The macroeconomic implications of deficit financing in Nigeria: 1986 – 2020

Abstract

The study examines the macroeconomic implications of deficit financing in Nigeria, centrally focused on the causal impact of Domestic and External debts on Nigeria’s Gross Domestic Product (GDP) and the Consumer Price Index (CPI) between 1986 and 2020. The Vector Error Correction Model (VECM) applied in the study uncovered a negative short run dynamic effect of domestic debt on real GDP by 0.16%. Having established at least, one cointegrating equation with 9.7% speed of adjustment towards long run convergence, the study also finds a long run positive impact of domestic debt on real GDP by 0.35% and a negative impact on external debt on real GDP by 0.04%. The Vector Autoregressive (VAR) model on the other hand, estimates a positive lagged effect of external debt on real GDP by 0.03%, and a positive lagged effect of domestic debt on the price level by 0.3%. The study overall concludes that deficit financing initially has an adverse implication on economic growth in a short run before a positive effect on domestic growth in a long run provided, they are obtained from domestic sources. However, the negative impact of external debt on real GDP and Government Expenditures raises concerns regarding the efficient allocation of external resources. Hence, the study recommends channeling external sources of deficit financing into more productive sectors of the economy. Policy makers should also propose appropriate contractional fiscal policy initiatives to provide an enabling environment that optimizes government finances