Inflation in Nigeria, a Historical Fact or Consequences of Fiscal Deficit?: An Empirical Examination Using Threshold VECM

Abstract

The study empirically examines the consequences of the relationship between fiscal and monetary policies in Nigeria. To do this, an Inter-temporal Budget Constrain (IBC) of the federal government was estimated using annual time series data for budget deficit, growth rate of monetary aggregates(M1 and M2), change in federal government stock of debt and directs CBN financing of budget deficit. The series were collected from the Central Bank of Nigeria’s statistical bulletin, 2015. To examine the evidence, the study assessed the univariate and multivariate stochastic properties of the series using Perron (1997); LP (1997) and Gregory and Hansen (1996); Hateemi J.(2008) respectively. The following evidences were found for the univariate stochastic properties and the results reveal the presence of unit root at levels for all the series except CBN financing of budget deficit. This finding is consistent across the two tests. For the multivariate counterpart, the evidence reveals that seigniorage and debt are the two components used in long run budget deficit financing in Nigeria. In terms of the short run dynamics of the relationship, Threshold VECM was estimated and the result reveals that both debt and seigniorage components, except growth rate of broad money supply, affect budget deficit in the short run. Therefore the study made the following conclusions: firstly, seigniorage and borrowings are the two important components used in budget deficit financing both in the short and long run in Nigeria. Secondly, the evidence found by the study is in favor of fiscal policy dominance which has an implication of affecting interest rates and/or prices. Therefore, inflation in Nigeria is both historical fact and consequences of budget deficit.