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NKALU, Chigozie Nelson PG/MSc/14/69634
THE EFFECTS OF BUDGET DEFICITS ON SELECTED MACROECONOMIC VARIABLES IN
NIGERIA AND GHANA
DEPARTMENT OF ECONOMICS
FACULTY OF THE SOCIAL SCIENCES
Ebere Omeje Digitally Signed by: Content manager’s Name DN : CN = Webmaster’s name O= University of Nigeria, Nsukka OU = Innovation Centre
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THE EFFECTS OF BUDGET DEFICITS ON SELECTED MACROECONOMIC
VARIABLES IN NIGERIA AND GHANA
By
NKALU, Chigozie Nelson
PG/MSc/14/69634
DEPARTMENT OF ECONOMICS
FACULTY OF THE SOCIAL SCIENCES
UNIVERSITY OF NIGERIA, NSUKKA
SEPTEMBER, 2015
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THE EFFECTS OF BUDGET DEFICITS ON SELECTED MACROECONOMIC
VARIABLES IN NIGERIA AND GHANA
AnMSc. Thesis
By
NKALU, Chigozie Nelson
PG/MSc/14/69634
DEPARTMENT OF ECONOMICS
FACULTY OF THE SOCIAL SCIENCES
UNIVERSITY OF NIGERIA, NSUKKA
SUPERVISOR: PROF. C. C. AGU
SEPTEMBER, 2015
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TITLE PAGE
The Effects of Budget Deficits on Selected Macroeconomic Variables in
Nigeria and Ghana
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CERTIFICATION
This is to certify that NKALU, Chigozie Nelson, a post-graduate student of the Department
of Economics, University of Nigeria, Nsukka with Registration Number: PG/MSc/14/69634
has satisfactorily completed the requirements for the award of Master of Science (MSc.) in
Economics
____________________________ ____________________
Nkalu, Chigozie Nelson Date
PG/MSc/14/69634
(The Researcher)
________________ ___________________
Prof. C. C. Agu Date
(Supervisor)
________________ ___________________
Prof. S. I. Madueme Date
(Head of Department)
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APPROVAL PAGE
This research work titled: “The Effects of Budget Deficits on Selected Macroeconomic
Variables in Nigeria and Ghana” has followed due process and has been approved to have
met the minimum requirement for the award of the Master of Science degree in the
Department of Economics, Faculty of the Social Sciences, University of Nigeria, Nsukka.
________________ ___________________
Prof. C. C. Agu Date
(Supervisor)
________________ ___________________
Prof. S. I. Madueme Date
(Head of Department, Economics)
________________ ____________________
Prof. A. I. Madu Date
(Dean, Faculty of the Social Sciences)
________________ ____________________
Date
(External Examiner)
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DEDICATION
To:
My beloved mother
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ACKNOWLEDGMENT
This study would not have been a huge success without the inputs of some men of goodwill.
Let me first and foremost express my deep gratitude to my family for whom I derive
unquenchable zeal to surmount some constraints in the course of this study. Special thanks to
my mother, brothers and sisters for the much love and encouragements which indeed has
reshaped my entire being. My most and sincere thanksgiving goes to the Almighty God for
His infinite mercies throughout my existence.
I must as a matter of fact recognize my able and capable supervisor and academic adviser –
Prof. C. C. Agu for his ever and relentless guidance and mentorship. My heartfelt gratitude
goes to my brothers, lecturers and senior colleagues in the Department of Economics,
University of Nigeria, Nsukka for their immeasurable contributions towards making this
study a colossal success. Special thanks to Dr. Jude O. Chukwu, Dr. Richard K. Edeme, Dr,
Emmanuel Nwosu, Dr. Ezebuilo R. Ukwueze, Dr. I. Ifelunini, Dr. (Mrs) Gladys Aneke, Prof.
(Mrs) S. I. Madueme, Miss Anaduaka Uchechi S., Emecheta Chisom, Nnetu Vivian, Mr.
Ekene and Mr. Nchege Johnson. Regrettably enough, others whose names cannot contain on
this page due to time and space constraints should bear with me.
Thank you all, and may our good Lord shower you with abundant blessings - Amen!
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TABLE OF CONTENTS
Title Page - - - - - - - - - - i Certification - - - - - - - - - - ii Approval Page - - - - - - - - - iii Dedication - - - - - - - - - - iv Acknowledgement - - - - - - - - - v Table of Contents - - - - - - - - - vi List of Figures - - - - - - - - - ix List of Tables - - - - - - - - - - x Abstract - - - - - - - - - - xi CHAPTER ONE: INTRODUCTION
1.1 Background of the Study - - - - - - - 1
1.2 Statement of the Problem - - - - - - - 4
1.3 Research Questions - - - - - - - 7
1.4 Objectives of the Study - - - - - - - 8
1.5 Hypotheses of the Study - - - - - - - 8
1.6 Policy Relevance of the Study- - - - - - - 8
1.7 Scope of the study - - - - - - - 9
1.8 Conceptual Framework - - - - - - - 9
1.9 Structure of the Study - - - - - - - 13
CHAPTER TWO: REVIEW OF RELATED LITERATURE
2.1 Review of Theoretical Literature - - - - - - 14
2.1.1 Budget Deficits, Crowding In and Crowding Out Effects Schools of Thought- 14
2.2 Thematic Issues - - - - - - - - 17
2.2.1 Budget Deficits in Ghana: An Overview - - - - - 17
2.2.2 Determinants of Budget Deficit Growth in Ghana - - - - 18
This study investigates the effects of budget deficits on selected macroeconomic variables in Nigeria and Ghana using annual time-series data of both economies covering from 1970 to 2013; and taking previous empirical studies as its point of departure. The specific objectives of the study include: to examine the effects of budget deficits on interest rates, inflation, and economic growth in Nigeria and Ghana within the methodological framework of Seemingly Unrelated Regression (SUR) model and Two-Stage Least Squares (2SLS). The study employs Eagle-Granger Cointegration test, Augmented Dickey Fuller (ADF) and Phillips-Perron (PP) tests in estimating the systems equations. Data sourced from World Bank, IMF - World Economic Outlook, Central Bank of Nigeria, Bank of Ghana and others, were analyzed using SUR model with several diagnostic and specification tests to examine the objectives of the study. From the perspective of this study, the empirical findings demonstrated that budget deficit has statistically negative effects on interest rate, inflation, and economic growth for both economies thereby supporting the neoclassical argument in the literature that budget deficit slows growth of the economy through resources crowding-out. Based on the empirical findings, many recommendations were made for both Nigeria and Ghana economies one of which stated that the government of Nigeria and Ghana should be mindful of the sources of financing the budget deficits so as to effectively manage the economic fluctuations and increase activities in the real sector. Also, it was recommended that both economies should pursue policies that will boost production of goods for both domestic consumption and exports in the long run through a combination of import substitution and export promotion strategies.
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Budget deficit and its effects on macroeconomic variables is one of the most discussed issues
amongst economists and policy makers in both developed and developing countries (Saleh,
2003; Aisen & Hauner, 2008; Georgantopoulos & Tsamis, 2011). Intuitively, it is a
commonplace to construe that huge budget deficits have adverse macroeconomic effects such
as high interest rates, current account deficits, inflation, exchange rates volatility, with
implications on growth and development (Bernheim, 1989).
