FISCAL AND MONETARY POLICY INTERACTIONS IN THE NIGERIAN ECONOMY- A NEW KEYNESIAN APPROACH

FISCAL AND MONETARY POLICY INTERACTIONS IN THE NIGERIAN ECONOMY- A NEW KEYNESIAN APPROACH

ABSTRACT

A political economy environment typified by political corruption, poor implementation of economic policy rules and weak policy coordination, can alter the fiscal behaviour of government and how it interacts with the monetary policy of the Central Bank. This study solved and estimated a Small Open Economy New Keynesian Dynamic Stochastic General Equilibrium model with a modified fiscal bloc. This is done in order to examine fiscal and monetary policy interactions under alternative assumptions of a rent-seeking government that follows discretionary policies and where no economic policy coordination exists. Its specific objectives were to assess the nature of fiscal policy interactions with monetary policy in Nigeria; examine the transmission effect of the policy interactions on output and inflation, and to investigate the optimal fiscal and monetary policy mix that guarantees economic stability in Nigeria. A first-order Taylor approximation method was used to solve the model around its deterministic steady state. Thereafter the Bayesian method, specifically the MetropolisHastings algorithm was used to estimate the parameters of the model. In order to derive the optimal combination of fiscal and monetary policy, the Dynare computational routines on Ramsey policy and Discretionary policy were employed. The results from this study revealed that both fiscal policy and monetary policy act as strong substitutes. This highlights the possibility of conflicts between fiscal and monetary decisions. Secondly, the overall impact of policy interaction negatively affects both inflation and output. This corroborates the lack of coordination between both policies. Moreover, it implies that stabilisation policies may be inadequate in guiding the Nigerian economy. Thirdly, the results on the optimal fiscalmonetary combination point out that politicians and bureaucrats in government should commit to policy rules. At the same time, they should implement policies that enhance the welfare of the entire citizens, not just a subset of the citizens. In addition, the study recommends among others that fiscal and monetary policies should be harmonised. For instance, the Central Bank of Nigeria and the Federal Ministry of Finance can adopt the same economic model and assumption in planning and forecasting policy targets.

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