Academic journal article Journal of Economic Cooperation & Development

Real Money Supply, Price and Fiscal Deficit in Nigeria: Evidence from Multivariate Granger Causality Tests

Academic journal article Journal of Economic Cooperation & Development

Real Money Supply, Price and Fiscal Deficit in Nigeria: Evidence from Multivariate Granger Causality Tests

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The choices of fiscal policy have been argued to have significant effects on the economic performance of the oil producing and exporting nations like Nigeria. This is due to the significant nature of the country's oil sector and because the income realized from oil mostly accrue to government's coffer (Sturm, Gurtner and Alegre, 2009). However, fiscal policy in oil producing nations has faced some challenges of how to sustain government expenditures and revenues in the future, and how to stabilize macroeconomic variables in the economy by a well fiscal plan. Reactions by the concerned authorities in response to the fiscal challenges in Nigeria have involved fiscal rules, basing budget on oil price assumptions, how to stabilize oil and incomes realized from high oil prices. In spite of these reactions, fiscal policy continues to be expanding rapidly without completely been met by the increase in the revenue generated. As a result, Nigeria periodically faces fiscal imbalances and her fiscal deficits have been increasing since 1975 (CBN, 2010).

Fiscal deficits have become an important issue in the area of public finance when considering the level of economic growth. Three major opposing views can be distinguished. Keynesian economics posited that through the multiplier, the influence of budget deficit on the macroeconomic activity is positive. In the context of endogenous growth models, if budget deficits are employed to offset expenditures that improve economic growth such as public infrastructure, research and development, education and health, then budget deficits can have positive influence on long-term growth (Barro, 1990; Lucas, 1988; Römer, 1990). Neoclassical economists put up a contrary view by arguing that budget deficits compete with the private sectors and so affect the long-term economic growth negatively. Finally, the demonstration of Ricardian equivalence approach by Barro (1989) shows that change in budget deficit has no effect on the growth of the economy. Due to these contrasting opinions, the employment of public expenditures for the enhancement of economic activity has not been encouraging. Recently, the conventional wisdom is of the view that deficits are not desirable due to their negative macroeconomic effects. This opinion serves as a guide to a country wishing to undertake sensible and careful fiscal policies for the purpose of decreasing the deficits (Keho, 2010).

According to theory, large fiscal deficits can have negative impacts on many macroeconomic variables such as domestic interest rates, investments, and trade deficits. For instance, large fiscal deficits often lead to high interest rates following the government's demand for funds. This conflicts with the financing needs of private sector to the extent that such high interest rates dampen private investment. Cebula (2000) and Dawyer (1985) note that government deficit can exert an upward pressure on real interest rates thereby decreasing the level of capital formation, business activities in terms of investment, and the real level of output. This connection also provides a basis in support of the argument that budget deficits are positively related to long-term interest rates (Barnes, 2008). In addition, fiscal deficits may affect interest rates via the channel of reduced savings and thereby saving ratios (Cebula, 1993).

From the Ricardian equivalence perspective, an increase in government debt results in a future increase in taxes and this does not add to private sector wealth. Given this view, the public expects future increase in taxes to compensate recent government excess spending (fiscal deficits). Therefore, households reduce their consumption spending now and raise saving to smooth out the expected reduction in their future disposable income when government eventually taxes them. This implies that deficit and taxes are equivalent in their effect on consumption, investment and hence current account. …

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