The budget deficit effects could either be negative, positive or a no positive or negative
relationship on macroeconomic variables. Budget deficit and its effects on any given
economy could be attributable to different methodologies countries employed and the nature
of data used by different researchers as most of the studies regress the macroeconomic
variable(s) on the fiscal deficit or the deficit on the macroeconomic variable(s)(Anyanwu,
1997).
Budget deficit refers to government expenditure exceeding government revenue over a period
of time (Anyanwu, 1997). When a deficit occurs in a country, it becomesimperative to find
remedy for financing such deficits so as to eradicate its negative implications. Nigeria and
Ghana as a developing economies have blamed prolonged economic crisis as one of the
major causes of budget deficit(s) in both economies as it has resulted in over indebtedness
and debt crisis, high inflation, poor investment performance and growth (Ezeabasili,
Mojekwu & Herbert, 2012). In Nigeria, public expenditure has led to increase in the fiscal
imbalances that siphon funds from the private sector investment, retarding growth and
reducing standard of living (Mpia & Ogrike, 2014). Fiscal imbalances create potential large
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burden on future generations as workers may be forced to finance unfunded social
programmes. Budget deficits, therefore, lead to incurring debts which is a stock of liabilities
of the government (Udu & Agu, 2000). Budget deficit is generally associated with recession
because of the effect on revenues and expenditures (Dernberg, 1985).
The Ghanaian economy embarked recently, on the second leg of its centenary of
independence and democracy, announcing bold objectives that included an accelerated gross
domestic product (GDP) growth rate of 8% in 2009 and 10% before 2015 and achievement of
middle-income status of US$1000 dollars per capita by 2015 (Ackah, Aryeetey & Aryeetey,
2009). In the five decades since her independence from British rule in 1957, Ghana has gone
through different cycles of growth, marked by poor economic performance and military coup
d’états through to the 1980s. National economic policies during this period were often devoid
of market principles, and characterized by frequent price and income controls. At best, the
economy muddled through, with low productivity, high and volatile prices, an overvalued
currency and high interest rates (Ndulu & Connell, 2008).
The choice of this study which brought the economies of Nigeria and Ghana into focal point
for empirical investigation is formed by a number of reasons. Besides the obvious reason that
both economies share similarities in political and economic structures, the economies have
experienced very large fluctuations in the government budget deficits and high accumulation
of foreign debt, poor export performance, huge service account deficits, external debt
amortization, low inflow of foreign direct investment, misappropriation of external funding
support, excessive domestic monetary and credit expansion; price distortions and a
deterioration in the terms of trade (Ogiogio, 1996; & Obioma,1998).
In Nigeria, available data from the CBN (2012) statistical bulletin, show that deficit of -
8.62% of GDP was recorded in 1970 which rose to a surplus of 2.58% of GDP in 1971 and
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declined to -0.82% of GDP in 1972. In 1974, Nigeria experienced a remarkable improvement
in the overall fiscal balances from 1970 to 2013 as surplus rose from 1.92% of GDP in 1973
to a surplus unit of about 9.54% of GDP. The Nigeria overall fiscal balance deteriorated
between 1980 and 1994 and recorded greater deficit of about -12.44% of GDP in 1982 on the
average. However, between 1995 and 2013, the Nigerian economy recorded a surplus of
about 1.19% of GDP on the average in 1996 with other years experiencing different deficit
percentages to GDP.
In Ghana, there has been huge and continuous deterioration in government fiscal position.
The economy has been in a persistent tendency towards budget deficit since independence as
a result of over expanding government expenditure, inadequate revenue generation capacity
of government and increasing debt levels (Pomeyie, 2001). The available statistics from
World Bank (2014) show that the Ghanaian economy has not recorded any surplus since their
independence and between 1970 and 2013.It is evidenced that the trends of the overall fiscal
balances of Ghanaian economy between 1970 and 2012 has been on the deficit side with a
huge deficit records of about -10.79% of GDP and -12.12% of GDP in 1982 and 2012
respectively. Apart from the period between 1981 and 1990 when there was remarkable fiscal
discipline, the government budget was consistently in deficit in the 1990s. On average, the
deficits was more than 5% of GDP in 1993.
As the economy of Ghana grows, policy makers have been concerned with the extent to
which the budget deficit is sustainable, and its effects on macroeconomic variables. However,
a deficit policy plays a vital role in assisting countries to achieve macroeconomic stability,
poverty reduction, income redistribution and sustainable growth. For this reason, most
governments use the budget as effective tool in achieving their economic objectives. This
means that large and accumulating budget deficit may not necessarily be a bad policy
objective if such deficits are effectively utilized to enhance economic growth. It is in line
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with this that an appropriate operational definition and measure of budget deficit must be
clearly stated. Otherwise, the occurrence of large nominal budget deficit may be misleading
depending on the operational measure adopted by a particular country (Antwi, & Mills,
2013).
In Nigeria, the economy was caught in the deficit trap since early 1980s when the world oil
market collapsed, and since then, there have been frantic efforts to exit the trap but all to no
avail(Wosowei, 2013). Nevertheless, the fiscal policy adoption of Nigeria and Ghana in
financing deficits are attributable to major factors causing rapid monetary growth, exchange
rate depreciation and rising inflation. Thus the motivation for this study is to examine the
short and long run effect of budget deficit on interest rate, inflation and economic growth in
Nigeria and Ghana.
1.2 Statement of the Problem
Different schools of thought have demonstrated their opinions on budget deficits. Most
common are the Keynesian and the Ricardian Schools of Thought. While the Keynesian
posits that budget deficit affects mainly macroeconomic variables, Ricardian School refutes
the proposition (by the Keynesian school) and posits that budget deficits do not affect mainly
macroeconomic variables. However, budget deficit in developing economy like Nigeria and
Ghana plays a pivotal role in achieving economic and social objectives including
macroeconomic stability, sustainable growth and poverty reduction.
In recent times, the deficit positions of the Ghanaian budgets have worsened, drawing
attention to its long term sustainability (Bank of Ghana, 2005). As the two countries (Ghana
and Nigeria) consistently operate budget deficits, this lead to accumulation of government
debts. As past deficit adds up to current borrowings, it creates higher interest payments,
raising inflation with high volatility in real interest rate, depreciates exchange rate and retards
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growth. This calls for further borrowing to cover the interest payment and the increasing
primary deficit which affects the rate of future borrowing.
Figure 1.1 Graph showing Inflation and Budget Deficit interactions in Nigeria (1970 -
2013)
Source: Researcher’s computation using data from CBN Bulletin of various years As seen in figure 1.1 above, the greater percentage of the overall budget balance in Nigeria
were on the deficit side with high inflation rate and unstable real interest rate. In 1990s the
average inflation rate soared to 72.8%. But, by 2007, the economy experienced a sharp
average fall of 6.57% in the inflationary trend.The interactions of real interest rate and budget
deficits in the figure 1.3 clearly distinguish between inflation and real interest rate.
