The Relationship Between Fiscal Deficit And Macroeconomic Performance In Nigeria

Project and Seminar Material for Economics

The Relationship Between Fiscal Deficit And Macroeconomic Performance In Nigeria


There has been so much debate on issues in public finance in developing countries as they relate to fiscal deficits. Few issues in public finance of developing countries have generated so much debate on fiscal deficits. Critics have rejected the claims that any positive contribution have been made to the economy. The Nigerian government has been committed to a stable macroeconomic environment, characterized by low and stable inflation and sound fiscal policy. However, in the late 1970s to date, the government has continued to experience high, persistent and unsustainable deficits. Despite the fact that economic reform programs adopted in recent years have emphasized demand management through fiscal restraint, fiscal deficit has been phenomenal to Nigeria’s economy coupled with a dwindling economic growth.

Chapter One


1.1. Background to the Study

The growth and development of the Nigerian economy has not been stable over the years as a result, the country’s economy has witnessed so many shocks and disturbances both internally and externally over the decades. Internally, the unstable investment and consumption patterns as well as the improper implementation of public policies, changes in future expectations and the accelerator are some of the factors responsible for it (Siyan and Adebayo, 2009). Similarly, the external factors identified are wars, revolutions, population growth rates and migration, technological transfer and changes as well as the openness of the country’s economy.

The cyclical fluctuations in the country’s economic activities has led to the periodical increase in the country’s unemployment and inflation rates as well as the external sector disequilibria(Okunrounmu, 2003). In other words, fiscal policy is a major economic stabilisation weapon that involves measure taken to regulate and control the volume, cost and availability as well as direction of money in an economy to achieve some specified macroeconomic policy objective and to counteract undesirable trends in the Nigerian economy (Okunrounmu, 2003).

Therefore, they cannot be left to the market forces of demand and supply as well as other instruments of stabilization such as monetary and exchange rate policies among others, are used to counteract are problems identified (Odedokun, 2008). This may include either an increase or a decrease in taxes as well as government expenditures which constitute thebedrock of fiscal policy but in reality, government policy requires a mixture of both fiscal and International Review of Social Sciences and Humanities, monetary policy instruments to stabilize an economy because none of these single instruments can cure all the problems in an economy (Ndiyo and Udah, 2003).

The Nigeria economy started experiencing recession form early 1980s that leads to a depression in the mid 1980s. This depression continued until early 1990s without recovering from it. As such, the government continually initiated policy measures that would tackle and overcome the dwindling economy. Drawing the experience of the great depression, government policy measure to curb the depression was in the form of increase government spending (Nagayasu, 2003). According to Okunroumu, (2003), the management of the Nigerian economy in order to achieve macroeconomic stability has been unproductive and negative hence one cannot say the Nigeria economy is performing.

This is evidence in the adverse inflationary trend, government fiscal policies, undulating foreign exchange rates, the fall and rise of gross domestic product, unfavourable balance of payments as well as increasing unemployment rates are all symptoms of growing macroeconomic instability. As such, the Nigeria economy is unable to function well in an environment where there is low capacity utilization attributed to shortage in foreign exchange as well as the volatile and unpredictable government policies in Nigeria (Anyanwu, 2007).

In any economic system, there is always the need for government to undertake very useful measures aimed at shaping various developmental aspirations. One of such measures is fiscal/budget deficit. The relationship between fiscal deficits and macroeconomic variables (such as growth, interest rates, trade deficit, exchange rate, among others) represents one of the most widely debated topics among economists and policy makers in both developed and developing countries (Obinna, 2000). This relationship can either be negative, positive or a no positive or negative relationship. The differences on the nature of the relationship between budget deficits and these macroeconomic variables as found in economic literatures according to Egwaikhide (2002), could be explained by the methodology the country and the nature of the data used by the different researchers.

There is a sharp divergence of views on how fiscal deficit affects the economy. The conventional view, embodied in the Washington Consensus and held by the international financial institutions (IFIs), is that fiscal deficit, particularly in the context of developing countries, represents the most important policy variable affecting the rest of the economy.

According to this view, the relationship between fiscal deficit and other macroeconomic variables is set to depend on how the deficit is financed. It stipulates that money creation leads to inflation, government borrowing crowds out private investment and external debt leads to balance of payments crises (Easterly and Schmidt, 1993).

