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CHAPTER ONE

BACKGROUD TO THE STUDY

1.1 Introduction

The Nigerian economy has been plagued with several challenges over the years. In spite of many, and frequently changing, fiscal, monetary and other macro-economic policies, Nigeria has not been able to harness her economic potentials for rapid economic development (Ogbole, 2010). According to Adeoye (2006), the debate on the effectiveness of fiscal policy as a tool for promoting growth and development remains inconclusive, given the conflicting results of current studies. Over the last decade, the growth impact of monetary policy has generated large volume of both theoretical and empirical literature. However, most of these studies paid more attention to developed economies and the inclusion of developing countries in case of cross-country studies were mainly to generate enough degrees of freedom in the course of statistical analysis (Aregbeyen, 2007). Nigeria as a developing economy has, since independence in 1960, been striving to achieve economic growth. One of the channels of doing this is through the instrumentality of monetary policy. According to Central Bank of Nigeria (CBN 1979) has the primary responsibility for formulating monetary policy and has enjoyed a good deal of independence in doing so, although the final authority for the policy rests with the Federal Executive Council. It would be recalled that in Nigeria, it has been the practice that CBN’S monetary policy proposals are made as an integral part of the Federal Government annual budget which combines approved monetary and fiscal measures. In attempt to achieve these objectives government has adopted two major mechanisms namely the monetary and fiscal policies. In Nigeria for instance, undue reliance has been placed on fiscal policy rather than monetary policy (Darrat, 1984), which has led to greater distortions in Nigerian economy. A redirection in the monetary policy and in particular emphasis on more relevant and effective instruments came in the wake of deregulation of the money market beginning growth and development. Today, fiscal and monetary policies are both commonly accorded prominent roles in the pursuit of macroeconomic stabilization in developing countries. Given the fact that both monetary and fiscal policies impact on economic growth and development, it is not surprising that they are entwined. This relationship has been explicitly explained thus; Fiscal and monetary policies are inextricably linked in macroeconomic management; developments in one sector directly affect developments in the other. Undoubtedly, fiscal is central to health of any economy, as government’s power to tax and to spend affects the disposable income of citizens and corporations, as well as the general business climate. In this regard, the interrelationship between public spending and private sector performance is of paramount importance (Ekpo, 2003). The impact of fiscal and monetary policy has been the subject of controversy among economists. The monetarist regarded monetary policy more effective than fiscal policy for economic stabilization. On the other hand, Keynesians hold the opposite view of Friedman and Meiselman (1963), Chowdhury (1986, 1988) and Cardia (1991); have examined the impact of fiscal and monetary policies on various aggregates. However, the bulk of theoretical and empirical research has not reached a conclusion concerning the relative’s power of monetary policy on economic growth. Some researchers find support for the monetarist view, which suggests the monetary policy generally has a greater impact on economic growth and dominates fiscal policy in terms of its impact on investment and growth (Elliot, 1975). However, others argued that fiscal policies are crucial for economic growth (Chowdhury, 1986; Olaloye and Ikhide, 1995). Cardia (1991) found that monetary and fiscal policies play only a small role in varying investment, consumption and output. The experiment of 1970s clearly demonstrates that policy mix produced only stagflation. Some economists took keen interest in money by combining Keynesian neoclassical mixture which called the “funnel” theory by James Tobin. The argument was that tax rate and money growth simultaneously leads to stagflation thus the Government could choose either fiscal or monetary policy stimulus which will enhance growth. Contrary to the Say’s law supply was thought to create its own demand. If the economy were below full employment, money growth will stimulate economic growth by escalating both nominal and real GDP. If the money were above full employment by stimulating money growth can leads to stagflation, because workers would demand high wages and firms will hike prices. Any economy whether developed or developing is out to achieve certain objectives which include full employment, equitable distribution of income, desired rate growth and price stability.

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