Testing the non-linearities of exchange rate pass-through in Somalia: does dollarization affect consumer prices?

Abstract

Over the past three decades, Somalia’s economic landscape has witnessed a noticeable dependence on imported goods. The exchange rate was unregulated owing to the collapse of the country’s central bank. This unregulated environment has introduced significant volatility in exchange rates, profoundly impacting consumer prices and fostering a prevalent shift towards the utilization of the US dollar in economic transactions. Hence, this undertaking delves into the asymmetric effects of exchange rates on consumer prices in the presence of dollarization in Somalia from 1995 to 2019. Employing both linear and nonlinear autoregressive distributed lag (NARDL) cointegration methodologies, we explore the short-run and long-run dynamics between exchange rates and consumer price levels. The long-run empirical results from the NARDL demonstrate asymmetrical cointegration between the unregulated exchange rate and inflation in Somalia. Both appreciation and depreciation of exchange rates exert differing impacts on consumer prices, with depreciation exhibiting a more pronounced effect. In addition, the evidence suggests that the exchange rate pass-through is incomplete in Somalia regarding its inelastic coefficient. Oil prices exhibit a substantial and statistically significant association with inflation, both in the long-run and short-run, while GDP remains inconsequential. In the short-run, the most remarkable outcome indicates that dollarization significantly contributes to mitigating inflationary pressures. Based on our empirical insights, the central bank should enhance regulatory oversight of the foreign exchange market by strictly controlling and prohibiting the issuance of counterfeit banknotes to achieve price stability.

Impact statement

This research comprehensively analyzes the complex dynamics between exchange rate fluctuations and consumer prices in Somalia, revealing a pronounced asymmetry. Through sophisticated modeling, the study demonstrates that exchange rate depreciations significantly impact inflation more than appreciations, a finding critical for effective monetary policy in dollarized economies like Somalia. The findings indicate the need for robust regulatory frameworks to mitigate the adverse effects of exchange rate fluctuations on the economy. This work is instrumental for policymakers, providing evidence-based recommendations to enhance regulatory measures aimed at stabilizing prices and managing inflationary pressures. Additionally, it contributes to the broader economic literature by detailing the unique challenges and strategies relevant to managing economies with significant dollarization.

Keywords:

• Inflation
• dollarization
• oil prices
• exchange rate pass-through
• NARDL
• Somalia

Reviewing Editor:

• Goodness Aye, University of Agriculture, Makurdi Benue State, Nigeria

Subjects:

• International Finance
• Economic Forecasting
• Econometrics
• Macroeconomics
• Economics
• International Economics

Authors’ Contributions

The authors have contributed significantly to the conception, design, and development of this article. Abdikafi Hassan Abdi was responsible for writing the first draft of the article, the introduction, and literature review, as well as reviewed and edited the manuscript. Abdimalik Ali Warsame was responsible for the data collection, analysis, writing the discussion section, reviewed and edited the manuscript. Ibrahim Abdukadir Sheik-Ali wrote the econometric methodology and data section.

Disclosure statement

The authors do not have any competing financial, professional, or personal interests from other parties.

Data availability

The datasets used and/or analyzed during the current study are available on a reasonable request.

Additional information

Funding

This research is supported by SIMAD University, Somalia (Grant number: SU-PG-2023-015).

Notes on contributors

Abdikafi Hassan Abdi

Mr. Abdikafi Hassan Abdi is a researcher and lecturer at the Faculty of Economics, SIMAD University. He earned an MSc in Economics from Universiti Kebangsaan Malaysia (UKM) in December 2021. In addition, Mr. Abdi is the Head of Research at the Institute of Climate and Environment (ICE), SIMAD University. His research interests mainly focus on environmental economics, econometric modeling (time series and panel data), technological change and growth, sustainable development, and international trade. Up to now, Mr. Abdi has published over 10 papers in high-impact refereed journals.

Abdimalik Ali Warsame

Mr. Abdimalik Ali Warsame is a researcher and lecturer at SIMAD University. He holds a Bachelor’s degree and Master’s degree in Economics from the SIMAD University and University Putra Malaysia (UPM), respectively. His research interests are focused on climate change, sustainable environments, environmental and resource economics, agriculture economics, and energy economics. He has published more than 25 papers in high-impact peer-reviewed journals. Out of curiosity about research, Abdimalik has been working as a lecturer and researcher at the Faculty of Economics at SIMAD University and different research institutions since 2020.

Ibrahim Abdukadir Sheik-Ali

Mr. Ibrahim Abdukadir Sheik-Ali is a researcher and lecturer, who holds a Master’s degree in Economics from the University of Malaya. His research interests mainly focus on international economics, environmental economics, agriculture economics, and energy economics. Mr. Sheik-Ali has published over 10 research articles in high-impact peer-reviewed journals. In addition, he works with various research institutions and international companies.