Impact of Budget Deficit on Nigeria Economic Growth 1981-2015

The Impact of Budget Deficit on Nigeria Economic Growth 1981-2015. Download the full project work with reference and abstract.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The growth and persistence of fiscal deficits in both the industrialized and developing countries, most especially Nigeria in recent times have brought the issue of fiscal deficits into sharp focus. The issues surrounding fiscal deficits are certainly not new, but the economic development of the past decade has rekindled the interest in fiscal policy issues.

In the less developed countries including Nigeria, fiscal deficits have been blamed for much of the economic crisis that beset them in the 1980s: over-indebtedness and the debt crisis; high inflation, poor investment performances and economic growth. Attempts to regain stability at the macro-level through fiscal adjustment achieved uneven success, raising questions about the macroeconomic consequences of public deficits and fiscal deterioration or fiscal stabilization (Easterly and Schmidt-Hebbel, 1993).

Conventional monetarist believes in the linkage from the creation of base money to inflation; when Central Banks issue money at a rate that exceeds the demand for cash balances at the existing price level, the increased demand in the goods market pushes up the price level as the public tries to get rid of its excess cash holdings. It is the contention of these economists that the Central Banks can eliminate the link between budget deficits and inflation by refusing to monetize the deficit, i.e., by not buying the bonds issued by governments. Higher deficit policies may, however, lead to higher inflation even in the absence of monetization by Central banks (Ibrahim and Adesanya, 2014). The government’s borrowing requirement will increase the net credit demands in the economy, drive up the interest rates and crowd out private investment. The resulting reduction in the growth rate of the economy will lead to a decrease in the amount of goods available for a given level of cash balances and hence the increase in the price level.

A number of studies have examined the possibility of a relationship between deficit financing and the general price level. Deficit financing is a major cause of inflation. Budget deficit, money supply and inflation have been regarded as some of the important factors on issues relating to economic growth and development in Nigeria. One of the fundamental issues in Nigeria’s policy formulation is how to put inflation, money supply and budget deficit under effective control (Omoke and Oruta, 2010).

According to Ibrahim and Adesanya (2014) budget deficit refers to government expenditure exceeding government revenue over a period of time. When a deficit is involved, it is important to find remedy for financing such deficits so as to eradicate its negative effects. The growth and persistence of developing countries in recent times has brought the issues of budget deficits into sharp focus. In the developing countries like Nigeria, fiscal deficits have been blamed for much of the economic crisis that beset them about two decades ago resulting in over-indebtedness and the debt crisis, high inflation, poor investment performance, and growth (Ezeabasili, et al , 2012).

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, the consequences of budget deficit on macroeconomic variables cannot be underestimated in most countries of the world, including Nigeria (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 (Cebula, 2000). Most analysts therefore argued that deficit reduction 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.

The Nigerian government has greater influence on the nation’s economic activities through the use of fiscal instruments amongst which are budget deficit operation. However, this has effect on macroeconomic variables such as interest rate, exchange rate, inflation, consumption, investment, etc which serve as media through which budget deficit affects economic development. In Nigeria, for example, high incidence of projected budget deficit persists and the risk of severe adverse consequences must be taken very seriously, although it is impossible to predict when such consequences may occur. For instance, Oyejide (1972) established, that Nigeria started experiencing budget deficit in her budgetary system since 1957 and became persistent in the 1970s prior to the civil war of 1967 to 1970, and up till date, Nigeria only has seven years of budget surplus (CBN, 2005).

There exist controversies in the literature as to whether budget deficit is inflationary or not. Oyejide (1972) argues that in a less developed country, sustained growth of deficit financing could hardly take place without some amount of inflation. It should be noted that inflation is persistent increase in price and not high price. Thus, it is against this backdrop that this study intends to empirically investigate the relationship that exists between budget deficit and inflation in Nigeria. Budget deficit- inflation nexus has been an issue in both developing and developed countries of the world.

1.2 Statement of the Problem

The budget deficit recorded in Nigeria for many years were as a result of many factors that made the proposed expenditure to exceed the expected revenue. Some of these factors are: mismanagement of available resources, fall in the price of oil in the world market, corruption, social and religious crises, creation of more states and local governments, Egwaikhide (1996).

Inflation is one of the variables affected by budget deficit operation over the years in Nigeria. Government has continuously pursued an expansionary fiscal policy with the exception of few years (CBN, 2005). This was in a view to improve economic growth and economic development. However, the major impact of the increase in budget deficit was felt in 1993, with high rate of inflation which shows an evidence of a positive relationship between budget deficit and inflation in Nigeria.The problem of inflation in Nigeria dates back to the 1970’s when the Nigerian – Biafra war ended and was succeeded by the Udoji awards of 1974. With the increase in public expenditure, enhanced by increases in oil revenues, there was vast expansion in aggregate demand. With the inelastic supply of domestic output, inflation inevitably resulted (Imobighe, 2012). The effects of inflation on the economy are generally considered as predominantly harmful and this explains why price stability is often regarded as one of the fundamental objectives of government’s macroeconomic policy.

It has been claimed that the main causes behind these high rates of inflation could be the widening fiscal imbalances, sources of deficit financing, economic growth and the depreciation of the Naira exchange rate. Nonetheless, the transition to high inflation rates over the period resulted, undoubtedly, in substantial real cost and large losses in income, at the same time as the performance of the economy as a whole declined as a result of widening fiscal deficits and decreasing oil revenues, owing to the collapse of oil prices in the early 1980s, exacerbated by poor macroeconomic management and political uncertainty. Hence, the main thrust of this study shall be to evaluate the link between budget deficit financing and inflation in Nigeria, using granger causality test.

1.3 Research Questions

This research shall be guided by the following questions.

  • To what extent has budget deficit impacted the price level in Nigeria?
  • Is there any observed long-run relationship between budget deficit financing and inflation in Nigeria?

1.4 Objectives of Study

The main objective of this study is to examine the link between budget deficit financing and inflation in Nigeria. However, the following specific objective would also be achieved:

  1. To evaluate if there any observed long-run relationship between budget deficit financing and inflation in Nigeria.
  2. To examine the extent at which budget deficit financing impact on inflation in Nigeria.

1.5 Statement of Hypothesis

H0There is no significant impact of budget deficit financing on inflation in Nigeria.

H0 There is no long-run relationship existing between budget deficit financing and inflation in Nigeria.

1.6 Significance of the Study

This study aims at making meaningful contribution to the general knowledge and understanding of the nature of deficit financing and how it relate to inflation in Nigeria settings.The work also intend at arousing interest and to stimulate further research in the area of deficit financing.

Finally, it would provide policy recommendations to policymakers on measures to ensure price stability and basis for further research.

1.7 Scope and Limitation of the Study

This study aims at assessing the link between deficit financing and inflation in Nigeria, taking cognizance of the various episode of deficit financing on inflation between the periods under study. Data and information for this study shall be sourced from the CBNstatistical bulletin, annual report and statement of account, books, internet among others.

The researcher encountered a number of constraints in the course of this work to include; data sourcing or data inconsistence due to poor nature of information management in Nigeria. In spite of these problems, efforts were put in place to enhance the quality of this study.

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