In Ghana, the stock of government debt to GDP has been rising steadily from 17.2% in 2006
to 24.9% in 2007 and to 28.1% in 2008 (Bank of Ghana, 2007). Clearly, Ghana cannot use
new borrowing indefinitely to finance interest payments since changes in taxes and
government spending is followed by adjustment in future taxation and spending (Luporini,
1999).
-20.00
0.00
20.00
40.00
60.00
80.00
% of GDP
Year
Budget Deficit (% of GDP), and Inflation in Nigeria
BD(% of GDP) INFL
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Figure 1.2 Graph showing, Inflation, and Budget Deficit interactions in Ghana (1970 -
2013)
Source: Researcher’s computation using data from World Bank, WEO Database, (2014)
In figure 1.2 above, Ghana recorded a deficit of -7.05% of GDP on the average in 1981 with
inflation soaring to about 117.8%. In 1982, budget deficit worsen on the average of -10.79%
of GDP with low inflation of about 21.3%. This shows that even if Ghana meets its interest
payment on debt by borrowing more, it must roll over its debt indefinitely because tax
revenue is not enough to pay for other expenditure. This has led to growing debt and
increasing tax rate.
Generally, in the case of Nigeria and Ghana, it has been claimed thatthe main causes of these
high rates of inflation were the widening fiscal imbalances, sources of deficit financing,
economic growth and the depreciation of the exchange rate. Nonetheless, the transition to
high inflation rates over the period resulted in substantial real cost and large losses in income,
at the same time as the performance of the economy as a whole declined as a result of
widening fiscal deficits and exacerbated by poor macroeconomic management and political
uncertainty(Arestis & Sawyer, 2006).
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Nevertheless, empirical studies on the effects of budget deficit on macroeconomic variables
such as interest rate, inflation and growth seem not to lay credence on Keynesian proposition
or Ricardian Equivalence Hypothesis (REH). The major trust of this study is to examine the
short and long-run effect of budget deficits on interest rate, inflation and economic growth in
Nigerian and Ghana. This is necessitated by the fact that the previous empirical studies in this
area have no conclusive evidence in support of Keynesian-Ricardian paradigms in Nigeria
and Ghana. This is because, none of the previous studies conducted on the effects of budget
deficits in both economies used all the relevant variables and a few do not employ the
appropriate methodology. This is one of the motivations behind this study.Hence, this study
departs from previous studies due to the inclusion of relevant variables and thus employs the
most appropriate and robust methodology to explore the budget deficits and how it affect the
selected macroeconomic variables of these economies in both short and long run.
Against this background, the study contributes to the large body of the existing literature on
fiscal policies in Nigeria and Ghana in two ways. First, unlike many empirical studies, the
study employs a more vigorous and robust approach; the Seemingly Unrelated Regression
(SUR) model to analyze the effect of budget deficit on the selected macroeconomic variables
in Nigeria and Ghana over the period covering from 1970 to 2013. Second, the study
provides empirical evidence for the economies with recent fiscal policies for which
researches have not been conducted recently. Besides, previous studies have advanced in
characterizing the implications of alternative sources and composition of deficits spending
without investigating the effects of budget deficits on the selected macroeconomic variables
in the two economies.
1.3 Research Questions
In the light of the above discussions, the following research questions shall be addressed:
i. What are the effects of budget deficiton interest rate?
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ii. What are the effects of budget deficit on inflation?
iii. Does budget deficit have any impact on economic growth?
1.4 Objectives of the Study
The broad objective of this study is to investigatethe short and long run effects of budget
deficits on selected macroeconomic variables in Nigeria and Ghana. Specific objectives of
the study are:
i. To examine the effects of budget deficits on interest rates in Nigeria and Ghana.
ii. To ascertain the effects of budget deficits on inflation in Nigeria and Ghana.
iii. To evaluate the effects of budget deficits on economic growth in Nigeria and Ghana.
1.5 Hypotheses of the Study
In view of the above research questions, the following hypotheses are formulated in order to
ascertain the answers to the questions:
H01: Budget deficitshavenosignificant effects on interest rate in Nigeria and Ghana.
H02: Budget deficitshavenosignificant effects on inflation in Nigeria andGhana
H03: Budget deficits have no significant effects on economic growth in Nigeria and Ghana.
1.6 Policy Relevance of the Study
Developing economies like Nigeria and Ghana are in search of long-term policies not only
for macroeconomic stabilization but also for sustainable economic growth and development.
The private sector has always mourned that the fiscal deficit and its inflationary financing has
led to a slow-down in economic activity. There is need for a comprehensive study which
exposes the dynamics of the government fiscal deficit and its effects on the economy. This
study is designed to investigatethe short and long run effects of budget deficits on some
selected macroeconomic variables in Nigeria and Ghana. An academic study such as this is
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crucial to both the Nigerian and Ghanaian economy in ascertaining the extent to which
budget deficit affects some macroeconomic variables in both short and long run. However,
the justification of this study is that it will add value to policy making especially in fiscal
adjustment and macroeconomic management. The findings of the study will also assist policy
makers to understand the centrality of the government fiscal deficit in policy formulation. It
is further hoped that the findings of the study will assist policy makers to place the right
emphasis on the role of fiscal adjustment in economic policy.
Furthermore, given the Keynesian-Ricardian dichotomy on budget deficit, it is needful to
investigate the effects of budget deficits on some selected macroeconomic variables in
Nigeria and Ghana. As a result, this research work seeks to contribute to the ongoing debate
on the relationship of budget deficits and some selected macroeconomic variables in Nigeria
and Ghana. Therefore, policy makers, experts, institutions, government agencies, researchers
and students in areas of public sector economics, development economics, international
economics, and econometrics are likely to find the outcome of this study very useful.
1.7 Scope of the Study
The study, as stated abinitio tends to investigate the short and long run effects of budget
deficits on selected macroeconomic variables in Nigeria and Ghana. It is pertinent to note that
the nexus between budget deficits and macroeconomic variables are still not well ascertained
especially when viewed in both short and long run. However, the study covers from 1970 to
2013. The range is chosen to ensure high level of degree of validity and precision in the
study. The variables of interest which are used to investigate the short and long run effects of
budget deficits on the selected macroeconomic variables in Nigeria and Ghana are: budget
deficit, interest rates, inflation,exchange rate depreciation, government expenditure, money
supply (M2), total savings, and real GDP.
1.8 Conceptual Framework
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Awe and Funlay (2014) state that budget deficit occurs when government expenditures
exceed its revenues, thus the level of public savings is negative. This may harm the economic
growth of a country. Budget deficits lead to incurring debts which is a stock of liabilities of
the government (Keating, 2000). Budget deficit is a situation where the government budgets
to spend more than it intends to collect as revenue (Udu and Agu, 2000). Dernberg (1985)
posits that budget deficits are generally associated with recession because of the effect on
revenues and expenditures.
Fiscal deficit has gathered substantial attention in the literature in the area of macroeconomic
theory due to its impact on the macroeconomic variables. When budget deficit is financed by
borrowing, it expands government’s demand for credit through competition with households
and business firms (Hyman, 1994). This puts upward pressure on interest rate and slows
down the rate of capital formation. In Keynesian models, this occurs through a rise in real
interest rate which reduces investment purchases through the transmission mechanism.
