Monetary policy implications of the new fiscal regime in Nigeria: A simulation study

Abstract

In this policy research, we examine the effects of the new fiscal regime [the signing of the new Finance Act 2023, the setup of a tax reform committee, and the removal of fuel subsidy] on the Nigerian economy and its implication for fiscal and monetary policy coordination in Nigeria. We explore these by estimating a macro-econometric model, which comprises a fiscal rule, monetary policy rule, and a Phillips curve relation to simulate the impacts of the regime on fiscal, macro and monetary fundamentals in Nigeria. We find in the model estimation that (a) lower public debts can be achieved faster through a reduction in expenditure than by an increase in revenue, (b) inflation in Nigeria is driven by demand and supply-side factors, (c) the monetary policy instrument does not possess stabilizing power over the economy. The forecasting analyses show that the contractionary fiscal regime that raises the revenue by about 75 per cent will instantaneously clear out the fiscal deficit and lead to significant reductions in public debts but at the cost of higher inflation. We suggest sufficiently reducing the monetary policy rate to the optimal value obtained from the structural model, and coordination of demand management and supply-side policies by both the monetary and fiscal policy authorities in Nigeria.