The Relationship Between Budget Deficit , Inflation And Money Supply Growth In Nigeria , From 1970-2014

Economists are generally of the view that if output cannot be increased to meet the increased demand for goods and services arising from the increased nominal stock of money, a pressure on price will be exerted. Most economists argue that inflation is strictly a monetary phenomenon as inflation rate rises due to high growth rate of money supply in the economy. Tekin-Koru and Özmen (2003) stated that budget deficits are inflationary in the monetarist framework only to the extent that they are monetized. This argument on inflation centered on money supply as the major cause. Other arguments view causation as running from inflation to money supply (Sargent and Wallace, 1973). While Kilindo (1997) noted the response of money supply to inflation through fiscal operation. According to Chimobi and Igwe, (2010), the Central Banks can eliminate the interrelationship between budget deficits and inflation by not monetizing the deficit. For instance, by not buying the bonds issued by governments. The development of a budget deficit is often traced to the Keynesian theory inspired by expenditure-led growth. Most economies adopted the Keynesian framework which motivated demand side of the economy geared towards stimulating growth. However, its consequences on macroeconomic variables cannot be underestimated in most countries of the world, Nigeria inclusive (Olomola and Olagunju, 2004). In the monetarist Abstract: The interrelationship between budget deficit, money supply and inflation have continued to generate a lot of debate among scholars on the direction of causality. This study investigates the relationship between budget deficit, inflation and money supply growth in Nigeria from 1970 to 2014; using Vector Auto regression (VAR) specification and Johansen cointegration test procedure. The standard deviation show that the highest standard deviation of (79429.43) is recorded by the DEFICIT while the least standard deviation of (15.67525) is recorded by INF. The skewness statistics from the result reveals that DEFICIT is negatively skewed while the rest of the variables are positively skewed. The correlation result shows INF has positive sign while M1GROWTH has a negative sign. The response of DEFICIT to M1GROWTH indicates a negative shock with no significant effect and continued with the sign to positive shock at later horizon. The response of the DEFICIT to INF shock shows a decreasing response in the initial stage but with a positive sign at a later horizon. The shock to M1GROWTH and INF decreases from the beginning to later time horizon. From the above findings, it is recommended that the Nigeria government during this economic recession should embark on deficit financing of capital projects to stimulate massive increase in productivity and employment opportunities. In the long run, the Nigeria government should highly reduce the deficit financing and manage the gains from the increased productivity to finance most of the capital projects though fiscal policies, especially, taxes. In conclusion, budget deficit financing of capital projects does not cause either inflation or excessive money supply in the economy in the short run except in the long run if not managed well. Consequently, deficit financing of capital projects at this period of economic recession will result in economic growth and reduce inflation in Nigeria.