effect of oil price
volatility over the period; from 0.88% in the first quarter to 13% by the tenth quarter. This implies
that oil price changes will stir up price instability in the country. This can be adduced to the ―Dutch
disease‖ and the ―Spending effect‖. The findings of Barker and Paul (2004), that oil price changes
can significantly affect inflation rate confirms the results of this study.

Another interesting angle to the analysis is the tremendous impact of real government expenditure
on variations in real money supply in Nigeria. Following from the explanation on the dominant role
of government in Nigeria, this result should not be surprising. Government is the largest employer
of labour in Nigeria. This implies that government dishes out the lion share of liquid assets (cash)
circulating in the economy by way of salaries, benefits, compensations, subsidies, subventions,
periodic allocations, which all form part of government expenditure. Expectedly, the result shows
that real exchange rate impacts significantly on real imports in Nigeria. The depreciated Naira was
expected to reduce imports, but that has not been the case. On the other hand, Nigeria has been
importing refined petroleum products over the last two decades, this also accounts for the
significant impact government expenditure has on real imports. Exchange rate stabilization policies
should be implemented, while measures at controlling ―unnecessary imports‖ should be taken. In
conclusion, the effect of oil price volatility on the economy can be said to be rather divergent.
While the effect on some variables have been significant, the effect on others have been either
weakly significant or insignificant.

RECOMMENDATIONS AND CONCLUSION

Recommendations
This paper has analyzed particular effects arising from oil price volatility on the growth of the
Nigerian economy. On the basis of this, some recommendations are put forward to ensure
sustainable growth of the Nigerian economy,
i. Policy makers should strengthen manufacturing through tax incentives and infrastructural
development by way of public-private sector partnership in order to create the enabling
environment for local and foreign investment.
ii. The country‘s refineries should either be privatized or re-positioned, while crude oil
should be supplied to them at less than international prices. This will put an end to the
incessant fuel shortage experienced in the country.

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iii. Concrete steps aimed at decoupling budgetary management from oil-revenue inflows
should be taken. The Fiscal Responsibility Act and the recent oil wealth fund are steps in
the right direction.
iv. More stringent policies to discourage importation, especially of items which can be readily
purchased within the country, should be formulated and implemented to the letter.

Since real government expenditure significantly impacted on virtually all the other variables, it is
important government spending is not increased rapidly to levels which may become unsustainable
if oil prices fall in future. Fiscal prudence should be expressed through spending plans, with the
citizenry‘s welfare as its main objective.

In addition, the current practice whereby the Federal government of Nigeria solely controls
exploration rights of mineral resources anywhere and everywhere it may be located within the
country should be reviewed with a view to giving states some autonomy. Furthermore, it is
recommended that the monetary sector should be more vibrant, as it is the ―watch dog‖ of the
economy, considering the fact that Nigeria is renowned to possess an under-developed capital
market, a very large informal sector and a porous/loose financial system. Finally, the diversification
policy drive of government should not just focus on agriculture alone, rather its rich untapped solid
mineral deposits should be exploited. Lastly, Accountability, corporate governance and
responsibility should be cultivated as core values by all stakeholders to ensure that Nigeria‘s
growth ambitions remain firmly on track.

CONCLUSION

This study assessed the consequence of oil price volatility on the economic growth and
development of the Nigerian economy between 1970 and 2010. The focus was on the relationship
between oil price changes and selected macroeconomic variables with particular emphasis on real
GDP which acted as proxy for economic growth. The instruments of data analysis are the Granger-
causality tests and the Vector Autoregressive (VAR) techniques. As a first step the Augmented
Dickey Fuller (ADF) test showed that six of the seven variables used in the study namely; oil price
volatility, real GDP, real government expenditure, real exchange rate, real import and real money
supply were non-stationary in their levels, but achieved stationarity at first difference. The variables
were entered into the VAR model in an ordering which follows the intuition of the researcher and
in line with the Cholesky laid down criteria. Results from the Granger-causality tests and VAR
permit us to conclude that the interaction between oil price volatility and macroeconomic variables
in the Nigerian economy is significant, with the direction of causality going in at least one
direction. However, an interesting observation was made in the nature of causality between oil
price volatility and real GDP. Oil price volatility is found to impact on real GDP, through other

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variables in the economy. The variables were found to be real government expenditure and real
exchange rate, simply referred to as ―impact variables‖ in Economics. This finding is confirmed by
other related studies. (See sub-section 4.4 for explanations).

From the findings, it was observed that ―Oil price at the prevailing exchange rate determines the
level of government spending, which in turn determines real GDP‖. Overall, it can be said that
there is a crucial relationship between oil price volatility and economic growth and due to the fact
that the Nigerian economy is highly vulnerable to oil price changes, expected growth targets are
hardly met.