On the contrary, many economists question the validity of the view that budgets should always be balanced. James Tobin is of the view that what is really important is appropriate fiscal policy which may or may not balance the budget. He argues that there are built-in stabilizers in the fiscal system and that deficit performs a useful function in absorbing savings that would otherwise be wasted in unemployment, excess capacity or lower output. This view is shared by Saleh (2003), who maintains that even in the long- run equilibrium; zero is not a uniquely interesting figure for the budget deficit. Fiscal deficit could be seeing from many angles. It is the gap between the government’s total spending and the sum of its revenue receipts and non-debts capital receipts, (Easterly and Rebelo, 2003).It represents the total amount of borrowed funds required by the government to completely meet its expenditure. It could also be defined as the excess of total expenditure including loans net of payments over revenue receipts and non-debt capital receipts. It also indicates the total borrowing of the government, and the increment to its outstanding debt.

Despite the fact that realized revenues are often above budgeted estimates, extra budgetary expenditures have been rising so fast and result in fiscal deficit, Anyanwu (2007), and Robini(2001), shows that budget deficit in developing countries are heavily influenced by the degree of political instability as well as public finance considerations with no apparent direct effect of elections. Investigations show that Nigeria was caught in the deficit trap since early 1980s when the world oil market collapsed. Since then, there have been frantic efforts to exit the deficit trap but all to no avail instead, the mode of financing the deficit has been the major factor including rapid monetary growth, exchange rate depreciation and rising inflation.

1.2. Statement of Problem

In spite of government efforts at devising policy measures aimed at overcoming fiscal deficit, fiscal deficit has persisted in the Nation’s economy which its adverse effect is being perceived on key macro-economic variable. In less developed nations, borrowing from international financial institutions and Central Bank to finance sizeable portion of the deficits contribute to liquidity and inflation (Egwaikhide, 2002).

This is because rather than spending the borrowed money on capital expenditure such as building roads and dams improving agricultural sector, etc which may improve standard of living of the people, and hence, their productivity which in turn, may improve the country’s economic growth, this borrowed money is spent on pension and transfer payment. This has led to situations where expenditure could not be curtailed, resources could not be raised for fear of adverse effects, and greater deficits fuelled further inflation.

The impact of fiscal deficit on the development of the Nigerian Economy depends on the financing techniques(Inflation tax or bond financed deficit). Money creation to finance deficit often leads to inflation while domestic borrowing inevitably leads to a credit squeeze through higher interest rates or through credit allocation (Easterly and Robello 2004, Sowa, 2004). It is pertinent to note that Nigeria has relied very much on inflation tax (about 70%) and the non-banking holding about15-20% in government bond, (Diamond and Ogundare, 2002). The exact quantitative impact of such mix of deficit financing can better be X-rayed by the impulse response function. Some researcher believe that fiscal deficit has a positive relationship (without put growth while others state that deficits are negatively with output growth accumulation and hence negatively with output growth (Egwaikhide 2005, Soludo 2008).

It is therefore a core research issue and this is the pivot of this study. To critically look at the impact of fiscal deficit on the development of the Nigeria Economy in Nigeria. Currently, there is no consensus on the matter. The level of economic development and the fiscal structure of Nigeria compound this problem. Besides, previous studies have advanced in characterising the implications of alternative sources and composition of deficits spending without investigating whether fiscal deficit lead to economic growth.

1.3. Objectives of the Study

The broad objective of the study is to determine the relationship between fiscal deficit and macroeconomic performance in Nigeria.

Specifically, the study will:

  1. Determine the impact of fiscal deficits on macroeconomic aggregates in Nigeria.
  2. Examine whether fiscal deficit leads to economic development in Nigeria.
  3. Examine the nature of relationship between fiscal deficits and macroeconomic aggregates in Nigeria.

1.4. Research Hypotheses

  • H0: There is significant relationship between fiscal deficit and inflation, government taxes in Nigeria
  • H0: There is no significant relationship between government deficit and government expenditure in Nigeria
  • H0: There is significant relationship between Fiscal deficits and unemployment, economic growth in Nigeria

1.5. Scope of the Study

The study is on “fiscal deficit and development of Nigeria economy”. Hence, it entails the use of macroeconomic variables such as Gross Domestic product (GDP) a proxy for economic growth, government expenditure (GEXP), Inflation rate (INF), government deficit (GDEF),government taxes (GTAX), and unemployment (UNEMP) and also the long-run relationship between fiscal deficit and macro-economic variables like exchange rate, interest rate. The data on the above variables will cover the period of 1984-2014. The choice of this period is based on data availability.

