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Abstract This study examines the conduct of optimal fiscal and monetary policy in Nigeria under the assumption of a rent‐seeking government. To answer this question, a Dynamic Stochastic General Equilibrium (DSGE) model featuring a rent‐seeking fiscal authority is calibrated. The study also conducted a sensitivity analysis to compare the welfare effect of optimal simple policy rules under a corrupt versus benevolent regime. The results from the study showed that optimal monetary policy should target the double mandate of price and output stabilization when the government is a rent‐seeker. The study also found that it is optimal for the Central Bank to commit to an active monetary stance. The optimal fiscal policy rule in a rent‐seeking economy is passive and pro‐cyclical. Furthermore, welfare is negligibly better off in the benevolent economy. From a policy perspective, rent‐seeking activities are triggered by the proportion of rent‐seeking agents. This induces inefficiencies in government spending, which constrains growth in a developing economy. Furthermore, rent‐seeking can “coerce” the Central Bank of Nigeria to focus on a double mandate to stabilize both prices and output. Therefore, it is desirable for the monetary authority to possess due independence in controlling prices without interference from the fiscal authority.
Oye et al. (Sun,) studied this question.
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