However, this depends on the responsiveness of interest rate to increased demand for credit
and the reaction of private investors to higher interest rate. For instance, if investment
demand is unresponsive to changes in interest rate, the effect on investment will be very
small. Also, if the economy is in deep recession, any extra borrowing by government may put
little upward pressure on interest rate because the supply curve for funds will be quiet flat.
Yet, if the return on private investment exceeds the return on government investment
particularly on infrastructure, the rise in public investment would crowd in private investment
(Barua, 2005).
Also, large budget deficit increases the debt crisis in terms of its services and levels. As the
national debt grows, interest payment also grows which serves as tax on investment. This
reduces private investment, increases unemployment, lowers tax revenue and leads to higher
future deficits. Hence, the economy continues to incur mounting debts which may lead to its
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collapse. Most countries trapped in debt servicing difficulties did run huge budget deficits at
some point in time. Yet, it is argued that public debt growth compels government to target
higher economic growth and revenue in order to finance any rising debt obligations.
Otherwise it will force the economy into a deficit trap (Barua, 2005).
On the burden of future generations, most economists agree that financing budget deficit
through external debt means the postponement of tax increases. However, it is asserted that
such burden depends on how the contracted loan is utilized. If the funds are spent on current
consumption expenditure, future generations are likely to be worse-off but if spent on
productive activities such as education and health then future generations are likely to be
better-off (Mankiw, 2003).
In addition, if budget deficit is monetized, it increases aggregate demand through increase in
government purchases without a corresponding increase in taxes. Hence, governments need
to run fiscal deficit particularly in the early stages of development to lead the economy in the
path of growth and development (Xiomara & Greenidge, 2003). Secondly, it increases money
supply. This exerts downward pressure on interest rate and upward pressure on equilibrium
money stock and price level unless the economy is in deep recession. This leads to higher
inflation, uncertainty and instability of real interest rate which tends to lower real tax revenue.
Hence, monetized deficit should be kept low and effectively managed in the short-to-medium
term (Bebi, 2000; Turnovsky, 2000).
Causes and Determinants of Budget Deficit Growth
In general, changes in budget deficit is attributed to changes in government spending or tax
revenue or both. Government receives revenue in its daily transactions and on capital items in
the form of taxes and interests. On the other hand, government pays for daily activities and
capital items such as administrative expenses, loans and grants. Thus, budget deficit increases
when government spending persistently exceeds its revenue. If expenditure continue to mount
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up throughout the years whereas revenues especially taxes are poorly collected, it widens the
budget deficit position of the country. In this case, the accumulated value of past deficit
creates increase debts which must be financed together with the accompanying interest
payments.
With reference to political-economic models of government behaviour, it is recognized that
incumbent administrations tend to stimulate their economies on the eve of political elections
through tax cuts, increase spending and transfer payments. This occurs in countries where
political power changes frequently between rival parties. In such cases, each rival
administration spends over and above its budget and deliberately wait until after election
before implementing policies to reduce the deficit. These ad hoc policies tend to widen the
overall budget deficit and debt levels of the countries (Sachs & Larrain, 1993).
However, the extent of the impact of budget deficit on an economy is blamed by
macroeconomic factors such as expected inflation, cyclical position of the economy which
influences tax revenues and changes in expenditure. Theory predicts that cyclical fluctuations
in output which is caused by economic boom and/or recession impact significantly on budget
deficit. In periods of recession when output is low, budgets tend to be in deficit because direct
taxes fall sharply due to contraction in tax base. Also, certain categories of government
spending become countercyclical and rise during business cycle downturn. Yet, such
fluctuations in output growth are endemic in free market economies (Gebhard & Silika,
2006).
Budget Deficit Growth and Economic Sustainability
Financing of budget deficit in Ghana and other developing economies like Nigeria have had
diverse macroeconomic burden on the economy (Antwi et al, 2013). For instance central
bank financing of budget deficit have expanded the monetary base and money supply.
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According to Wetzel and Roumeen (1991) central bank financing of budget deficit in Ghana
has distorted the distinction between monetary and fiscal policies whereas the sale of
domestic bond increased interest rate and this has led to increase in the net domestic
financing from 0.49 percent of GDP in 2004 to 4.15 percent in 2006. As a result, money
supply (currency and deposits) increased from 6.84 percent in 2005 to 34.4 percent in 2006,
and thus the domestic interest and bank rate reduced due to low demand for bonds (ISSER,
2007). Also, Ghana has accumulated large external debt and so borrow externally only on
short term bases at high interest rate. This is because foreign financing raises the cost of
servicing external debt. For this reason, Ghana’s access to external borrowing prior to 1984
had been limited, ranging between -0.74 and 1.62 percent of GDP. In recent times however,
debt levels have been falling. External debt fell from 72.5 percent in 2004 to 26.9 percent in
2006 with debt service to GDP reducing from 6.8 percent in 2004 to 6.0 percent in 2006
(Wetzel and Roumeen, 1991: 48; ISSER, 2007)
1.9 Structure of the Study
This study will be organized in five chapters. Following this introduction as Chapter 1,
Chapter 2 presents a review of literature on both thetheoretical and empirical evidences.
Chapter 3 discusses the methodology used in the study, Chapter 4 presents the analysis and
interpretation of the results obtained using the methodologies in previous chapter. Finally,
Chapter 5 highlights the conclusion and recommendations on fiscal policy management in the
Nigeria and Ghana.
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CHAPTER TWO
REVIEW OF RELATED LITERATURE 2.1 Review of Theoretical Literature
This section reveals the theoretical framework related to budget deficit and macroeconomic
variables. Some of the economist such as Keynesian, Neoclassical and Ricardian Schools of
Thought gave either positive or negative support to the relationship between budget deficits
and macroeconomic variables.
2.1.1 Budget Deficits, Crowding In and Crowding Out Effects Schools of Thought
In analyzing the literatures on the relationship between budget deficits and macroeconomic
variables, Bernhein (1989) provides a brief summary of the three paradigms, and the cursory
of the paradigms are presented below.
The Neoclassical School
The neoclassical school proposes an adverse relationship between budget deficits and
macroeconomic variables. They argue that budget deficits lead to higher interest rates,
discourages the issue of private bonds, private investments, and private spending, increases
inflation level, and cause a similar increase in the current account deficits and finally slows
the growth rate of the economy through resources crowding out.
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The Neoclassical school considers individuals planning their consumption over their entire
cycle. By shifting taxes to future generations, budget deficits increase current consumption.
By assuming full employment of resources the neoclassical school argues that increased
consumption implies a decrease in savings. Interest rate must rise to bring equilibrium in the
capital markets. Higher interest rates, in turn, result in a decline in private investment,
domestic production and an increase in the aggregate price level. Furthermore, Yellen (1989)
in Onuorah, and Ogomegbunam (2013) argues that in standard Neoclassical Macroeconomic
models, if resources are fully employed, so that output is fixed, higher current consumption
implies an equal and offsetting reduction in other forms of spending. Therefore, there will be
fully crowding-out of investment and/or net exports.