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APPENDIX

Table-1. Summary of Result for Unit Roots Test of Variables

Variables ADF Lag ADF test Statistic 95% critical value for the Remark
ADF Statistic
OPRV 1 -0.933478 -2.8801 Non-Stationary
RGDP 1 -2.079468 -2.8799 Non-Stationary
RGOVEX 1 -0.091294 -2.8799 Non-Stationary
REEX 1 -0.069071 -2.8799 Non-Stationary
INFL 1 -4.109861 -2.8799 Stationary
RMS 1 1.637732 -2.8799 Non-Stationary
RIMP 1 -0.332549 -2.8799 Non-Stationary
DOPRV 1 -5.025705 -2.8800 Stationary
DRGDP 1 -6.820084 -2.8800 Stationary
DRGOVEX 1 -6.253270 -2.8800 Stationary
DREEX 1 -4.557885 -2.8800 Stationary
DINFL 1 -5.486349 -2.8800 Stationary
DRMS 1 -26.15264 -2.8800 Stationary
DRIMP 1 -6.117871 -2.8800 Stationary
Note: Dickey-Fuller Regressions include an Intercept and a linear trend.
Source: Author‘s Results Using E-views.

Table-2. Summary of results for the Forecast Error Variance Decomposition

Variance Decomposition of OPRV
Period S.E. Oprv Rgdp Rgovex Reex Infl Rms Rimp
1 0.009995 100.0000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000
5 0.047241 93.49504 0.861945 4.746571 0.057023 0.255780 0.145435 0.438201
10 0.055304 74.96952 3.957954 16.01444 0.627148 0.219542 3.382599 0.828804
15 0.056891 72.06586 4.302276 17.20838 1.105099 0.346066 3.811691 1.160624
20 0.057211 71.51677 4.440430 17.03788 1.202698 0.742451 3.778070 1.281710
25 0.057351 71.19355 4.548817 16.95786 1.229016 0.769830 3.808214 1.492710

Variance Decomposition of RGDP

1 0.075749 0.116533 9.88347 0.000000 0.000000 0.000000 0.000000 0.000000
5 0.242637 0.058540 91.99949 3.342377 0.189656 0.008895 3.794889 0.606153
10 0.270366 4.292087 0.052889 0.84402 3.377134 2.621404 3.284385 5.528080
15 0.325902 3.705664 0.077303 76.02527 6.949374 3.437225 4.724856 5.080309
20 0.378984 4.727300 0.098548 72.91848 10.78233 2.824173 4.513374 4.135791
25 0.425522 6.670427 0.201876 69.05926 13.90276 2.249247 4.335029 3.581404

Variance Decomposition of RGOVEX

1 0.046106 0.309076 0.248801 99.44212 0.000000 0.000000 0.000000 0.000000
5 0.185685 1.401942 0.020150 95.26844 0.646296 0.526609 0.598970 1.537598
10 0.270366 4.292087 0.052889 80.84402 3.377134 2.621404 3.284385 5.528080
15 0.325902 3.705664 0.077303 76.02527 6.949374 3.437225 4.724856 5.080309
20 0.378984 4.727300 0.098548 72.91848 10.78233 2.824173 4.513374 4.135791
25 0.425522 6.670427 0.201876 69.05926 13.90276 2.249247 4.335029 3.581404

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Variance Decomposition of REEX

1 0.052242 0.740266 0.270797 10.11625 88.87268 0.000000 0.000000 0.000000
5 0.212797 3.274547 0.288358 9.573110 84.32200 1.765182 0.087175 0.689629
10 0.361242 14.34455 0.301330 7.465599 71.36477 5.327485 0.122025 1.074239
15 0.451142 18.99467 0.459427 6.396064 65.88685 7.133425 0.341458 0.788103
20 0.506291 22.26525 0.763387 5.792353 62.36130 7.320967 0.811056 0.685688
25 0.539850 24.21844 1.106787 5.659672 59.50197 7.249609 1.467331 0.796197

Variance Decomposition of INFL

1 0.170258 0.881896 5.900053 2.248032 0.285546 90.68447 0.000000 0.000000
5 0.534746 3.445223 9.976532 3.167031 0.813537 82.50914 0.031734 0.056804
10 0.665274 13.15063 12.61302 5.373210 1.744169 66.57855 0.400199 0.140220
15 0.717111 12.95375 13.95477 10.81862 2.504664 57.42898 1.689724 0.649490
20 0.735166 12.98389 14.58107 12.03938 2.878609 54.69192 2.072374 0.752760
25 0.738405 12.93096 14.89212 11.98696 2.889156 54.29018 2.063226 0.947400

