IMPACT OF FISCAL POLICY INSTRUMENTS AND INFLATION AS MACROECONOMIC KEYS ON THE ECONOMY

IMPACT OF FISCAL POLICY INSTRUMENTS AND INFLATION AS MACROECONOMIC KEYS ON THE ECONOMY

This study is to examine the relative impact of fiscal policy instruments and inflation as macroeconomic keys and how their manipulations in the past have affected the economy either positively or negatively.

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CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

In trying to achieve its macroeconomic objectives which are full employment, price stability, growth in gross domestic product as well as the balance of payment equilibrium, the government has employed various macroeconomic tools. The policy, as well as the instruments applied to attain these economic goals in Nigeria, have been adequately pursued through increase reliance on fiscal rather than monetary policy which is frequently breached Darrat, (1984).

Monetary and fiscal policies are used by both developed and developing economies. The significance of monetary policy is felt in advanced economies with developed capital markets, while the importance of fiscal policy is felt more in the developing economies where the financial markets are still developing Onoh (2007)

According to Gbosi (2000), attempts by economists to explain fiscal policy as a major tool of macroeconomic management emanated from the views of the classical and Keynesian schools of thought. The classical school of thought argued and opined that the market economy can adjust itself hence no need for government meddling. After the first and second world wars disapproved of this theory, the Keynesian school of thought, on the other hand, recognized that was potential instability in the economy which cannot be corrected by the market mechanism.

The revolutionary Keynesian viewed that the government must take a proactive role in stabilization of the business cycle focused on the large measures on the powers of the federal government to tax and to make expenditures (Dilts 2006). Fiscal policy gained its supremacy during the 1930’s economic depression. It specifically, increased its prominence when it became obvious that the market could no longer checkmate economic predicament.

To the classical economist, the likes of J.B. Say et al had taken the demand side for granted by believing that the goal of macroeconomic policy is to achieve full employment and this can be done through uninterrupted interaction of market forces. They held this view based on their belief in the say’s law of market which states that supply creates its own demand.

The Keynesians argued that the forces of demand and supply cannot achieve full employment due to the existence of potential instability in every market economy and this is because the aggregate demand structure has shown periodic deficiency tendencies of demand in an economy and the attendant decline in production. He further argued that these deficiencies surrounding demand and the subsequent decline in production and employment could be eliminated through government intervention by way of expenditure on public work as this will encourage the economy to further activities through the multipliers and the accelerator effect. This turns in economic events by Keynes’s new ere formation of economic thinking and policies as this justified him as advocating for the use of fiscal policy by the government to tackle economic instability Gbosi (2008).

He further, by definition, saw the fiscal policy as the deliberate change of levels of government expenditures, taxes and borrowing in order to achieve such national economic goal as full employment, price stability, growth in the gross domestic product (GDP) and balance of payment equilibrium. He further identified the instruments of fiscal policy to include, government taxes, expenditures, and borrowings

A government in determining its fiscal policy takes certain factors into consideration. Some of these factors include future employment growth rate or reduction (unemployment) rate as this will determine the likely revenue accruable to the government through income taxes and by extension its expenditures. The government also determines how to allocate this revenue when generated under capital and recurrent expenditure heads. The government does this by stating it clearly in its budget what amount will go to construction of a new projects, funding of a its programs, payment of salaries which falls into recurrent expenditures

Government expenditure guarantees private spending as increase expenditure by the government translates to an increase in disposable income of the households and business where taxes are within safe limits for these economic units. Taxes of corporate income and indirect taxes on domestic transactions are fiscal instruments that bring about price stability. By adjusting taxes on corporate income and indirect taxes on domestic transactions downwards, the cost of production and prices are lowered with time (Onoh 2007). The implication of this is that, if taxes are adjusted upwards on corporate income and indirect taxes on domestic transactions, the cost of production and prices will increase ceteris paribus.

The above scenario brings us into another variable of this research work which is inflation. The high cost of production and by extension, prices of goods and services are known characteristics of an inflation ridden economy.

However, inflation as usually occurring, as viewed by the Keynesians, whenever aggregate demand rises faster than aggregate supply thereby leading or pushing up prices and wages. Gbosi (1999).

Inflation can also be seen or defined as a general in an increase in the price of goods and services in all sectors of the economy (Gbosi, 2008) he further said that no matter how one defines inflation, the underlying philosophy is that, it is a major macroeconomic problem which occurs whenever there is an increase in the average prices of goods and services.