It is worth noting that it is important to distinguish between “financial” crowding out and
“resource” crowding-out. “Resource” crowding out occurs when the government competes
with the private sector on purchasing certain resources (skilled labour, raw materials and so
on). When the government sector expands, the private sector will contract because of the
increase in prices on these resources due to an excess demand by the government, hence this
leads to a fall in investment and consumption by the private sector. Thus the government
sector’s expansion crowds out the private sector. It is worth noting here as well that resource
crowding out is an important issue to take into account especially in developing countries
where resources are scarce even sometimes to the private sector, so any excess demand for
these resources by the government will severely impinge on private sector productivity.
The Keynesian School
The Keynesian economists propose a positive relationship between budget deficits and
macroeconomic variables. They argue that usually budget deficits result in an increase in
domestic production, increases aggregate demand, increases savings and private investment
at any given level of interest rate. The Keynesian absorptive theory suggests that an increase
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in the budget deficits would induce domestic absorption and thus, import expansion, causing
current account deficit. In the Mundell-Fleming framework, an increase in the budget deficit
would induce an upward pressure on interest rate, causing capital inflows and an appreciation
of the exchange rate that will increase the current account balance.
The Keynesians provide a counter argument to the crowd-out effect by making reference to
the expansionary effects of budget deficits. They argue that usually budget deficits result in
an increase in domestic production, which makes private investors more optimistic about the
future course of the economy resulting in them investing more. This is known as the
“crowding-in” effect. It is worth noting here that the traditional Keynesian view differs from
the standard neoclassical paradigm in two fundamental ways. First, it permits the possibility
that some economic resources are unemployed. Second, it presupposes the existence of a
large number of liquidity-constrained individuals. This second assumption guarantees that
aggregate consumption is very sensitive to changes in disposable income. Many traditional
Keynesians argue that deficits need not crowd out private investment. Eisner (1989) suggests
that increased aggregate demand enhances the profitability of private investments and leads
to a higher level of investment at any given rate of interest. Hence deficits may stimulate
aggregate savings and investment, despite the fact that they raise interest rates. He concludes
that “evidence is thus that deficits have not crowded-out investment. There has rather been
crowding-in”. Heng (1997) utilized an overlapping-generations (OLG) model to provide a
theoretical framework to analyze the “crowding-in” issue of private capital by public capital.
He shows that public capital crowds-in private capital through two channels, namely, via its
impact on the marginal productivity of labour and savings, and via (gross)
complementarity/substitutability between public and private capital.
The Ricardian School
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Finally, there is another contrary approach advanced by Barro (1989) known as the Ricardian
Equivalence Hypothesis (REH). Ricardian equivalence, or the Barro-Ricardo equivalence
proposition, is an economic theory which suggests that government budget deficits do not
affect the total level of demand in an economy. It was initially proposed by the 19th century
economist David Ricardo. In simple terms, the theory can be described as follows.
Governments may either finance their spending by taxing current taxpayers, or they may
borrow money. However, they must eventually repay this borrowing by raising taxes above
what they would otherwise have been in future. The choice is therefore between "tax now"
and "tax later". Suppose that the government finances some extra spending through deficits -
i.e. tax later. Ricardo argued that although taxpayers would have more money now, they
would realize that they would have to pay higher tax in future and therefore save the extra
money in order to pay the future tax. The extra saving by consumers would exactly offset the
extra spending by government, so overall demand would remain unchanged.
More recently, economists such as Robert Barro have developed more sophisticated
variations on the same idea, particularly using the theory of rational expectations. Ricardian
Equivalence suggests that government attempts to influence demand using fiscal policy will
prove fruitless. He argues that an increase in budget deficits, due to an increase in
government spending, must be paid for either now or later, with total present value of receipts
fixed by the total present value of spending. Thus, a cut in today’s taxes must be matched by
an increase in future taxes, leaving real interest rates, and thus private investment, and the
current account balance, exchange rate and domestic production unchanged. Therefore,
budget deficits do not crowd-in nor crowd out macroeconomic variables i.e. no positive or
negative relationship exists.
2.2 Thematic Issues
2.2.1 Budget Deficits in Ghana: An Overview
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Ghana’s economy has maintained commendable growth trajectory with an average annual
growth of about 6.0% over the past six years. In 2013 growth decelerated to 4.4%,
considerably lower than the growth of 7.9% achieved in 2012. Growth has, however, been
broad-based, driven largely by service-oriented sectors and industry, which on average have
been growing at a rate of 9.0% over the five years up to 2013. Over the medium term to 2015,
the economy is expected to register robust growth of around 8%, bolstered by improved oil
and gas production, increased private-sector investment, improved public infrastructure
development and sustained political stability (African Economic Outlook, 2014).
According to AEO (2014), the continued widening budget deficit has been a major constraint
to fiscal and debt sustainability. Following an expenditure overrun in 2012, marked by an
unprecedented budget deficit of around 12% of GDP, the situation persisted in 2013, with
about the same level of budget deficit. Revenue enhancing and expenditure consolidation
measures underway in 2014 are expected to ease the fiscal deficit to 9%. In conjunction with
fiscal constraints, inflation has been on the rise resulting from a number of factors including
the removal of subsidies on petroleum prices and a gradual rise in electricity and water tariffs.
It is also worth noting the rise in public debt from 43% of GDP in 2011 to 48% in 2012, and
further to 53.5% in September 2013, resulting from a widened budget deficit. The external
sector will continue to experience a widened current-account deficit of around 12% of GDP
in 2014, exacerbated by a decline in commodity prices of major export commodities,
particularly on gold and cocoa.
2.2.2 Determinants of Budget Deficit Growth in Ghana
A model involving variation in inflation, government expenditure during wartime, cyclical
fluctuation in output during economic boom and recession in the postwar period was tested to
ascertain if it differs significantly from those during the world wars in the Swiss federal state.
The estimate showed some cyclical fluctuation in the world war periods. This supports the
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assertion that significant determinant of budget deficit is increase in state expenditure during
wartime. In this case, civilian expenditure was reduced and/or taxes increased to finance
military expenditure during the war (Gebhard and Silika, 2006). In Ghana, changes in
inflation, interest rate and real GDP have reacted negatively to changes in budget deficit. For
instance, Antwi and Mills (2013) observed that high inflation in 1983 caused budget deficit to
increase by 35.8 percent due to decline in direct tax revenue. Also, changes in real interest
rate increased budget deficit by 11.3 percent of GDP in 1984. Again, high wage bill increased
the deficit by 2.5 percent in 1985. Thus, changes in macroeconomic variables have had strong
impact on the fiscal deficit in Ghana. However, these effects have become less pronounced
over the past years as the Ghanaian economy has grown more stable (Wetzel & Roumeen,
1991).
2.2.3 Fiscal Policy in Ghana
The government of Ghana is committed to fiscal consolidation with the ultimate objective of
reducing the budget deficit to around 5% of GDP by 2016. However, trend performance of
government operations continues to register widened budget deficit. Following an
expenditure overrun in 2012, marked by a significant budget deficit of around 6% of GDP,
the situation persisted in 2013 with a deficit of 7.8%. Fiscal measures implemented in the
second half of 2013 are expected to yield dividends in 2014. Key contributors to widened
budget deficit have been increased spending on wages and salaries, interest payments,
subsidies and arrear payments (African Economic Outlook, 2014).