Variance Decomposition of RMS

1 1 0.142188 1.465713 29.90223 0.045817 3.019969 65.42408 0.000000
5 0.102256 0.367040 0.637223 44.08197 0.123700 6.529105 48.07788 0.183089
10 0.177561 2.419841 0.232567 58.15206 0.453709 5.572181 32.96528 0.204353
15 0.247184 4.361254 0.128298 67.20977 1.641185 3.937308 22.21354 0.508642
20 0.306685 5.753647 0.123765 69.04292 3.352520 3.398615 17.44289 0.885643
25 0.357098 6.381869 0.164416 68.99691 5.282543 3.145013 15.05047 0.978770

Variance Decomposition of RIMP

1 0.065899 3.772981 0.415052 16.34752 0.117844 0.043264 0.004320 79.29902
5 0.235094 2.052242 0.711874 23.98596 0.189387 0.642689 0.419708 71.99814
10 0.346492 1.236452 0.463242 45.38562 3.991972 1.649460 1.172248 46.10100
15 0.450422 1.255395 0.329299 54.21267 11.25625 3.285475 1.264441 28.39647
20 0.529493 3.356947 0.276328 53.19547 17.98639 2.577015 1.146538 21.46132
25 0.588715 5.517519 0.356024 50.32819 22.69577 2.169442 1.200951 17.73210

Table-3. Granger Causality tests results

Pairwise Granger Causality Tests
Date: 07/08/11 Time: 07:07
Sample: 1970:1 2010:4
Lags: 3
Null Hypothesis: Obs F-Statistic Probability
OPRV does not Granger Cause INFL 157 4.20127 0.03030
INFL does not Granger Cause OPRV 0.36461 0.77865
REEX does not Granger Cause INFL 157 0.08201 0.96973
INFL does not Granger Cause REEX 1.00097 0.39424
RGDP does not Granger Cause INFL 157 0.38459 0.76425
INFL does not Granger Cause RGDP 0.26057 0.85370
RGOVEX does not Granger Cause INFL 157 0.40913 0.74666
INFL does not Granger Cause RGOVEX 0.37206 0.77328
RIMP does not Granger Cause INFL 157 0.55845 0.64327
INFL does not Granger Cause RIMP 0.30671 0.82051
RMS does not Granger Cause INFL 157 0.22528 0.87870
INFL does not Granger Cause RMS 1.38244 0.25039
REEX does not Granger Cause OPRV 157 0.82906 0.47983

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OPRV does not Granger Cause REEX 4.07063 0.03410

RGDP does not Granger Cause OPRV 157 2.18809 0.09182
OPRV does not Granger Cause RGDP 0.21980 0.88254
RGOVEX does not Granger Cause OPRV 157 2.06584 0.10717
OPRV does not Granger Cause RGOVEX 3.74130 0.41006
RIMP does not Granger Cause OPRV 157 1.51214 0.21372
OPRV does not Granger Cause RIMP 0.26563 0.85009
RMS does not Granger Cause OPRV 157 2.30886 0.07877
OPRV does not Granger Cause RMS 0.07028 0.97573
RGDP does not Granger Cause REEX 157 2.23235 0.08681
REEX does not Granger Cause RGDP 1.74304 0.16065
RGOVEX does not Granger Cause REEX 157 1.21729 0.30552
REEX does not Granger Cause RGOVEX 1.24775 0.29458
RIMP does not Granger Cause REEX 157 0.77530 0.50952
REEX does not Granger Cause RIMP 2.55572 0.05750
RMS does not Granger Cause REEX 157 1.99999 0.11645
REEX does not Granger Cause RMS 0.64532 0.58707
RGOVEX does not Granger Cause RGDP 157 1.75839 0.15761
RGDP does not Granger Cause RGOVEX 1.06782 0.36466
RIMP does not Granger Cause RGDP 157 8.66764 2.4E-05
RGDP does not Granger Cause RIMP 0.19790 0.89769
RMS does not Granger Cause RGDP 157 28.1205 1.7E-14
RGDP does not Granger Cause RMS 4.99308 0.00249
RIMP does not Granger Cause RGOVEX 157 2.20024 0.09041
RGOVEX does not Granger Cause RIMP 2.99560 0.03271
RMS does not Granger Cause RGOVEX 157 1.24221 0.29654
RGOVEX does not Granger Cause RMS 8.86731 1.9E-05
RMS does not Granger Cause RIMP 157 1.67336 0.17518
RIMP does not Granger Cause RMS 3.80037 0.01159

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