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Fiscal policy and output gap is important to tinker the economy on the path of growth and development. Fiscal policy is implemented by the government through the Ministry of finance. Fiscal policy entails government management of the economy through manipulation of income and spending power, by controlling taxes and government expenditure, to achieve desired macroeconomic objectives. Output gap is the difference between potential output (production capacity) and actual output (actual production). The study addressed the contribution of fiscal policy and output gap to Nigerian economy from 1981-2015. The variables captured in the course of the study’s statistical analysis are Gross domestic product (GDP) gap, Inflation, Government (Public) expenditure, Interest rate. From the estimated regression result it can be seen that in the period under review, fiscal policy proxied by government expenditure has a significant and negative impact on output gap at impact and lag one. This means that within this period, fiscal policy is an effective tool in remedying adverse output gap. If for instance actual output is far below expected output, an increase in government expenditure will reduce the gap and the reverse will occur when actual output is above expected output. This finding is in line with Keynesian theories of government intervention in the economy. This finding is also in line with the works of Adeniyi (2010) .The relationship between government expenditure and GDP gap is however positive at lag two and three. Turning to the control variables it was found that interest rate has a positive but insignificant impact on output growth in Nigeria as shown by the very low p value. On the other hand, inflation rate was negatively related to output growth in Nigeria within this period. Its impact was however shown to be statistically insignificant. Taking a look at the group statistics we find that the R2 Value of 0.52 indicate that the independent variables as a group explains about 52% of the variations in economic development in Nigeria. The probability of the F- statistic which stands at 0.04 indicates that the jointly, the independent variables are statistically significant at the 5% significant level. From the estimated granger causality test, it can be seen that there exist a unidirectional causality from GDP gap to government expenditure (p value is 0.00007). However there is no reverse causality from government expenditure to GDP gap. On the other hand, there is no causal relationship whatsoever between GDP gap and the other control variables namely: inflation and interest rate. From the estimated Breusch Godfrey serial correlation test, it can be seen that the null hypothesis of no serial correlation cannot be rejected as the probability of the F- statistic arising from the LM test is very high. It is above the 0.05 threshold level for serial correlation to be accepted. Finally, the absence of autocorrelation was indicated by the Durbin Watson statistic which stands at about 2.0


Keywords: GDP gap, inflation, interest rate, Government expenditure.







1.1 Background to the Study

The Nigerian government has consistently embarked on diverse macroeconomic policy options to tinker the economy on the path of growth and development, amongst the policy options readily employed is the fiscal policy (Iyeli and Azubuike, 2013), and output gap (positive and negative) management. fiscal policy entails government’s management of the economy through the manipulation of its income and spending power to achieve certain desired macroeconomic objectives amongst which is economic growth (Gbosi, 2008). Fiscal policy refers to the use of government revenue collection and expenditure (spending) to influence the economy. Fiscal policy as a tool for economic management focuses on the effect of changes in government budget on the overall economy. The two main fiscal policy instruments are taxes and government expenditure.

Fiscal policy can either be expansionary or contractionary.  Expansionary fiscal policy are those policies that are used to expand the economy (Engen, 1992), which comprise reducing tax rates. Contractionary fiscal policies are those policies that are used to contract or slow down an economy. They include measures such as: increasing taxes and decreasing government spending. (Adebayo 1991,)

The immediate effect of fiscal policy in an economy is to change the aggregate demand for goods and service. A fiscal expansion for example raises aggregate demand through one of these two channels: first, if the government increases its purchases but keeps taxes constant, it increases demand directly. Secondly, if the government cuts taxes or increases transfer payment, households’ disposable income rises and they will spend more on consumption. The rise in consumption will in turn raise aggregate demand. Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output produced- that is, he gross domestic product. (Adebayo, 1991)

In a recession, the government can run an expansionary fiscal policy, thus helping to restore output to its normal level and to put unemployed workers back to work. During a boom when inflation is perceived to be greater problem than unemployment, the government can run a budget surplus, helping to slow down the economy fiscal policy is especially difficult to use for stabilization because of the inside lag, that is the gap between the time when the need for fiscal policy arises and when it is being implemented. A fiscal expansion affects a country’s output level in the long run because it affects the country’s saving rate.