According to AEO (2014), for the government of Ghana to address fiscal constraints
effectively, efforts should aim to raise tax revenue, in view of its substantial share (80%) of
total domestic revenue. Oil revenue is still low, accounting for just 0.2% of total revenue.
Grants from development partners are marginal and have maintained a diminishing trend,
accounting for only 7% of total revenues in 2013, down from around 14% in 2010. Despite
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the marginal contribution of oil receipts, it is worth noting the distribution formula of such
receipts. In compliance with the Ghana Petroleum Revenue Management Act, about 30% of
total oil revenue to government is retained by the Ghana National Petroleum Commission
(GNPC) for the development of the oil and gas industry, while the remaining 70% is
appropriated through the Annual Budget Funding Amount (ABFA) and Ghana Petroleum
Funds (GPF) at around 40% and 60% respectively. While resources under ABFA are
reserved for funding priority projects, petroleum funds (GPF) are partly invested for future
generations through the established Ghana Heritage Fund.
2.2.4 Interest Rate Policy in Ghana
Interest rates were administratively controlled by the Bank of Ghana (BOG). The rationale
for the controls was that credit had to be cheap so as to promote investment and support that
favors borrowers (Daumont, Le Gall, & Leroux, 2004). It was the BOG that determined the
structure of the bank interest rates, which include the minimum interest rates for deposits and
maximum lending rates. Preferential lending rates were given to priority sectors such as
agriculture. The structure of interest rates determined by the BOG made no allowance for
loan maturity or risk; indeed, incentives for banks to extend credit were often perverse
because riskier sectors such as agriculture were accorded preferential inflation rates. In most
of the years, nominal interest rates were held below the prevailing inflation rates. However,
when inflation escalated in the middle of 1970s and the early 1980s, real interest rates were
highly negative (Antwi, 2009)
2.2.5 Fiscal Policy in Nigeria
Fiscal policy Management in 2012 and 2013 has centred on consolidation in order to ensure
macroeconomic stability. The fiscal deficit as a percentage of GDP has been estimated at -
1.8% in 2013, up from -1.4% in 2012, but well below the fiscal stance of a maximum of 3.0%
deficit enshrined in the Fiscal Responsibility Act. The Medium Term Expenditure
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Framework (2014-2016)and Fiscal Strategy Paper proposed benchmark oil prices of USD 74,
USD 75 and USD 76 per barrel (pb) for 2014, 2015 and 2016 respectively. A benchmark oil
price of USD 77.5 pb was however set in the 2014 budget presentation to the national
assembly.
The 2012 budget was signed into law by the president of the Federal Republic of Nigeria in
April of the year following its passage into law by the legislative arm of government. The
level of implementation of the budget was 71.6%. The 2013 budget was signed into law by
the president in February, which was two months earlier than the preceding year as the
disagreement between the executive and the legislature over appropriation were resolved
early. The eventual implementation rate was around 70.0%. The ratio of capital expenditure
to total expenditure diminished to an estimated 23.9% in 2013 from 24.3% in 2012. The share
of capital expenditure on social community services (Health, Education and other allied
services) in the total rose from 10.0% in 2011 to 11.1% in 2012 while economic services
(agriculture and infrastructures) declined from 42.1% to 36.7%, respectively. The capital
component of Subsidy Reinvestment and Empowerment Programme (SURE-P) contributed
about NGN 272.5 billion, or USD 1.72 billion, thus raising the total capital expenditure to
Effects of budget deficits on interest rates are more robust in the emerging markets and in later periods than in the advanced economies and in earlier periods
P a g e | 53
Noula (2012) Cameroon 1974 – 2009
ADF test, ECM, Pairwise Granger Causality, and Loanable Funds Model
Budget deficit affects GDP and saving through financing the deficit. Also, real interest rates are negatively and significantly correlated with GDP and saving
P a g e | 56
Najid (2013) Pakistan 1971 – 2007 OLS, Granger-causality test
Budget deficit, GDP
Bi-directional causality Budget deficit to GDP, and GDP to budget deficit
Negative relationship between budget deficit and GDP in the long run
Larbi (2012) Ghana 1980 – 2010 Johanson Cointegration and
Budget deficit, openness,
Positive long run
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Granger Causality test
capital stock, government expenditure, growth rate
relationship between budget deficit and economic growth; and significant positive causality exist the capital stock, openness, total government expenditure & growth rate
Yaya (2010) 7 West African countries
26 years Granger-causality Budget deficit, GDP
no causality between budget deficits and GDP in 3 countries; and causality exist between budget deficits and economic growth in 4 countries
Wosowei (2013)
Nigeria 1980 – 2010 OLS, Granger-causality test
Budget deficit, GDP, unemployment, inflation, government expenditure and tax
Bi-lateral causal relationship betweenbudget deficit and GDP, government tax and unemployment
Antwi and Mills (2013)
Ghana 1960 – 2010 Present Value (PV) budget constraint approach, Granger-causality, ADF and PP tests
Budget deficit, interest rate, exchange rate, government expenditure and revenues
Bi-directional causation in both government expenditure and revenues
Awe and Funlayo (2014)
Nigeria 1980 – 2011 OLS, ECM, Johanson cointegration test
Budget deficit, GDP, investment
Long-run relationship exist between budget deficit and GDP, with negative correlation with growth, and positive with
P a g e | 59
investment.
Bakare, Adesanya, and Bolarinwa (2014)
Nigeria 1975 - 2012 ADF test, ECM, and Johanson cointegration test
of 0.28 for the deficit indicates that it is fairly normally distributed. Real GDP was normally
distributed with a mean 1090.47 USD, a median of 988.95 USD, Jacque-Bera probability
value of 2.58 USDand standard deviation of 884.89 USD. Real interest rate negatively
skewed at -2.03 USD while inflation was positively skewed with value 1.96 USD.
4.1.2.2 Analysis of the Correlation Matrix
Table 1.4 present the correlation matrix of the variables applied in this study. The highest
correlation (-0.94) is between inflation (INF) and real interest rate (RIR). This is consistent
with economic theory. The correlation coefficient of (-0.21) was registered between our
variable of interest budget deficit (BD) and real GDP. This not really a problem as the static
correlation is most times not a true reflection of the relationship between the variables when
dynamic models are specified. The weakest correlation (0.11) is between budget deficit (BD)
and inflation (INF).
Table 1.4: Ghana Correlation Matrix
Source: Computed by the Author with EViews 8.
4.2 Stationary (Unit Root) Tests Results
To examine the time series characteristics of the variables in the models, the Augmented
Dickey-Fuller (ADF) and Phillips-Perron (PP) stationarity (unit root) tests were conducted.
Essentially, both the ADF and PP tests are presented in table 1.5 below:
Table 1.5: Summary of ADF and PP Stationary (Unit Root) Tests for the Variables in
the Models, 1970 – 2013.
