Fiscal and Monetary Policy and Economic Growth in Nigeria. A Comparative Analysis


Master's Thesis, 2016

37 Pages, Grade: 3.67


Excerpt

Table of Content

1.1 BACKGROUND TO THE STUDY
1.2 STATEMENT OF RESEARCH HYPOTHESIS

2.1 Conceptual Framework
2.1.1 The Concept of Policy
2.1.2 Economic Growth
2.1.3 Fiscal Policy
2.1.4 Monetary Policy
2.2 THEORETICAL REVIEW
2.2.1 Fiscal Policy and Economic Growth
2.2.2 Monetary Policy and Economic Growth
2.3 EMPIRICAL REVIEW

3.1 RESEARCH METHOD
3.1.1 Model Specification

4.1 RESULTS AND FINDINGS
4.2 DATA ANALYSIS

5.0 Conclusions and Recommendations

References

ABSTRACT

The study examined the impact of government fiscal and monetary policies on economic growth within the period of 33 years (1981-2014). Time series data were derived from the Central Bank of Nigeria statistical bulletin, while the method of analysis was the Johansen Cointegration test, vector error correction method and the Wald test of coefficient. The result of the findings showed that there is a significant relationship between explanatory variables (government expenditure, interest rate and money supply) taken jointly and the dependent variable (real gross domestic product) in the long run. The coefficient of error correction term is -0.02 showing a 2% yearly adjustment towards the long run equilibrium. This proves that there is a relationship between the dependent variable- real gross domestic product and the independent variables - government expenditure, money supply and interest rate in the long run. The estimated coefficients of the short run model indicate no significant relationship between the dependent variable real gross domestic product and independent variables government expenditure, money supply and interest rates taken together but individually a short run relationship exist between the fiscal variable (government expenditure) and real GDP and between the monetary variable (money supply and interest rate) and real GDP. The policy implication of these findings is that more strategies needs to be put in place in order to ensure that monetary and fiscal policies taken jointly positively impacts on economic growth the in the shortrun.

1.1 BACKGROUND TO THE STUDY

Economic growth is a major macroeconomic objective for most economies. Among other factors which are likely to influence this objective is the issue of policies which is very cardinal in determining the growth of the economy. In theory Keynesians and Neoclassical economists provided various macroeconomic policy tools of government intervention which are broadly grouped into fiscal and monetary policies While monetary policy has to do with the process by which monetary authorities of a country controls monetary aggregates (such as money supply, interest rate, inflation rate etc.) in order to influence the economy. Fiscal policy is all about how the government uses its revenue (taxes) and expenditure (spending) to influence the economy. The government intervenes in undertaking fundamental roles of allocation, stabilization, distribution and regulation especially where or when market proves inefficient or its outcome is socially unacceptable (Usman A. et al: 2011). An efficient policy could serve as a booster for economic growth in a nation and make it better-off while an inefficient policy producing undesired and unintended effects could impede the growth potential of an economy and make it worse-off.. This forms the rationale behind a good macroeconomic or public policy.

Most times what the government receives as revenue is usually been channeled as expenditures. Therefore when the government revenue increases it is also expected that expenditure will increase. According to the Keynesian economics when government increases expenditure and reduces tax, aggregate demand is stimulated and therefore productivity. But what determines the impact of government expenditure on economic output is dependent on the kind of expenditure it is been channeled to. Government expenditure can be productive and unproductive (or wasteful). An expenditure channeled to unproductive expenditure such as purchase of military weapons, expenditure on infrastructure affected during periods of war, welfare expenditures etc. will have little or no effect on the economic growth. Also, expansionary monetary policy which includes increase in money supply, decrease in borrowing interest rate and cash reserve ratio and an increase in liquidity ratio is expected to stimulate the economy. Nevertheless the impact such a policy such as increase in money supply will have in the economy is dependent on the elasticity of the money demand-supply curve. Expansionary monetary policy is said to be weak when investment is very insensitive to interest rate. That is when investment is insensitive to interest rate an expansionary monetary policy will have a weak effect on output.

