Exchange-Rate Volatility and Inflation in an Oil-Dependent Economy: Asymmetric NARDL Evidence from Iraq, 1990–2023

Abstract

Exchange-rate uncertainty can affect inflation through channels that are distinct from the level of the exchange rate: it alters importers' pricing rules, raises precautionary margins, shortens contract horizons, feeds expectations, and encourages dollarization. This paper isolates the volatility–inflation channel for Iraq—an economy in which oil dominates exports and budget revenue—over 1990–2023, a period spanning sanctions-era monetary chaos, post-2003 stabilization, and the oil-shock and devaluation phase after 2014. Exchange-rate volatility is measured as the rolling standard deviation of log exchange-rate changes and decomposed into cumulative increases and decreases within the nonlinear autoregressive distributed lag (NARDL) framework of Shin, Yu, and Greenwood-Nimmo (2014). The bounds test yields overwhelming evidence of a long-run level relationship (F = 23.888), and the error-correction coefficient of −0.307 (p = 0.029) implies that only about 31% of disequilibrium is corrected per year—half the speed found for the exchange-rate level channel—indicating that uncertainty operates through persistent expectational mechanisms. Rises and falls in volatility both carry significant long-run coefficients (−10.085 and −4.149), with the effect of rising volatility more than twice as large in absolute value; Wald tests reject symmetry in both the long run (t = −5.591, p = 0.0001) and the short run (F = 14.821, p = 0.0001), making the volatility channel the strongest source of asymmetry in Iraqi inflation dynamics. The signs of the full-sample coefficients are shown to be regime-conditioned, and CUSUM/CUSUMSQ instability confirms that the volatility–inflation relationship shifted structurally across regimes. The findings imply that exchange-rate volatility is an independent policy concern: stabilizing the level of the dinar without compressing uncertainty around it will not neutralize the inflationary consequences of currency turbulence.