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***Significant at 1%, **Significant at 5%, *Significant at 10% Source: Stationarity test results computed using EViews 8 Note: For both ADF and PP, the 5% critical values are given below the statistics in parentheses. Asterisk (**) shows no unit root at 5% critical value.
NIGERIA
Variables Augmented Dick-Fuller (ADF) Test Phillip-Perron (PP) Test At Level At First
Difference Order of
Cointegration
At Level At First Difference
Order of Cointegration
RIR -7.046315** (-3.518090)
- I(0) -3.518090** - I(0)
GEX - -4.561458* (-3.557759)
I(1) - -3.520787** I(1)
MS - -6.331609** (-3.520787)
I(1) - -3.520787** I(1)
INF - -6.587901** (-3.523623)
I(1) - -3.520787** I(1)
BD - -4.099735** (-3.520787)
I(1) -3.518090** - I(0)
RGDP - -5.238360** (-3.520787)
I(1) - -3.520787** I(1)
EXDEP -3.843817** (-3.518090)
- I(0) -3.518090** - I(0)
SAV - -6.001551** (-3.520787)
I(1) - -3.520787** I(1)
***Significant at 1%, **Significant at 5%, *Significant at 10%
GHANA Variables Augmented Dick-Fuller (ADF) Test Phillip-Perron (PP) Test
At Level At First Difference
Order of Cointegration
At Level At First Difference
Order of Cointegration
RIR - -11.30048** (-3.520787)
I(1) - -4.682621** (-3.518090)
I(1)
GEX -4.307310** (-3.518090)
- I(0) -4.261254** (-3.518090)
- I(0)
MS - -6.053898** (-3.520787)
I(1) - -6.057001** (-3.520787)
I(1)
INF -5.084804** (-3.518090)
- I(0) -5.029343** (-3.518090)
- I(0)
BD - -6.249993** (-3.520787)
I(1) - -7.440796** (-3.520787)
I(1)
RGDP - -9.619379** (-3.520787)
I(1) - -5.169553** (-3.518090)
I(1)
EXDEP - -5.463968** (-3.520787)
I(1) - -5.454011** (-3.520787)
I(1)
SAV -3.704077** (-3.518090)
- I(0) -3.682215** (-3.518090)
- I(0)
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In Nigeria, the result of the unit root tests (ADF) shows that all the variables with the
exception of real interest rate and exchange rate depreciation failed the unit root test at 5%
level of significance in their level form. All variables, however, passed the test for
stationarity in their first difference. Similar results using Phillip-Perron (PP) test were carried
out, and the result also shows that all the variables with the exception of real interest rate,
budget deficit and exchange rate depreciation failed the unit root test at 5% level of
significance in their level form. All variables, however, passed the test for stationarity in their
first difference. In Ghana, both the ADF and PP test present identical results as all the
variables with the exception of government expenditure, inflation and savings failed the unit
root test at 5% level of significance in their level form. All variables passed the test for
stationarity in their first difference.
4.2.1 Lag Length/Bandwidth Selections
Appropriate lag length/Bandwidth was automatically chosen for the variables in the models
as informed by both Schwarz Information Criterion and Bartlett Kernel (See appendix for the
results).
4.3 Cointegration Tests
Having established the fact that some variables in the models are stationary at level I(0) and
others in first difference I(1), it is necessary to further examine if there exist a likelihood of a
long-run relationship amongst the variables. That is to ascertain if the variables are co-
integrated. Once this is done, it implies that although some of the variables exhibit random
walks, there is a stable long-run relationship amongst them and that the randomness will not
make them to diverge from their equilibrium relationship.
However, to do this, Engle-Granger two-step (EGTS) procedure on the variables that are
integrated to order one, that is I(1). The test involves first regressing these variables and
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obtaining the residuals. Next, the residuals are tested for unit roots by applying ADF
framework. Once the results show a stationary process, it means that the variables are co-
integrated. Furthermore, this was done to know if the variables in the models have a
sustainable long-run relationship and also to avoid the problem of running a spurious
regression. The result for this test is reported in Table 1.6 below:
Table 1.6: Cointegration (Augmented Engle-Granger) Test Results
NIGERIA Variable ADF Test Statistic Test Critical Value at
5% Conclusion
RESID01 -5.936582 -2.931404 Stationary at level
GHANA
Variable ADF Test Statistic Test Critical Value at 5%
Conclusion
RESID01 -3.825501 -3.518090 Stationary at level Source: Author’s computation using EViews 8 The ADF tests on the residuals at level form confirmed that the calculated ADF statistics in
both Nigeria and Ghana are greater (in absolute terms) than the tabulated critical values at 5%
critical value. Thus, the null hypothesis of non-stationarity of the residuals is rejected, thus
concluding that there exist a stable long run relationship amongst them – though there might
be some deviations in the short-run.
4.4 Analysis of the SUR Models and Two-Stage Least Squares Estimation Results
To capture the three objectives of the study, a Seemingly Unrelated Regression (SUR) was
applied using both the Nigerian and Ghanaian data. The estimation of results for the SUR
model (equation 10, 11 and 12) are presented in Table 1.7 below. The equations represent
formulation of the hypotheses on the effects of budget deficits on (1.) interest rate, (2.)
inflation and (3) economic growth in both economies. However, the SUR estimation results
are presented in tables below:
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Table 1.7: SUR Estimation Results Source: Author’s estimation using STATA 13.
Note: Asterisk (**) shows statistically significant at 5% level of significance. The t-Statistic is given below; the statistics in parentheses.
4.4.1 Analysis of the SUR Estimation based on Economic Criteria
The estimation results for the Seemingly Unrelated Regression (SUR) equations are presented in
Table 1.7above. The equations represent formulation of the hypotheses that budget deficits exert
effects on interest rate (first study objective), inflation (second objective), and economic growth
(third objective) in Nigeria and Ghana.
The result obtained from the estimation exercise are fairly robust and satisfactory, such that the
variables in the estimation models conformed largely to a priori expectations in terms of
statistical significance. However, as indicated in the SUR equations results above, some
estimated coefficients are consistent with a priori expectations, while others are not. Focusing
our major interest on our core variable which is budget deficit, it is of great interest to note that
the coefficients of the variables in three equations (as shown in Table 1.7) maintain negative
signs in line with our a priori expectations. This suggests that the relationship between budget
deficit; interest rate, inflation and economic growth from the linear-log and log-log form of the
model(s)in Nigeria and Ghana are respectively negative. The t-statistics, that is, the variables in
parentheses in the Table (1.7) confirm that the coefficient of budget deficit is statistically
significant at 5.0 percent. Thus, we can safely reject the null hypotheses that budget deficits do
not have significant effects on interest rate, inflation and economic growth in Nigeria and Ghana.