Fiscal policy was not generally recognized as important until the birth of Keynesian Economics in the mid-nineteen thirties which enhanced its significance as a policy tool to overcome the economic depression of Western Europe and North America (Babalola, 2015). The threat of inflation in the immediate post-war years and the desire to maintain continuous full employment following World War II has also meant the continued use of fiscal policy in these same economies (Babalola, 2015). In more recent years, however, the limited success in the achievement of the above objectives has brought into sharp focus the question of the effectiveness of fiscal policy in relation to other policies especially monetary policy (Babalola, 2015).

While in the developing economies, the economic policy objectives of fiscal policy have been pursued to a greater or lesser degree, the one and overriding objective, the furtherance of which has relied greatly on fiscal policy, is economic development, defined not only as a continuous and sustained growth in total output as well as in output per head, but also as the structural transformation from the basically underdeveloped agricultural economies to fully industrialized ones (Olaloku, 1987).

The output gap is an economic measure of the difference between the actual output of an economy and its potential output. Potential output is the maximum amount of goods and services an economy can turn out when it is most efficient—that is, at full capacity. Often, potential output is referred to as the production capacity of the economy.¬ According to Emerenini (2007) GDP or output gap is the difference between the potential GDP and actual GDP, potential GDP is realized when only the natural rate of unemployment exists while actual GDP is the sum of frictional, structural, and cyclical unemployment. Meaning that GDP gap widens as the unemployment rate increases

Just as GDP can rise or fall, the output gap can go in two directions: positive and negative. Neither is ideal. A positive output gap occurs when actual output is more than full-capacity output. This happens when demand is very high and, to meet that demand, factories and workers operate far above their most efficient capacity. A negative output gap occurs when actual output is less than what an economy could produce at full capacity. A negative gap means that there is spare capacity, or slack, in the economy due to weak demand.

An output gap suggests that an economy is running at an inefficient rate either overworking or under-working its resources. Hence according to Arthur (2013), a macroeconomist is of the view that any time actual rate of unemployment is greater than the natural rate of unemployment by one percent (%), the gap of about 2 percent(%) results. For the cause of this study more emphasis will be on the negative aspect of output gap, which is often referred as inflationary. Inflationary gap according to Keynesian economists is an excess of planned expenditure over the available output of pre-inflation or basic prices. Lipsey (2015) said that inflationary gap is the amount by which aggregate expenditure would exceed aggregate output of the full employment level of income.

Governments can in this sense use fiscal policy to close the output gap. For example, fiscal policy that is expansionary that raises aggregate demand by increasing government spending or lowering taxes can be used to close a negative output gap. By contrast, when there is a positive output gap, contractionary or “tight” fiscal policy is adopted to reduce demand and combat inflation through lower spending and/or higher taxes.

Some policymakers have recently suggested that, in an increasingly integrated world economy, the global output gap can affect domestic inflation. In other words, all things being equal, a booming world economy may increase the potential for inflation pressure within a country. For example, stronger global demand for computers raises the price U.S. producers can charge their foreign customers. But because all computer producers are facing a stronger global market, U.S. producers can charge more for their output at home as well. This is known as the “global output gap hypothesis” and calls for central bankers to pay close attention to developments in the growth potential of the rest of the world, not just domestic labour and capital capacity.

Therefore, the aim of this paper, on a general term, is to assess the impact of fiscal policy and output gap in Nigeria between 1981 and 2015 fiscal years.

