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THE IMPACT OF GOVERNMENT EXPENDITURE ON INFLATION IN NIGERIA

ABSTRACT

This study examined the impact of government expenditure on inflation in Nigeria. This research work made use of secondary data which were collected from the central bank Nigeria Statistical Bulletin (2017). The data were collected for a period of thirty two years (i.e. 1981-2017). The Study establishes the order of integration of individual time series through the unit root test and also subjected all the variable to stationary test, however, haven test the stationarity for each time series, test for co-integration was conducted between the variables, which reveals that none of the variables co-integrated, and thereafter an error correction mechanism or model (ECM) was conducted on the model. The result of the Error Correction Mechanism reveals that government expenditure has no statistical relationship with inflation, though the coefficient of government recurrent expenditure was positively related to inflation. Government expenditure and exchange rate was able to explain 9.65% of the total variation in inflation, after taking cognisance of the degree of freedom. The study concluded that Government expenditure is able to induce inflation through its impact on money supply. The study recommends that: Much  of  government  spending  should  be  channeled  into  productive  ventured  such  as  directly productive  activities  (DPAs)  and  Social  Overhead  Capital  (SOCs); Money  supply  should  be  strictly  controlled; Formulate appropriate fiscal and monetary policy - mix to effectively  Control inflationary pressure in the economy; Maintain a good strategic balance between capital and recurrent expenditure to prevent the economy from being consumption - based.

CHAPTER ONE

INTRODUCTION

1.1   Background to the Study

Government Expenditure is the amount of resources spent by a particular government to finance all its operations so as to provide public goods. Oyinlola (2010) observed that the size of government expenditure and its impact on economic growth have emerged as a major fiscal management issue facing economies in transition. Singh and Sahini (2014) has urged that a large and growing government is not conducive to better economic performance. For decades public expenditures have been expanding in Nigeria, as in any other country of the world. Akpan (2015) opines that the observed growth in public spending appears to apply to most countries regardless of their level of economic development. Over the years, increases in the finances of government have led to a number of theoretical and empirical investigations of the sources of such increases. Researchers have particularly questioned whether increases in the size of federal budget tend to be initiated by changes in expenditure followed by revenues adjustments or by the reverse sequence or both Baghestani & Mcnown, (2004), Akpan, (2015). A growing government expenditure is contrary to a government’s economic interest because the various methods of financing government such as taxes, borrowing and printing money have harmful effects. Government spending by its very nature is often economically destructive regardless of how it is financed Kneller (2009).

Governments need finances because of their roles in the society. For a government to provide all the public goods, it requires finances which are obtained mainly through taxes, grants and loans Tanzi, (2004). In Nigeria, governments depend more on oil revenues and taxes to finance their operations and often borrow and get grants to finance their budget deficits. Inflation on the other hand determines the value for money that a government will achieve out of its expenditures. One of the most macroeconomic objectives of any country is to sustain high economic growth with low inflation Liu, (2008). Inflation imposes negative externalities on the economy when it interferes with the economies efficiency. It may also reduce a country’s international competitiveness, by making its exports relatively more expensive than its imports thus impacting on the balance of payments Koiman, (2007). Individually, inflation and government expenditure do affect economic growth.

Government expenditure plays an important role in physical and human capital formation over time. Government performs two functions namely: protection and provision of certain goods Abdullah, (2010) and Fasta, Hagen, Hughes, Siebert and Strauch (2003). Protection function consists of the creation of the rule of law and enforcement of property rights which help minimize risk of criminality and external aggression. Under the provision of public goods are health, education, power, agriculture, transportation etc. Many political philosophers like Hobbes and Locke considered the hypothetical disadvantages of life without government Devarjan, Swaroop and Zou (2006). The ideal size of government is not the problem of the economic theory. But, economic theory tells us to examine cost and benefit in order to determine whether resources are allocated in a manner that increase or decrease economic growth.

The basic economic policy of the good society is public expenditure in line with future economic growth and wellbeing. For example, expenditure on health and education raises the productivity of labour and increase the growth of national output. Similarly, expenditure on infrastructure such as roads, Communication, power reduces productions cost and increases private sector investment and profitability of firms thus fostering economic growth. Supporting this view, Scholars such as Abdullah, (2010) concluded that expansion of government expenditure determine the inflation rate of an economy. In the Nigerian context for instance, the public sector consists of the Federal, state and local government enterprises. Some government financial operations remain entirely outside the budget and are funded by extra budgetary accounts. Therefore, the effects of expenditure on economic growth may be a comprehensive indicator of public productivity. However, governments have always been very careful in planning her expenditures by means of government budgets and National income.

