Fiscal-Monetary Policy Interactions and Macroeconomic Performance in a Small Open Economy: A GMM Approach

Abstract

The study investigates the nature and the effect of fiscal and monetary policy interactions on major macroeconomic variables in a small open economy of Nigeria between 1981 and 2018. The paper employs the generalized method of moment as technique of analysis due to its potential to address the endogeneity issues among the explanatory variables. Findings from the study reveals that interest rate and government expenditure have significant effect on output and inflation. Also, the study finds that fiscal and monetary policy interact as strategic substitutes in Nigeria. This implies that when one policy authority pursues a contractionary measure, the other policymaker counteracts the action using an expansionary policy. It is also revealed that the effect of fiscal and monetary policy interactions on output and inflation is negative and significant. This implies that the two policies perform better when combined in achieving price stability and sustained output growth in the country. Based on the findings, there is a need for macroeconomic policy coordination in Nigeria to optimise the macroeconomic objectives of the country.