Monetary and fiscal policy interactions in Nigeria: An application of a state-space model with Markov-switching

Abstract

This paper uses quarterly data to explore the monetary and fiscal policy interactions in Nigeria between 1970 and 2008. As a preliminary exercise, the paper examines the nature of fiscal policies in Nigeria using a vector autoregression (VAR) model. The simulated generalized impulse response graphs generated from the VAR estimation provides evidence of a non-Ricardian fiscal policy in Nigeria. Further, the paper analyzes the interactions between monetary and fiscal policies by applying a State-space model with Markov-switching to estimate the time-varying parameters of the relationship. The evidence indicates that monetary and fiscal policies in Nigeria have interacted in a counteractive manner for most of the sample period (1980-1994). At other periods, we do not observe any systematic pattern of interaction between the two policy variables, although, between 1998 and 2008, some form of accommodativeness can be inferred. Overall, the results suggest that the two policy regimes (counteractive and accommodative) have been weak strategic substitutes during the post 1970 (Civil War) period. For the policy maker, our results imply the existence of fiscal dominance in the interactions between monetary and fiscal policies in Nigeria, implying that inflation, predominantly results from fiscal problems, and not from lack of monetary control.

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