Managing Monetary Policy In An Environment Of Fiscal Policy Dominance In The Nigerian Economy

Project and Seminar Material for Economics

Managing Monetary Policy In An Environment Of Fiscal Policy Dominance In The Nigerian Economy


This study sets out to examine managing monetary policy in an environment chocked up with huge fiscal deficits and public debt, high inflation rate etc, (which gives rise to fiscal dominance), in Nigerian setting during the period 1980 to 2004.

To accomplish this, statistical hypotheses were stated empirically. In chapter two, of the study, the review of various monetary policies in Nigeria was highlighted. Also there were emphasis on the fiscal policy and arguments on which of the two policies actually dominates.

The theoretical frame work was formulated and presented in chapter three.
While in the forth chapter, the model developed in chapter three was specified and estimated by the ordinary least square (OLS) technique and the Cochrane-Orcutt as a corrective measure for auto-correlation, using the annual data for the period under study.

The fifth chapter concludes with the findings of the study which are;
Firstly, the results of the model showed that the specified variables which includes; banking system holdings of public domestic debt outstanding, domestic public debt, total government expenditure and inflation rate were all significant in explaining the systematic variation in the level of money supply with the exception of the domestic public debt.

Secondly after the application of the corrective mechanism i.e. the Cochrane-orcutt measure, all variables were statistically significant except that of total government expenditure. And all the variables conformed to Apriori specification.

The study there fore points to the need for a prudent fiscal policy and monetary authorities should place more emphasis on monetary actions than on fiscal action in their drive towards stabilization of the economy.

Chapter One


1.1 Background to the Study

The achievement of macroeconomic policy objectives should be the desire of every nation. These macroeconomic objectives include price stability, external equilibrium, full employment level, sustainable growth and development. For a developing economy like Nigeria, other important economic objectives includes; debt management, equitable distribution of income, elimination of economic dualism, provision of subsistence, environmental protection, etc. (CBN, 2003). In the natural settings, all these objectives are not easy to come by, but any economy that aims towards development must strive hard to leave no stone unturned. Macroeconomic policy suggests that an economy, especially a free market economy is being managed to ensure stability and growth, however, if left unmanaged, a free market economy would be subject to business fluctuations that may even threaten the survival of the economy. This calls for government intervention in the management of the economy to limit the treat of such fluctuations. This management includes the use of some policy measures, notably among them are fiscal and monetary policy.
Fiscal policy is the deliberate action of the government to manipulate items of expenditures, revenue and borrowings in order to achieve macroeconomic objectives (Idowu, 2009). It is a growing belief that sustained economic growth is possible only within a sound macroeconomic framework and in that framework; fiscal policy plays a crucial role (Fischer and Easterly, 2002). Monetary policy on the other hand includes the control of money supply and credit availability to influence the level of economic transactions. The monetarist argued that only money matters and as such monetary policy is more potent instrument than fiscal policy in economic stabilizer. Ojo (1992) asserts that an effective and efficient monetary policy is essential for growth and development.

The potency of these two economic policies has been argued extensively by their proponents (see Keynes, 1936 and Friedman, 1968). One way in which fiscal and monetary policy can be linked together is fiscal dominance. It describes the condition in which the monetary authority accommodates completely, all government debt (Sanusi and Akinlo, 2016). That is, it is the situation where monetary policy operates to facilitate fund for the government as against the objectives of price stability. Turner, (2011) is of the opinion that the potential impact of debt on inflation depends on the response of monetary policy. That is, high government debt could well constrain the ability of the Central bank to set the policy rate to control inflation. As pointed out by Ekpo, et al. (2015) that in some developing economy, budget deficits are mostly financed by printing more money and the monetization policy often results in inflation and leads to the dominance of fiscal policy over monetary policy. Theoretical literatures linking fiscal and monetary policy together can be found in the works of (Metzer 1951; Patinkin 1965; Friedman 1968; Sargent and Wallace 1981; Aiyagari and Gertler 1985; Bohn 1998)

The Nigerian debt profile has been on the rise from time immemorial, particularly from 1986, when government expenditure is expected to be limited with the proposed Structural Adjustment Programmed (SAP). In 1986, the total debt of the country stood at N69.89 billion, by 1996, it was recorded for a figure of N1.03 trillion. Also, N3.18trillion and N17.36 trillion was recorded for the periods of 2006 and 2016 respectively. This was accompanied by a perpetual increase in Money Supply (M2) even within the same periods. As at 1986, Money Supply was estimated around N27.31 Billions, in 1996, the figure increased tremendously to about N370.33 Billions, N4.03 trillion and 23.73 trillion for 2006 and 2016 respectively. The Nigerian budget deficit has also been perpetually deficit within these periods with the exception of 1995 and 1996 where surplus of N1 billion and 32.05 billion Naira were recorded respectively (computed from CBN, 2016). A long period of large fiscal deficit and a very high public debt to GDP ratios raises the concern for fiscal dominance.

Studies related to fiscal deficit and the independence of central bank have been conducted in developed countries by scholars like, Hein (1981), kings and plosser (1985) and Ahking & Miller (1985) and in developing nations by, Dornbush & Fisher (1981), Buiter & Patel (1992), Dogas (1992). These studies have produced mixed results. Surprisingly, not much of this investigation has been empirically carried out in Nigeria, particularly investigating fiscal dominance and the conduct of monetary policy. It is against this backdrop that the study seeks to investigate fiscal dominance and monetary policy in Nigeria.