1.2       Statement of the Problem

From economic literature, fiscal policy is the government actions affecting its receipts (revenue) and expenditure. Then output gap is affecting its receipt and payments (difference between actual and potential output/GDP) The use of fiscal policy is very paramount in every society most especially in the less developed countries (LDCs) as a major tool for stabilization and for development to be sporadic, when the government uses government revenue and expenditure policies to regulate and stabilize the economy toward development, the action is fiscal policy (Babalola, 2015). It thus serves as an economy’s “shock- absorber” in specific areas of development.

The Nigerian economy has been plagued with several challenges over the years. Researchers have identified some of these challenges as: gross mismanagement/ misappropriation of public funds, (Okemini and Uranta, 2008), corruption and ineffective economic policies (Gbosi, 2007); lack of integration of macroeconomic plans and the absence of harmonization and coordination of fiscal policies (Onoh, 2007); inappropriate and ineffective policies (Anyanwu, 2007). Reckless public spending and weak sectorial linkages and other socio- economic maladies constitute the bane of rapid economic growth and development (Amadi et al., 2006). Also according to Kumapayi et al.(2012) reveals that over the last few decades, high inflation as a result of negative output gap has caused yield on investment decline while government policy objectives has been adversely affected as the real size of its budgets shrinks with rising inflation which has hampered output. Ogbole, et al (2011) it is evident that one of Nigeria’s greatest problems today is the inability to efficiently manage her enormous human and material endowment.

During 1981-1999 total capital expenditure amounted to N1694.04billion with an average of 5.33% of total GDP while from 2000-2014 it was averaged at 3.68% with and all time high of 11% in the year 2014 lowest of 1.23% in the year 2012 CBN (2014).  In the year 1993 government expenditure more than doubled and grew by 106% whereas GDP grew at 2%. Interestingly in the year 2000 government expenditure dropped by 26% whereas GDP grew by 5%. However by 2013 government expenditure grew by 13% which was accompanied by a growth in GDP by 7%. Over the years (1981-2014) the trend pattern between economic growth and GDP has been somewhat fluctuating (CBN, 2014). From the above it can be deduced that irrespective of the fact that there is a sharp increase in government expenditure the resulting effect does not trickle down to economic growth rather there is a slow growth rate in the GDP as compared to the government expenditure.

There have been several fluctuations in the revenue of government. During 1982 government revenue dropped by 13.97% which was followed by a decline of the GDP by 1.72% however in the year 1995 government revenue increased by 127.82% but despite this sharp rise the economic growth rate at same date was averaged at 2.25% also similarly in 2009 government revenue dropped by 38.42% as a result of world financial crisis of 2009 but interestingly economic growth recorded a growth rate of 6.96% (CBN, 2015). Given these fluctuations in government instrument of macroeconomic output gap management and fiscal policies, the main thrust of this study is to empirically investigate the impact of government fiscal policy and output gap in Nigeria economy.Thus the study seeks to answer the following questions

(i) What are the impacts of fiscal policy in Nigeria?

(ii) What is the Impact of fiscal policy-output gap relationship in Nigeria?

1.3 Objectives of the Study

The broad objective of this research work is to analyse the impact of fiscal policy and output gap in Nigeria economic growth. This will be achieved through specific objectives below.

(i) To determine the impacts of fiscal policy in Nigeria?

(ii) To ascertain the Impact of fiscal policy-output gap relationship in Nigeria

1.4 Research Hypotheses

Based on the above stated research objectives, conclusion will be drown from the following research hypothesis.

  1. H01: There are no significant impacts of fiscal policy in Nigeria
  2. H02: There is no significant fiscal policy-output gap relationship in Nigeria

1.5 Significance of the Study           

The study of fiscal policy and output gap is important to the policy makers, politicians, and students of economics. To the policy makers ascertaining the measure of fiscal policy used so far in an economy to a desired level, the policy makers with the knowledge of the level of output gap in the system stands the best chance of controlling it through appropriate initiative like  increase in savings so that the aggregate demand is reduced, poverty eradication programs etc.

1.6 Scope of the Study         

This research will be restricted to the Nigerian economy as it relates to fiscal policy and output gap rate in the country from 1981 – 2015







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