Second‐Round Effects, Inflation Persistence and Chaotic Dynamics: Implications for Transition to Inflation Targeting in Nigeria

ABSTRACT

In January 2024, Nigeria switched to inflation targeting with the policy rate reaching a historical high. However, inflation remained elevated, reflecting persistence, uncertainty, second‐round effects, and exchange rate depreciation. Thus, this study examines the implications of the interplay between inflation persistence, chaotic behaviour, and second‐round effects for the newly adopted inflation‐targeting regime. The study employs state‐space vector autoregressive models, entropy, and multifractal spectrum. First, the results show that inflation persistence is high and has been increasing since 2016. Second, findings reveal that periods of high inflation persistence coincide with substantial second‐round effects. Third, the analysis indicates that persistence is asymmetric across size and the inflation regimes. Finally, this study also observes complex chaotic behaviour and uncertainty in the inflation process. Overall, these findings suggest that the transition to inflation targeting may involve prolonged disinflation and substantial output costs if policy relies mainly on aggressive monetary tightening. Thus, the Central Bank should therefore monitor second‐round effects and treat the estimated threshold as an early‐warning indicator rather than an inflation target. Also, the bank may have to strengthen scenario‐based forecasting and coordinate monetary actions with fiscal and supply‐side measures addressing food, energy and exchange rate pressures.