Public Debt, Fiscal Dominance, and Inflation in Nigeria: Evidence from ARDL Analysis

Abstract

This paper evaluates the dynamic association between public debt, fiscal dominance, and inflation in Nigeria between 1990 and 2023 using the Autoregressive Distributed Lag (ARDL) bounds testing model. The study is driven by the fact that Nigeria is experiencing an increasing profile of public debt, recurrent inflationary pressures and the issue of fiscal-monetary policy coordination. The paper is based on the fiscal dominance theory and whether the efficacy of monetary policy is compromised and results in inflation with the use of expansionary fiscal policy, which is financed to a large extent by borrowing and credits by the central bank. The main variables are the rate of inflation, aggregate government debt, fiscal deficit, overall money supply, exchange rate, and interest rate which were obtained in the Central Bank of Nigeria and the Debt Management Office. The ARDL bounds test results indicate the existence of long-run cointegrating relationship between the variables. Estimated coefficients show the statistically significant positive effect of both long-term and short-term inflations produced by public debt and fiscal deficit, which proves the hypothesis of fiscal dominance in Nigeria. In addition, the level of money supply, as well as exchange rate depreciation, are major causes of inflation, whereas the interest rate demonstrates a negative correlation. The model is also robust, stable, and free of serial correlation or heteroscedasticity that is confirmed by diagnostic tests. The paper concludes by saying that the fiscal activity of Nigeria has been eminent and limiting to monetary policy, which sustained the tendencies of inflation. Suggestions that have been put forward are the application of legislated fiscal regulations, the in-depth development of the domestic debt market to cut down on monetary finance, the central bank independence, and the productivity so that imported inflation can be checked. These are essential in unleashing the debts-inflation nexus and realize macroeconomic stability.