On the relationship between fiscal deficits and inflation: econometric evidence for Nigeria

Using a modelling approach that incorporates the theory of cointegration and its implied vector error correction model, this study investigates the long term relationship between fiscal deficits and inflation for Nigeria, a country which has experienced very large fluctuations in the government fiscal deficits. The empirical results show that there is a positive but insignificant relationship between fiscal deficits and inflation. The analysis of the Nigerian data also indicate a tenuous link to previous levels of fiscal deficits with inflation and provide, moreover, evidence of a positive long-run relationship between money supply growth and inflation, suggesting therefore that money supply growth is procyclical and tends to grow at a faster rate than the rate of inflation. Finally, from the impulse response and variance decomposition analysis, the study finds that the length of inflation is an important determinant of the ability of the system to return to its long-run equilibrium following a shock.