Oil Price Shocks and the Nigerian Economy : A Forecast Error Variance Decomposition Analysis

This study investigates the impacts of oil price shocks on the macroeconomic performance in Nigeria using Vector Autoregression (VAR) approach. Forecast error variance decomposition is estimated using seven key macroeconomic variables namely, real gross domestic product, consumer price index, real oil revenue, real money supply, real government recurrent expenditure, real government capital expenditure and real oil price. An annual data between the periods 1970-2005 were employed. The Johansen cointegration test identifies at least four cointegrating vectors among the variables. The forecast error variance decomposition estimated from the VAR model shows that oil price shocks significantly contribute to the variability of oil revenue and output. On the other hand, the result reveals that oil price shock does not have substantial effects on money supply, price level and government expenditure in Nigeria over the period covered by the study. This is evident, as its contributions to the variability of these variables are very minimal. The study again reveals that the variability in the price level, apart from its own shock, is explained substantially by output and money supply shocks. Also, apart from its own shock, the variability in money supply is also explained by price level and output. This finding confirms, therefore, that oil price shock may not be necessarily inflationary especially, in the case of an open developing economy like Nigeria. The policy implication of this is that fiscal policy can be used more effectively to stabilise the domestic economy after an oil shock