Exchange Rate Fluctuation Literature Review

CHAPTER TWO

2.0 LITERATURE REVIEW

For the purpose of achieving the objective of this study, it is pertinent to review previous works on this subject that will provide us with adequate conceptual, theoretical and empirical background for accessing the relevance and contribution of this study. The study tries to examine the relationship or linkage that exists between exchange rate fluctuation and employment paying attention to the manufacturing sector using analytical and econometric research tools.

2.1 CONCEPTUAL REVIEW

2.1.1 Exchange rate

Exchange rate as a term refers to the rate of exchange of one nation’s currency to another. According to Sloman and Wride (2009), it is the rate at which one currency trades for another on the foreign exchange

It was then that the floating or flexible exchange rate system was adopted, it was a regime where two separate rates operated in the foreign exchange market – the First Tier and Second Tier exchange rates. The official rate was the first-tier while the second tier which was CBN oriented was used by the CBN to achieve certain desired goals.

The year 1987 witnessed the merger of both the first-tier and second-tier exchange rates into a single rate, the Foreign Exchange Market (FEM). This was due to the abuses and multiplication of rates that was going on which further led to the depreciation of the naira. Later in 1988, there was a merger of the FEM to an autonomous rate to produce an Inter-bank Foreign Exchange Market (IFEM) as the exchange rate of the naira that experienced continuous fluctuations in a bid to raise the value of the naira. The dual exchange rate was again introduced in 1995 which was called the Guided Deregulation. Later, a decree was promulgated establishing the Autonomous Foreign Exchange Market (AFEM) for private source of exchange rate. The exchange rate at the AFEM was determined by the market however, the CBN occasionally intervened to bring about stability of the naira exchange

It was first developed in large part to understand how alternative exchange-rate regimes work and how the choice of exchange-rate regime impinges on monetary and fiscal policy (Floden, 2010). It is described as the dominant policy paradigm for studying open-economy monetary and fiscal policy (Obstfeld and Rogoff, 1996). The model is a close relative of the IS-LM, extending beyond it to the case of an open economy. Like the IS-LM model, the Mundell-Fleming model assumes a fixed price level and then shows the causes of short-run fluctuations in aggregate income (or, equivalently, shifts in the aggregate demand curve). The differing area is that the Mundell-Fleming model assumes an open economy whereas the IS-LM assumes a closed economy. The Mundell-Fleming model has been used to argue that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy (Warren and William,