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1 2014

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Determination of the optimal exchange rate via control of the domestic interest rate in Nigeria

Ekhosuehi V. U., Ogbonmwan S. M.

Operations Research and Decisions

2014

Vol. 24, No. 1

23--36

An economic scenario has been considered where the government seeks to achieve a favourable balance-of-payments over a fixed planning horizon through exchange rate policy and control of the domestic interest rate. The dynamics of such an economy was considered in terms of a bounded optimal control problem where the exchange rate is the state variable and the domestic interest rate is the control variable. The idea of balance-of-payments was used as a theoretical underpinning to specify the objective function. By assuming that, changes in exchange rates were induced by two effects: the impact of the domestic interest rate on the exchange rate and the exchange rate system adopted by the government. Instances for both fixed and flexible optimal exchange rate regimes have been determined. The use of the approach has been illustrated employing data obtained from the Central Bank of Nigeria (CBN) statistical bulletin.