Since independence various governments in Nigeria have embarked on several economic policies which have been geared towards democratization and development. Beginning from the era where most of the economic decisions were made by the state, to the era of structural adjustment programme (SAP) in 1986 to the present privatization programme which was initiated in the 1999 government. A recent interest in macroeconomic policies (fiscal and monetary policy) as a mechanism for achieving economic growth in Nigeria is fueled by the recent fall in the government revenue which is as a result of a fall in the international prices of oil. Since the sale of oil is the major source of revenue to the Nigerian government, government expenditure and therefore aggregate demand is drastically affected leading to a very slow growth rate. The exchange rate which was initially stabilized between the rate of 155 naira-160 naira/dollar is presently been exchanged at 198.5 naira/dollar at the official or interbank rate and even worst at the parallel or black market rate. The annual growth rate is presently as low as 2.35% (Trading Economics). With a falling external reserve, unstable exchange rate and very slow growth rate, appropriate macroeconomic policy is needed to safeguard the economy from falling into recession.

In general the economy may be exposed to vacillation which will lead to volatile macroeconomic milieu if appropriate macroeconomic policies are not put in place. Therefore it can be seen that fiscal and monetary policies are most relevant at this stage of the Nigerian economy in the determining its growth.

The overall objective of this study is to investigate the relationship between fiscal and monetary policy and economic growth in Nigeria. The specific objectives are to:

(i) Examine the impact of government expenditure on real gross domestic product in Nigeria.
(ii) Examine the impact of money supply and interest rate on real gross domestic product in Nigeria.
(iii) Examine the joint impact government expenditure, money supply and interest rates on real GDP in Nigeria.

1.2 STATEMENT OF RESEARCH HYPOTHESIS

The following testable hypotheses which are drawn from the research questions are considered appropriate for this study and are therefore subjected to empirical investigation. These hypotheses are stated in their null context as follows:

H0: Fiscal does not significantly influence economic growth in Nigeria

H0: Monetary policy does not significantly influence economic growth in Nigeria

H0: Fiscal and monetary policies taken jointly does not significantly influence economic growth in Nigeria

2.1 Conceptual Framework

2.1.1 The Concept of Policy

Policies may be regarded as a political, management, financial, and administrative mechanisms that are arranged to achieve explicit goals which may apply to government, to private sector organizations and groups, and to individuals (Geurts Thei ).

2.1.2 Economic Growth

Economic growth can be defined as an increase in the monetary value of goods and services produced by an economy over a given period of time (usually one year). The gross domestic product (GDP) is the indicator that measures the rate of economic growth in an economy. The gross domestic product (GDP) can be distinguished into nominal and real. While the nominal GDP measures the increases in goods and services without taking changes in prices into consideration, the real GDP measures changes in goods and services after making provision for adjustment in prices.

2.1.3 Fiscal Policy

This is the use of government expenditure and taxation to determine the direction of the economy. Fiscal policy can be expansionary (i.e. increasing government expenditure and reducing the tax rate) or contractionary (reducing the government expenditure and increasing the tax rates).

2.1.4 Monetary Policy

Monetary policy is the adjustment of monetary aggregates such as money supply, interest rate, inflation rate, cash reserve ratio, liquidity ratio etc. to influence the economy over a given period of time. Monetary policy can be used to achieve macroeconomic objectives such as economic growth, balance of payments equilibrium, exchange rate etc.

2.2 THEORETICAL REVIEW

2.2.1 Fiscal Policy and Economic Growth

Fiscal policy is the use of taxation and government spending to influence the economy. This may work via changing tax rates or the rules about liability to tax or via changes in government spending on real goods and services or transfer payments. Fiscal policy has two (2) possible roles. The first is to remove any severe deflationary or inflationary gaps. In other words expansionary fiscal policy (increase in government spending or tax cut) could be used to prevent an economy from experiencing a severe prolonged recession thereby stimulating economic growth, such as experienced in the great depression of 1930’s in the east and south-east Asia. Secondly, fiscal policy could also be used to prevent rampant inflation.