1.6 Organization of the Study

This study is divided into five sections. The first section is the introduction. In section two, relevant theoretical and empirical literatures are reviewed.

Section three is the methodology. The model used is stated. The sources of the data and their description, the estimation procedure are all stated. Section four shows the presentation, analysis and interpretation of results. The fifth section is the concluding part of the work, the summary of findings and policy recommendations.

Chapter Five

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was on the relationship between fiscal deficit and macroeconomic performance in Nigeria.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of fiscal deficit and macroeconomic performance in Nigeria.

5.2 Summary

The study shows significant positive effect of gross fixed capital formation as well as significant negative impact of inflation rate and unemployment on fiscal deficits in Nigeria. Though, there is evidence of negative effect of exchange rate, the study shows it is not significant. These results imply that policies aimed at enhancing the infrastructure base of the economy promote the practice of deficit budgeting, Similarly, economic policies that tend to reduce inflation (such as raising domestic output levels) and unemployment reflect in higher fiscal deficits. The causality tests show evidence of causal impact of government fiscal deficits on exchange rate, inflation rate and unemployment but failed to show evidence of causation between fiscal deficits and gross fixed capital formation. It is recommended that government should ensure prudent utilization of the proceeds of debt finance in promoting domestic production in order to strengthen the economic fundamentals required to support improved fiscal performance in the long-run.

5.3 Conclusion

The general acclaim with which the advent of democracy in Nigeria was greeted was due to the expectations of the country’s citizens that a democratic government would usher in an era of economic prosperity and the entrenchment of human rights. This it was believed would be achieved the implementation of prudent macroeconomic policies and the strengthening of institutions to ensure good governance. The then military government was accused of a high level of fiscal imprudence which it was pointed out was the reason for the country`s macroeconomic woes. However 16 years later, the country has still not experienced an a relatively appreciable rate of growth, this is in spite of the recent rebasing of the country`s GDP which makes the Nigerian economy the largest in Africa. Among Nigerian, the general feeling is that the relatively low growth rates of the country as is evidenced in the low levels of expansion of economic activity is largely a product of the sustained FSDs it has been argued is characterized by an extremely large recurrent expenditure. It is argued that the maintenance of large FSDs is largely due to over-inflation of contracts and the prevalence of unproductive projects. However, the empirical findings show that fiscal deficits even though met the economic a prior in terms of its negative coefficients yet, did not significantly affect macroeconomic output within the period of study. This result suggests that fiscal deficits do not contribute significantly to the overall performance of the economy. This finding reinforced the argument of Anne (1994) that the restoration of high economic growth will be difficult to achieve without a significant and sustainable reduction in the fiscal deficits

5.4 Recommendations

The following recommendations are made based on our findings. Government should minimize the level of deficit e.g by borrowing less for effective control of inflation rate in Nigeria. The need arises because increase in fiscal deficit increases money supply which negatively affects output growth. Government should as a matter of urgency and importance adopt fiscal management actions that aim at minimizing borrowing and capable of reducing fiscal deficits that often result in large chunk of transfer payment, and extra budgetary expenses of questionable viability. For instance, government should ensure that unjustifiable frivolous expenditure proposals do not find their way into the overall budget proposals of the government. Fiscal deficit financed principally via the Central Bank and external debt with high service rate should be discouraged. The level of unproductive debt expansion is quite high. The full adverse effects are still being masked by the favorable oil prices and ensuing earnings. This growth path however, can therefore only be sustained if monetary/fiscal stance of the government reduces the growth rate of money supply in line with the growth rate of the real GDP. Government must adopt fiscal adjustment mechanism that increases revenue through improved taxes rather than borrowing to finance deficit and dependence on crude oil. Government has to checkmate the level of deficits for effective control of the economy to enhance sustainable economic growth in the country. This can be done by ensuring that policies to address deficit have an inbuilt ability to increase the productive capacity of the country.

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