Interest Rate and Exchange Rate Thresholds in Explaining Inflation Dynamics in Nigeria: Evidence from NARDL and Threshold Regression Models

This study examines the impact of the exchange rate and the monetary policy rate (MPR) on inflation trends in Nigeria using a nonlinear framework of NARDL and threshold regression approach from 2001Q1 to 2024Q4. Three long-run models are estimated for headline, food and core inflation within a nonlinear autoregressive distributed lag (NARDL) framework to capture asymmetric short-run and long-run responses to monetary policy and exchange rate shocks. To further evaluate policy effectiveness across different macroeconomic regimes, a threshold regression approach by Tong H. (1978) is employed to identify critical interest rate levels at which monetary tightening becomes effective. The NARDL results for core inflation show that increases in the MPR have no significant effect, while decreases in the MPR significantly increase core inflation at the 5% level, it shows an asymmetric transmission. Exchange rate depreciation strongly and significantly increases core inflation, indicating a high exchange rate pass-through. For food inflation, both positive and negative changes in the MPR have no significant long-run effect, while exchange rate depreciation significantly increases food prices. The results for headline inflation indicate weak and asymmetric monetary transmission, increases in the MPR have no significant effect, while decreases in the MPR slightly increase headline inflation. On the other hand, exchange rate depreciation consistently and significantly increases headline inflation. The threshold regression results reveal that monetary tightening becomes effective only when the MPR exceeds a critical threshold of 26.75%. Below this level, policy rate increases are either ineffective or inflationary. These findings show that inflation in Nigeria is mostly caused by exchange rate pass-through and supply-side factors. The study concludes that effective inflation control in Nigeria requires a combination of monetary tightening, exchange rate management and structural reforms that reduce supply-side challenges and import reliance.