This phenomenon he named a social problem as well as a pervasive economic dilemma that concerns all sectors of the economy. Indeed it has been a problem proven difficult to handle because any move to make to cure it would entail trade-off among macroeconomic and social objects such as economic growth, increase employment, e.t.c

1.2 Statement of the Problem

Macroeconomic policies are stipulated to attain specific or multiple macroeconomic objectives and fiscal policy has a paramount long term effect on the health of the economy, especially when it comes to national savings as well as the growth of productivity and national savings can be generated privately, by households, business or publicly by the government  as a sound fiscal policy can achieve economic stability both in times of inflation and deflation by offsetting unwanted disparities in public expenditures and taxes vice versa, (Onoh 2007)

Although, in Nigeria, it is only in theory that fiscal policy can help boost private savings, not when it comes to practice and this is a result of the difficulty on how to make accurate short-run forecasts of the economic situation, Onuchuku, (2002). And the formulation of fiscal policy in Nigeria sometimes leads to leakages in the coffer of government leading to diversion and embezzlement of funds meant for economic growth and development. Gbosi (2008).

However, this study will bring to the forefront the significant impact of fiscal policy arrangements on the economic growth of Nigeria showing the various kinds of relationship between the fiscal policy variables and inflation and how they affect the economic growth of Nigeria.

1.3 Research Objectives

The main objective of this study is to examine the relative impact of fiscal policy instruments and inflation as macroeconomic keys and how their manipulations in the past have affected the economy either positively or negatively;

While the specific objectives are:

1. To examine the relationship between recurrent expenditure and inflation.
2. To know the relationship between federal government capital expenditure and inflation.
3. To establish the relationship between federal government domestic debt and inflation.
4. To uncover the relationship between federal government tax revenue and inflation
5. To establish the relationship between federal government foreign debts and inflation.

1.4     Research Question

The following research questions will be relevant to this study.

1. To what extent does federal government recurrent expenditure impact on inflation in Nigeria?
2. What is the relationship between federal government capital expenditure and inflation in Nigeria?
3. To what extent does federal government domestic debt impact on inflation in Nigeria?
4. What is the relationship between federal government foreign debt and inflation in Nigeria?
5. Does federal government tax revenue have an impact on inflation in Nigeria?

1.5 Research Hypotheses

H0₁:   There is no significant relationship between federal government recurrent expenditure and inflation in Nigeria

H0₂:   There is no significant relationship between federal government capital expenditure and inflation in Nigeria.

H0₃:   There is no significant relationship between federal government domestic debt and inflation in Nigeria.

H0₄:   There is no significant impact between federal government foreign debt and inflation in Nigeria.

H0₅:   There no significant relationship between federal government tax revenue and inflation in Nigeria.

1.6     Significance of the Study

This study on fiscal policy instruments and inflation will provide the necessary feedback for policy adjustment where necessary.

Specifically, this research work is important given this following;

1. This study will add to the existing body of literature in this field of research and also provide a lesson or cause a modification in the manipulation of fiscal policy to achieve Nigeria’s macroeconomic objectives in the future.
2. This work will shed light on the extent to which the long term stability in the relationship of the fiscal policy instruments can be applied for forecasting the economy.
3. It will also provide secondary and quantitative information for students and other researchers alike.

1.7     Limitation of the Study

This study is restricted or designed to focus on fiscal policy and the likely consequences of manipulating them without regard to inconvertible macroeconomic theories or empirical findings. The constraints of gathering accurate theories and empirical findings as regards to this work were noticed, But, surmounted to some extent.

1.8 Organization of the Study

This work is organized as follows: chapter one gives an insight of the research work by means of background to the study, statement of the problem, objective of the study, research question, research hypotheses, limitation of the study and definition of terms, and chapter two talks about the review of related literature which has to do with the theoretical underpinning, conceptual framework empirical review and gap in the literature.

1.9 Definition of Terms

EXPENDITURE: this is the payment of cash or cash equivalent for goods and services, or a charge against available funds in settlement of an obligation as evidenced by invoice, receipt, voucher e.t.c

FISCAL POLICY:  this is the use of government revenue and expenditure to influence the economy.

INFLATION: means a sustained, rapid increase in the prices of goods and services.

GOVERNMENT: the regulation, restraint, supervision or control which is exercised upon the individual members of an organized society by those vested with the supreme political authority, for the good and welfare of the body politic. It could also mean to be the act of exercising the supreme political power or control.

PUBLIC DEBT:  debt owed by the federal government of a country. It is also called government or national debt.

REVENUE:  the income of a government from all sources appropriated for the payment of public expenses.

TAXATION: A means by which governments finance their expenditure by imposing charges on citizens and corporate entities. Governments use taxation to encourage or discourage certain economic decisions.

MACROECONOMIC POLICY: the set of government convention and policy to control or stimulate the aggregate pointers of an economy