Government Expenditure and Economic Growth

The Keynesian model which explains the relationship between government expenditure and economic growth is given as

Abbildung in dieser Leseprobe nicht enthalten

Suppose there is an increase in government expenditure. What is the implication of this increase on the national output. The effect of an increase in government expenditure on output can be further explained below.

Substituting equation 3 into 2

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If we assume that other variables (T,C,X and M) remains constant a change in output ΔY as a result of change in government expenditure ΔG will is given by.

Abbildung in dieser Leseprobe nicht enthalten

This above expression is called the multiplier, in this case government multiplier. The Multiplier can be defined as the ratio of the change in income and the change in any of the components of aggregate demand (C,I,G,M). Therefore the government multiplier is defined as the ratio of change in the national output and the change in government expenditure. The economy thus multiplies the increase in government expenditure into an even larger increase in output that is why it is called a multiplier.

Summary of Multiplier Effect

- When government expenditure rises, national output rises
- As national output rises, disposable income also rises, so consumption increases as well.
- The increase in national output is larger than the increase in consumption. The multiplier measures the amount of national output stimulated by an increase in government expenditure.

2.2.2 Monetary Policy and Economic Growth

Monetary policy is the process by which monetary authority of a country controls the money supply, interest rates, lending rates and other monetary rates in order to ensure price stability, contribute to economic growth, lower employment, maintain predictable exchange rates and ensure general trust in the currency. Monetary policy can either be expansionary or contractionary. An expansionary monetary policy increases the supply of money more rapidly, while a contractionary monetary policy expands money supply more slowly.

Money Supply, Interest Rate transmission Mechanism and Economic Growth

Total money supply (Ms) consists of deposits in banks and building societies (D) plus cash (C) held by the public. Thus a change in money supply would be given by:

Abbildung in dieser Leseprobe nicht enthalten

Interest rate is an important economic price. This is because whether seen from the point of view of cost of capital or from the perspective of opportunity cost of funds, interest rate has fundamental implications for the economy. By either impacting on the cost of capital or influencing the availability of credit, by increasing savings, it is known to determine the level of investment in an economy. (Ikechuukwu and Chigozie:2011). Interest rate has been defined as the cost of credit. Any borrower normally has to pay the lender more than the principal originally received. The excess is the interest

Suppose money supply increases, what happens to total output? We shall use the quantity theory of money to determine this. To understand the reasoning behind the quantity theory of money, we need to examine the equation of exchange given as.

Abbildung in dieser Leseprobe nicht enthalten

The relationship between money supply and prices depends on what happens to V and Y. what happens to them has been the subject of considerable debate over the years between economists. Keynesians have generally had different views from monetarists and new classical economists.

2.3 EMPIRICAL REVIEW

Empirical studies have shown that there are large variations in social expenditures between countries. Also countries with high private welfare expenditures should theoretically be more efficient. However no significant correlation have been found between social expenditures on one hand and the level of growth of GDP on the other (Lindert: 2004). However summarizing empirical tests, Alkinson (1999:32-33) and Lindert (2004:86-88) demonstrate that most studies have found no significant associations even in multivariate tests. In his own, more sophisticated test, including only genuinely social expenditures (which amounts to a somewhat stronger test), Lindert (2004b:172-93) found no significant associations either.

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Details

Title
Fiscal and Monetary Policy and Economic Growth in Nigeria. A Comparative Analysis
Course
Development Economics
Grade
3.67
Author
Year
2016
Pages
37
Catalog Number
V375716
ISBN (eBook)
9783668574915
ISBN (Book)
9783668574922
File size
639 KB
Language
English
Tags
fiscal, monetary, policy, economic, growth, nigeria, comparative, analysis
Quote paper
Emmanuel Elakhe (Author), 2016, Fiscal and Monetary Policy and Economic Growth in Nigeria. A Comparative Analysis, Munich, GRIN Verlag, https://www.grin.com/document/375716

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