Budget Deficit and Inflation in Nigeria

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Journal of Emerging Trends in Economics and Management Sciences (JETEMS) 2 (1): 1-8 © Scholarlink Research Institute Journals, 2011 (ISSN: 2141-7024) Journal of Emerging Trends in jetems.scholarlinkresearch.org Economics and Management Sciences (JETEMS) 2(1):1-8 (ISSN:2141-7024)

Budget Deficit and Inflation in Nigeria: A Causal Relationship 1 1

S. O. Oladipo and 2T. O. Akinbobola

Department of Economics and Accounting, Bells University of Technology, Ota, Nigeria 2 Department of Economics, Obafemi Awolowo University, Ile-Ife, Nigeria Corresponding Author: T. O. Akinbobola ____________________________________________________________

______________________________ Abstract The study investigates the nature and direction of causality among the two variables. This is with a view to providing empirical evidence on budget deficit operation in stimulating economic growth through inflation in Nigeria. Secondary data were used in this study. Data on inflation rate, exchange rate, Gross Domestic Product (GDP) and budget deficit were collected from statistical Bulletin and Annual Report and Statement of Account published by the Central Bank of Nigeria (CBN) and the International Financial Statistics (IFS) published by International Monetary Fund (IMF). Granger Causality pair wise test was conducted in determining the causal relationship among the variables. The result showed that there was no causal relationship from inflation to budget deficit (F = 0.9, P > 0.005), while the causal relationship from budget deficit to inflation was significant (F = 3.6, P < 0.05). This implies that a uni-directional causality from budget deficit to inflation exist in Nigeria. Furthermore, the result showed that budget deficit affects inflation directly and indirectly through fluctuations in exchange rate in the Nigerian economy. ____________________________________________________________

______________________________ Keywords: budget deficit, consumer price index, gross domestic product, exchange rate, time series models ____________________________________________________________

______________________________ I TRODUCTIO Persistent government budget deficits and computing government debt have become major concerns in both developed and developing countries. Extensive theoretical and empirical literatures have been developed to examine the relationship between budget deficits and macroeconomic variables. The monetarists share the view that fiscal deficits are harmful to an economy. While some of the increases in the deficits have been associated with declining tax revenue resulting from the recession, others relate to the increase in debt service payments on public debt. The development of a budget deficit is often traced to the Keynesian inspired expenditure-led growth theory of the 1970s. Most countries of the world adopted this theory that government has to motivate the aggregate demand side of the economy in order to stimulate economic growth. However, its Consequences on macroeconomic variables cannot be underestimated in most countries of the world, Nigeria inclusive (Olomola and Olagunju, 2004). Monetary policy has over the years in Nigeria been largely expansionary with direct implications for price inflation (including food prices) and exchange rates. Over the years, there has been a persistent rise in private consumption expenditures and developments in the external sector have also impacted strongly on the budget deficit. Government’s narrow revenue base, vis-a-vis its expenditure, is likely to have serious consequences for the government’s budget balance (Cebula, 2000). Most analysts therefore argued that deficit reduction 1

is crucial to the future growth of an economy, although, economists are divided over its impacts. It is expected that lower budget deficits will lower real interest rates, increase investment, and thereby increase productivity, growth and real income. A country experience deficit in her...
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