The Curious Case of Petro-Monetary Transmission Mechanism in Oil-Producing Countries: An Analysis of the Effect of Oil Price on Inflation in Nigeria

Using Nigeria as a case study, this study shows that changes in oil price is central to the monetary transmission mechanism in oil-producing countries; a phenomenon which can be described as petro-monetary transmission mechanism. Using a Markov state-switching model, this study shows that there are high and low inflation regimes in the Nigerian economy. Oil price has significant impacts on inflation in the two regimes. Among the common coefficients, exchange rate and credit have significant effects. The empirical evidence from the impulse response functions of the VAR model shows that a one standard deviation shock to credit, interest rate, exchange rate, and oil price generates sharp increases in CPI, thus establishing a petro-monetary transmission mechanism in Nigeria. This study therefore establishes the presence of petro-monetary transmission mechanism in oil-producing countries. The central banks in these countries should therefore consider the oil price channel in the conduct of monetary policy.