Fiscal Deficit and Inflation: Evidence from the Nigerian Economy

Abstract This study investigated the complex relationship between fiscal deficits and inflation in Nigeria, examining their short-run dynamics, long-run equilibrium, and causal relationships. Using an Autoregressive Distributed Lag (ARDL) model and Granger causality testing, the research revealed several significant findings. In the short run, inflation demonstrated strong persistence, with past inflation values significantly influencing current levels. Fiscal deficits, particularly at their second lag, showed a positive impact on inflation, while real GDP and exchange rate stability exhibited deflationary effects. The error correction term indicated rapid adjustment to long-run equilibrium, highlighting effective fiscal and monetary coordination. Long-run analysis revealed a significant negative relationship between fiscal deficits and inflation, suggesting that disciplined fiscal policies could contribute to price stability over time. The money supply rate showed a positive long-term impact on inflation, consistent with classical monetary theory. Real GDP and exchange rates maintained their deflationary effects in the long run, serving as stabilizing factors in the Nigerian economy. Granger causality tests demonstrated unidirectional causality from fiscal deficits to inflation, establishing fiscal deficits as a predictor of inflation in Nigeria, though the reverse relationship was not significant. Based on these findings, the study recommends enhancing fiscal management through stronger deficit control measures and fiscal consolidation policies. This includes improved budgetary management, prioritized productive spending, and reduced reliance on borrowing. Additionally, the research emphasizes the importance of strengthening monetary and exchange rate policies, suggesting that maintaining exchange rate stability and controlling money supply growth are crucial for managing inflation. These recommendations aim to support price stability and mitigate inflationary pressures in Nigeria's developing economy. Keywords: Inflation, fiscal deficit, fiscal theory of price level, fiscal policy