Abstract:

Weak economic and social indicators which characterize developing economies have often been associated with poor economic performance in these economies. Though theory postulates a direct impact of deficit financing on the economy, literature is replete with theoretical arguments on their true relationship. Empirical evidence on the subject has rather been inconclusive. This paper seeks to examine the effect of deficit financing on the economic health of Nigeria using selected indicators of economic performance, like exchange rate, private sector credit, inflation, unemployment and poverty, as proxy for economic health. Econometric methodology based on the vector auto-regression (VAR) analytical technique was adopted. The study shows that (i) deficit financing impacts significantly but negatively on exchange and inflation rates. There is also evidence of significant positive impact of deficit financing on private sector credit. (ii) deficit financing shocks are largely attributed to own innovations. However, fiscal deficits significantly transmit shocks to exchange rate, private sector credit, inflation and unemployment.(iii) Granger-causality analysis also reveals uni-directional causal impact of deficit financing on exchange rate, private sector credit, inflation and unemployment. The finding of this study implies that (i) liquidity surfeit often associated with deficit financing in Nigeria promotes exchange rate volatility and inflationary trends, largely, due to excessive demand pressure. (ii) the implementation of deficit financing in Nigeria has been dismal thereby promoting a vicious cycle of deficits financing more deficits. (iii) deficit financing causes movements in exchange rate, affects the capacity of the banking sector to support the private sector, fuels inflationary trends and generates unemployment. We recommend strict fiscal discipline in the conduct of government fiscal operations to ensure productive use of government financial resources.