An Analysis of Fiscal Deficit and Inflation Dynamics in Nigeria

International Journal of Research and Innovation in Applied Science (IJRIAS) | Volume VII, Issue III, March 2022 | ISSN 2454–6194

An Analysis of Fiscal Deficit and Inflation Dynamics in Nigeria.

¹Eche Nwachukwu Austine, ²Pam Dung Felix, ³Haruna Ibrahim Babagana, and ⁴Ifeanyi Akadile Alexander
^1,2,4Department of Economics, Air Force Institute of Technology, Kaduna
³Department of Business Administration, Air Force Institute of Technology, Kaduna

Abstract

The study examined the impact of fiscal policy on inflation in Nigeria, using Auto regressive distributed lag model (ARDL), for a period of 1981-2020. Secondary data was used in the study. The variables that were utilized in the study include inflation rate (INF), as the dependent variable; and a set of independent variables; government deficit financing (GDF), interest rate (INT) exchange rate (EXR) and gross domestic product (GDP). Stationarity test was carried out using augmented dickey-fuller test (ADF). The result showed a mix of integration of order 1(0) and 1(1) which lends credence to the adoption of ARDL model. More so, the cointegration test revealed the presence of long run relationship. As such, the result of the long-run ARDL cointegration revealed that GDF exert positive impact on INF. This however, suggests that, a percent increase in government deficit (GDF) will lead to an increase of about 2.77 percent in the rate of inflation. More so, EXR, and INT also exerts positive impact on INF in the long-run. Moreover, only GDP was found to exert negative impact on INF. In line with this finding, the study concluded that, fiscal deficit does not create inflation, but inflation causes the fiscal deficit, making it a one-way causation from inflation to the budget deficit. The study recommended that government should strike appropriate balance between recurrent expenditure and capital expenditure, that is, Fiscal deficit should not be geared towards recurrent expenditure to the detriment of capital expenditure which has the capacity to stimulate employment.
Key words: Fiscal deficit, inflation, interest rate, exchange rate, economic growth

1.1 Introduction

Fiscal policy is critical for maintaining economic growth and achieving macroeconomic stability. The federal deficit in advanced nations such as the United States offers motivation for a re-evaluation of the impact of fiscal deficits on economic activity (Islam & Wetzel, 1991). Fiscal deficits have been blamed for most of the economic issues that have plagued less developed nations like Nigeria since the 1980s, such as over indebtedness and debt crises; excessive inflation; poor investment performance and growth (Onwioduokit, 1999).
Consequently, since the income surplus has not been sufficient to match development spending, Nigeria’s fiscal strategy is still characterized by deficit budgeting. As a result, since foreign grants alone will not be sufficient to pay the deficit, foreign and domestic loans will be required. As a result, the total loan value has been increasing, and the debt service burden has been increasing year after year. Since the 1980s, the persistence of fiscal deficits in developing countries, which are mostly financed by government borrowing from the banking system, has been blamed for many of the economic crises that have plagued them, including debt overhang and subsequent debt crises, high inflation, poor investment performance, and slow growth (Onwiduokit, 1999). Large deficits can sometimes have a negative impact on a country’s economic growth. Since 1970, deficits have accrued during periods of economic boom and bust, and the nation’s fiscal structure has not remained static. Various schools of thought have voiced their views on how the budget deficit impacts the economy’s performance. According to Keynesian theory, a budget deficit has a negative impact on macroeconomic variables such as interest rates, currency rates, and inflation. Excessive borrowing can also cause private investment to be crowded out, as well as inflation and currency rate volatility.
Despite the Nigerian government’s efforts to devise policy measures targeted at reducing the budget deficit, the country’s economy continues to suffer from it, with negative consequences on important macroeconomic indicators such as inflation, interest rates, and currency rates. It is clear that borrowing from foreign financial institutions and central banks to finance a significant amount of deficits contributes to liquidity and inflation crises in most developing countries, such as Nigeria, Ghana, and India.

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