Government in their different economic activities and policy formulations whether short term or long term usually encounters some problems which needs to be solved. Without solving these problems, government might not be able to formulate and implement of policies which is capable to put the economy along the path of sustainable economic growth and development. Knowledge of the effects of public expenditure on economic growth and the application of this knowledge in the solutions of some problems encountered by different policy makers in their short term or long term economic activities with a view of arriving at a specific and active policy is a problem which this study will attempt to address. In light of this, this present study will embarked on finding the relationship between the government expenditure and inflation in Nigeria using the economic period of 1981 and 2017 to determine this.

1.2    Significance of the Study

The significance of a research on the analysis of government expenditure and its impact on inflation in Nigeria cannot be over-emphasized. Inflation has become a monstrous challenge to developing nation like Nigeria. It is like a blight plaguing the economy of Nigeria resulting into reduction in the purchasing power of people, also curtailing investment and savings; thereby aggregating poverty level in Nigeria, affecting mostly the middle and low income groups especially the salary earners. Again, the conduct of this research work is important as it would guide the following stakeholders in making decisions that would curtail the harsh effects of inflation as regards to government expenditure. The study will also show how the government can effectively plan and allocate state funds during inflation. Not a lot of research on the analysis of government expenditure and its impact on inflation in Nigeria, so i am positive that the research work will contribute significantly to previous knowledge on the subject matter. The contents of the research work would equally bridge information gap created as a result of insufficient statistics relating to government expenditure and its effect on the rate of inflation in Nigeria also, the findings and recommendations of the research work will suggest ways by which the challenges faced by Nigerians because of inflation can be addressed. 

1.3   Statement of the Problem

One of the key macroeconomic goals every economies strive to achieve is price stability, or having a relatively low rates of inflation that facilitates employment and output expansion. Nigeria still suffers from price instability given its double-digits inflation rate.  According to the Keynesians school of thought, one of the principal causes of high rate of inflation in developing economies is excessive government spending. Excessive government spending raises aggregate demand over supply, thereby making prices to rise. Moreover, Nigerian governments at all levels often incur expenditure on unproductive and growth-enhancing projects, and this stirs inflationary pressure on the economy. The inability of government to incur expenditure in a prudential manner has contributed to high rate of inflation in Nigeria.  Fiscal recklessness has impeded the economy of Nigeria from having a low rate of inflation that foster economic growth. Thus, for inflation to be reduced to the barest minimum, there is need to check cautiously the manner in which government funds are expended.

1.4   Objectives of the Study

The main objective of the study will be to examine the impact of government expenditure on inflation in Nigeria. The specific objectives of the study are:

To evaluate the impact of government capital expenditure on inflation in Nigeria.

To assess the effect of government recurrent expenditure on inflation in Nigeria.

1.5   Research Questions

In the course of the research, efforts will be made to provide answers to the following questions:

To what extent does government capital expenditure influence in inflation in Nigeria?

What is the magnitude of the impact of government recurrent expenditure on inflation in Nigeria?  

1.6    Research Hypotheses

In accordance with the objectives of the study, the following research questions are put forward to order to be able to make valid conclusions about the subject matter.

H01: Government capital expenditure has no significant impact on economic growth in Nigeria.

H02: Government capital expenditure has no significant impact on economic growth in Nigeria.

1.7   Scope of the Study

The study covered a 37-year period spanning between 1981 and 2017. This time period is deemed appropriate for the study because it covers different economic and political dispensations in Nigeria. As regard, the economic dispensation, the period covered the pre-SAP, SAP and post-SAP period. Also, for the political dispensation, the period covered military and civilian administrations. However, the variables that would be used in the study is restricted to government capital expenditure, government recurrent expenditure, inflation rate and exchange rate (control variables). Thus, this implies that the variables of the study is delineated to time-series data.

1.8   Justification of the Study

Most developing economies, with Nigeria inclusive, is bedeviled with economic instability as portrayed by the high rate of inflation. Available statistics from the Central Bank of Nigeria revealed that inflation (consumer prices) was 18.87% in 2001, 17.86% in 2005, 13.72% in 2010, 15.70% and 15.98% in 2016 and 2017 respectively. Contrary to the monetarists postulation, inflation in Nigeria is not only caused by excessive growth of money supply, but also by government expenditure, which mostly are incurred unwisely. Majority of prior studies gave attention to the causes of inflation in Nigeria from the monetary side, and adequate attention has not been dissipated to the influence of inflation in Nigeria from the fiscal angle. The fact remains that if government expenditure is not directed to productive and development-inducing projects, aggregate supply will keep falling short of aggregate demand, and will put pressure on the prices of goods and services in the country. There is dearth of empirical evidence on the effect of government expenditure on inflation in Nigeria in recent years. The Keynesian position on inflation has not been thoroughly researched in economic literature. There is a need to know whether Keynesian posture on inflation is applicable to Nigeria.  To the best of the researcher’s knowledge, no studies have investigated the subject matter in recent years (2015, 2016 and 2017). The study will therefore contribute to literature by assessing the extent to which inflation in Nigeria is affected by government expenditure between 1981 and 2017, in which the last three years of the study’s time frame has not been researched on.

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