An econometric analysis of fiscal policy and monetary policy interdependence : comparative study between Nigeria and South Africa

Abstract

Fiscal policy and monetary policy are important macroeconomic tools used to achieve macroeconomic objectives. The dominant objective of fiscal policy is to increase the aggregate output of the economy while the overriding objective of monetary policy is to regulate and control the interest and inflation rates. Conventionally, both fiscal and monetary policies were under the control of the national governments. Consequently, traditional economic analyses were made with respect to both policies to attain the optimum policy mix of the two in order to achieve the broad macroeconomic goals. But more recently, as a result of the transfer of monetary policy control and monetary policy formulation to central banks, there has been a significant and notable structural change in the way in which fiscal and monetary policies interact. There has been a dilemma as regard whether these two policies are complementary, or are substitutes to each other for achieving macroeconomic goals. The issue of fiscal and monetary policies interaction and the idea of complementarity or substitutability for each other comes up only when both fiscal and monetary policies authorities are independent of each other. But when the goals of either of the authority, mostly monetary policy authority, is made subservient to the fiscal authority simply because national government controls the fiscal authority, then fiscal authority solely dominates the policy making and as a result hinder the monetary policy objective. This study revisits the discussion on fiscal and monetary policies interaction by econometrically analyzing the interdependence between fiscal and monetary policies interactions in Nigeria and South Africa. Consequently, the study aimed at estimating the degree of fiscal and monetary policies interdependence in Nigeria and South Africa; analyse the trend of inflation with respect to the degree of fiscal and monetary policies interdependence; and evaluate the dynamic responses between fiscal and monetary policies variables. In order to achieve the objectives of the study, the study employed a quantitative research methodology. Time series data on nominal consumption expenditure, money supply, government debt, inflation rate, interest rate, tax revenue, output level, and government spending for the period 1981-2016 were adopted for the analysis and simulation was also done within the DSGE modelling. The data were sourced from the World Bank Development indicator (WDI), a publication of World Bank. The study made use of dynamic ordinary least square (DOLS) proposed by Stocks and Watson to estimate the degree of fiscal and monetary policies interdependence in Nigeria and South Africa while a trend analysis was carried out to examine the trend of inflation with respect to the degree of fiscal and monetary policies interdependence. Dynamic Stochastic general equilibrium model (DSGE) and Bayesian vector autoregressive model (BVA) were used to evaluate the dynamic responses between fiscal and monetary policies variables. The result of the first model used to estimate the degree of fiscal and monetary policies interdependence showed that the degree of fiscal and monetary interdependence in Nigeria is 0.84 while it is found to be 0.67 in the South African economy. This empirical finding suggests that the degree of fiscal and monetary policies interdependence in both Nigeria and South Africa is greater than 0.5 and closer to 1. This implies that in coordination of fiscal and monetary policies interactions in both economies, central bank is more active and first mover. Put differently, because the degree of fiscal and monetary policies interdependence is greater than 0.5 in both countries, the apex bank enjoys a high degree of autonomy in coordination of fiscal and monetary policies. The implication is that about 84% and 67% of government debt are backed up by fiscal authority in Nigeria and South Africa respectively while remaining percentage is accommodated by monetary authority, and that monetary authorities in both countries fixed their policies ahead and enforce discipline on fiscal authorities. Hence, both economies could be said to be under a low fiscal dominance hypothesis. This is because the zero or low fiscal dominance requires that the degree of fiscal and monetary policies interaction be greater than zero and closed to one as found under the present study. Also the results of the trend analysis showed that the inflation rate has been consistently higher in the Nigerian economy than in the South African economy, while average annual inflation rate under the study period in Nigeria was 19.6% and 9.1% in South Africa. The empirical findings suggest that though Nigeria has a higher degree of fiscal and monetary policies interdependence than the South African economy, average inflation rate in Nigeria is higher than in South Africa. This result does not find evidence of low inflation being associated with higher degree of fiscal and monetary policies interdependence. Findings from the dynamic stochastic general equilibrium model (DSGE) and Bayesian vector autoregressive model (BVA) reveal that fiscal and monetary policy interacts with each other in both the Nigerian and South African economy. Inflation responds to fiscal policy shocks in the form of government spending, revenue and borrowing shocks. Monetary authority’s decisions also affect fiscal policy variables. However, monetary and fiscal policies interactions are largely stronger in South Africa than Nigeria. The empirical results show that the dominant sources of variation in output level in Nigeria are shocks to government debt while shocks to tax, interest rate and government spending are found to be dominant sources of variation in output level in South Africa. Also, output level, government debt and interest rate are important sources of variation in government spending in Nigeria while they are found to be output level, tax revenue and interest rate shocks in South Africa. Government debt and inflation shocks are significant and dominant of sources variation in interest rate in Nigeria while all the variables seemed to be significant sources of variation in South Africa. Tax revenue, government debt and government spending shocks are significant sources of variation in inflation in South Africa, while all the variables are found to be a significant sources of variation in inflation in Nigeria. The study concludes based on the empirical findings, that monetary policy authorities in Nigeria and South Africa should strive more to maintain the current level of their autonomy given their higher degree of fiscal and monetary policies interdependence. Current level of autonomy can be maintained by ensuring that the fiscal authority plans its inter-temporal budget constraints such that current level of government outstanding debt and its interest would always be offset by future primary surpluses rather than seigniorage. The productive base of Nigeria needs to be awakened as is almost moribound in terms of perfomance. This can be done through elimination of various structural rigidities in Nigerian economy, provision of adequate and modern infrastructure such as good roads, power suppy which aid productive activities, discouraging importation of already inflated products into the country and tax concessions to producers of essential commodities. Meanwhile, though the average level of inflation in South Africa is lower than that of Nigeria, South African inflation rate can still be brought lower given the degree of fiscal and monetary policies interdependence by also further strengthening the productive base of the economy.