1.2 Statement of the Problem

Fiscal dominance is an economic condition that occurs when monetary authority operates to facilitate funding of fiscal deficit or maintain a country’s solvency as opposed to maintaining low and stable price levels. Fiscal dominance is not only important in maintaining a country’s solvency or financing fiscal deficit but it also enables a country to maintain good international credit rating records for external borrowing. It is also an important stimulus to economic growth especially when the economy is in recession. However, fiscal dominance can lead to adverse effects on price levels of a country and crowd-out private investment which damages growth prospect of a country (Kumhof et al., 2008). Over the past four decades, Nigeria has been experiencing fiscal instability with average fiscal deficit as percent of GDP being greater than 5 percent threshold for developing countries. This, together with poor donors’ relations in the 1980’s and the substitution of foreign borrowing with internal borrowing has led to continued increase in fiscal dominance (Kosimbei, 2009).

Based on Keynesian theory, fiscal dominance is a stimulus to economic growth especially when the economy is in recession (Osoro, 2016). However, even with increasing fiscal dominance, Nigeria have been unable to reach the 10 percent growth rate target required for realization of Vision 2030, with annual economic growth in 2017 being 4.9 percent. The sudden increase in inflation rate above CBK target of 5 percent+2.5 to 7.999 percent in 2017 from 6.30 percent in 2016 can be attributed to increase in fiscal dominance to GDP ratio from 12.02 percent in 2016 to 12.69 percent in 2017 (Republic of Nigeria, 2018). Which implies that, in Nigeria, fiscal dominance as a percent of GDP has been moving in the same direction as inflation rate.

Despite several studies, fiscal dominance remains a vital worldwide debate especially for countries experiencing large public debts or fiscal deficit. The question being whether or not fiscal dominance affects price stability of a country and whether it stimulates economic growth (Ekpo et al., 2015). Several studies have been conducted globally to determine the effects of fiscal dominance on macroeconomic variables (Nachega 2005; Ozatay 2008; Lazaro 2008; Gitahi 2015 and Afolabi & Atelabe 2018). Some studies found that fiscal dominance have a positive effect on inflation (Nachega 2005 & Ozatay 2008). While other found that fiscal dominance have negative effect on inflation (Lazaro, 2008 and Afolabi & Atelabe 2018). Most of these studies had conflicting results and neglected the impact and the link between fiscal dominance and economic growth. The neglect of this important aspect plus the fact that none of the existing literature is based on Nigeria’s economy creates a knowledge gap which this study sought to close.

1.3 Research Objectives

The general objective of the study was to determine the managing monetary policy in an environment of fiscal policy dominance in the Nigerian economy.

The specific objectives were to:

  1. Analyze the effect of fiscal dominance on monetary policy variables in Nigeria.
  2. Examine the relationship between fiscal dominance and economic growth in Nigeria.

1.4 Research Questions

  1. What is the effect of fiscal dominance on monetary policy variables in Nigeria?
  2. What is the relationship between fiscal dominance and economic growth in Nigeria?

1.5 Hypotheses

  1. Ho1: There is no significant relationship between monetary policy variables and fiscal policy dominance in Nigeria
    Hi: There is significant relationship between monetary policy variables and fiscal policy dominance in Nigeria
  2. Ho2: There is no significant relationship between fiscal policy dominance and economic growth in Nigeria
    Hi2: There is significant relationship between fiscal policy dominance and economic growth in Nigeria

1.6 Scope of the Study

The present study employed quantitative time series data for the period between the years 1980 to 2004.. This period was chosen because it was adequate to determine the effects of fiscal policy dominance on the selected monetary policy variables in Nigeria. Furthermore, fiscal dominance data for the country is only available for the given period.

1.7 Types of Data

The secondary data type is what is going to be used in the study

1.8 Sources of Data

The source of data for the study is majorly secondary source ; it will be sourced from Central bank annual statistical bulletin covering the time period of the study

1.8 Justification of Study

Monetary policies and fiscal policies are the major tools for managing and attaining macroeconomic objectives in Nigeria. This study provides an insight to both monetary and fiscal policy-makers for informed decisions regarding fiscal deficit management and financing. The findings act as a guideline for the government on fiscal and monetary policy reforms that need to be pursued so as to achieve the country’s growth vision.

The study also provides evidence for the monetary authority on the level it should participate in facilitating funds for the government as it ensures price levels remains low and stable and also stimulate economic growth.

This study also provides a foundation for future research on fiscal dominance and economic performance.

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Conclusion and Recommendation

The study empirically examined whether there is fiscal dominance in Nigeria in the presence of persistent fiscal deficit and growing price level in the country. Adopting, VECM, a variant of VAR to investigate the responses of inflation to shocks in money supply, budget deficit and domestic debt; it was found that although, money supply responds positively to shocks in budget deficit and domestic debt, it has an insignificant effect on the average price level. The forecast error decomposition variance shows that money supply, budget deficit and domestic debt explains an insignificant variation in inflation, even though budget deficit and domestic debt accounts for a significant variation in money supply. This scenario is perfectly explain as presented by Mishkin (2004) who posits that if government deficit is financed by an increase in bond holdings by the public, there is no effect on monetary base and hence, on money supply. But if the deficit is not financed by increased bond holdings by public, the monetary base and the money supply increase. In the light of these results, it is safe to conclude that there is no evidence of fiscal dominance in Nigeria, even in the midst of persistent budget deficit and increase in money supply. This result corroborates the findings of Sanusi and Akinlo (2016) who investigated fiscal dominance in Nigeria between 1986 and 2003. It is recommended that the government should ensure fiscal discipline amidst increasing budget deficit and the Central Bank should be given autonomy to pursue the objectives of price stability, rather than financing government fiscal operation.

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