Furthermore, the coefficients of budget deficit is negatively related to interest rate (RIR) in the
first model; inflation (INF) in the second model, and economic growth (RGDP) in the third
model, but allare statistically significant. This further suggests that, if budget deficit increases by
one percent, the interest rate, inflation and economic growth will decrease by about 0.21%,
2.61%, and 2.47% in Nigeria respectively. Similarly, in Ghana, if budget deficit increases by one
percent, the interest rate, inflation and economic growth will decrease by about 1.23%, 1.11%,
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and 0.04% respectively. These results support the neoclassical argument in the literature that
budget deficit slows the growth rate of the economy through resources crowding-out. These
findings suggest that the model variables are robust determinants of real interest rate, inflation,
and economic growth in Nigeria and Ghana due to the fact that all their test statistics are
relatively significant.
4.4.2 Analysis of the SUR Results based on Statistical Criteria
4.4.2.1 The t-Test Results:The t-test shows the significance of each variables in the models. Hypothesis: H0: β = 0 (Parameter estimated is statistically insignificant)
H1: β ≠ 0 (Parameter estimated is statistically significant) Decision Rule: Reject H0 if |tcal| > |ttab| Accept otherwise. α = 5% with (n – k)df i.e. 0.05 (44 – 5)df = 0.05 (39)df |tcal| = 1.95 ≈ 2.0
Conclusion: In Nigeria, all the variables in the Model I of the empirical results are statistically
insignificant (with exception of budget deficit and inflation) at 5% level of significance as their
values are not greater than the |ttab|. Also, in Model I of Ghana, all the variables are statistically
significant. In Model II, all the variables in both Nigeria and Ghana are statically significant with
the exception of Real GDP and money supply, likewise the total savings in Model III.
4.4.2.2 The F-tests: This measures the overall significance of the regression models.
Hypothesis:
H0: β0 = β1 = β2 = β3 = β4 = β5 = 0(The model is statistically insignificant)
H1: β0 ≠ β1 ≠ β2 ≠ β3 ≠ β4 ≠ β5 ≠ 0(The model is statistically significant)
Ββ = 5% with k-1/n-kdf
i.e. 0.05 with 4/39df
Decision Rule:
Reject H0 if |tcal| > |ttab|
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Accept otherwise
F-cal: the values of F-cal in the three (3) models in both economies are all greater than F-tab (see Table 1.7). Where; F-tab = 2.69 Therefore, since F-cal > F-tab in all the models in Nigeria and Ghana, we reject H0 and conclude that the models are statistically significant at 5% level of significance. 4.4.2.3 The Coefficient of Determinations (R2):
In the Table 1.7, the values of R2 in the three (3) models in Nigeria and Ghana hovers between
0.70 and 0.92. However, the R2explains the extent at which the respective dependent variables
(real interest rate, inflation and economic growth respectively) caused the variations in all the
explanatory variables in the respective models. This further suggests that the explanatory
variables explain about specific percentages of the total variations in real interest rate, inflation
and economic growth in the models in both economies respectively.
4.4.3 Analysis of the SUR Estimation based on Econometric Criteria
4.4.3.1 Autocorrelation
The Durbin-Watson (DW) test statistic was employed to check for serial correlation in the
model. From the empirical results presented in Table 1.7, DW ranges from the minimum 1.376
to maximum of 1.631 in the models of the two economies. n = 44; k = 5 (on the average,
excluding the intercept) and from the DW table; dL = 1.336and dU = 1.720 at 0.05 level.
Hypothesis:
H0: No positive autocorrelation
H0: No negative autocorrelation
H1: There is autocorrelation
Decision Rule:
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Since dL<1.376 < - ... < 1.631< dU, there is inconclusive evidence regarding the presence or
absence of positive first order serial correlation.
4.4.3.2 Other Diagnostic Tests Table 1.8: Other Diagnostic Tests
Source: Author’s estimation using EViews 8 The result of residuals generated the estimated equation was found to be normally distributed for
both Nigeria and Ghana. No serial correlation and heteroscedasticity was observed in the
equation, implying that the estimates are reliable, and result can be relied on for policy
recommendation and formulation.
4.4.3.3 Functional Form Specification (Ramsey Reset) Test
This test is conducted to check whether the models in this study are correctly specified or not.
Here, the F-distribution was used.
NIGERIA
Test Type Statistic Value Probability Remarks Normality Jarqua
Bera 1.684908 0.430654 Normally distributed
residuals Serial Correlation (LM)
F-statistic 6.913589 0.0029 No serial correlation
Heteroscedasticity ( Harvey )
F-statistic 0.821468 0.6475 No heteroscedasticity
GHANA
Test Type Statistic Value Probability Remarks Normality Jarqua
Bera 2.886401 0.236171 Normally distributed
residuals Serial Correlation (LM)
F-statistic 1.136370 0.3319 No serial correlation
Heteroscedasticity (Harvey)
F-statistic 1.339767 0.2464 No heteroscedasticity
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Table 1.9: Ramsey Reset Specification Test
Source: Author’s computation using EViews 8 Hypothesis:
H0: βi = 0 (the model is wrongly specified)
H1: βi ≠ 0 (the model is correctly specified)
Αt α = 5% level
Decision Rule:
Reject H0 if F-stat > F-tab. (k-1/n-k)df.
Accept otherwise.
Where k = number of parameter; n = number of observations Ftab = (5-1/44-5) = (4, 39). Then, from F-Distribution Table = 2.69. Since F-stat (5.39) > F-tab (2.69) in Model I. F-stat (7.46) > F-tab (2.69) in Model II. F-stat
(2.86) > F-tab (2.69) in Model III at 5% levels, we reject H0 and conclude that the Models are
correctly specified.
4.5 Evaluation of Hypotheses
MODEL I
Variables F-Stat. F-tab. Assessment
Fitted^2 5.39 2.69 Well Specified
MODEL II
Variables F-Stat. F-tab. Assessment
Fitted^2 7.46 2.69 Well Specified
MODEL III
Variables F-Stat. F-tab. Assessment
2.86 2.69 Well Specified
P a g e | vi
The study hypotheses stated in Section 1.5 are evaluated as follow:
H01: Budget deficitshas noeffects on interest rate in Nigeria and Ghana.
Decision:
The t-statistic of the slope of the budget deficit on interest rate is -3.42 and -2.71 in Nigeria and
Ghana respectively, hence statistically significant at 5% (α > 1.95 ≈ 2). We reject the null
hypothesis that budget deficits has no effects on interest rate, thereby concluding that there exists
significant negative effect of budget deficits on interest rate in Nigeria and Ghana.
H02: Budget deficitshas noeffects on inflation in Nigeria andGhana
Decision:
The t-value of the slope of the budget deficit on inflation is -2.61 in Nigeria, and -3.08 in Ghana;
hence statistically significant at 5% (α > 1.95 ≈ 2). We reject the null hypothesis that budget
deficits has no effects on inflation, thereby concluding that there exists significant negative effect
of budget deficits on inflation in Nigeria and Ghana.
H03: Budget deficits has no effects on economic growth in Nigeria and Ghana.
Decision:
The t-value of the slope of the budget deficit on economic growth is -2.47 and -3.57 in Nigeria
and Ghana respectively, hence statistically significant at 5% (α > 1.95 ≈ 2). We reject the null
hypothesis that budget deficit has no effects on economic growth in both economies, thereby
concluding that there exists significant negative effect of budget deficits on interest rate in
Nigeria and Ghana. However, these findings support the neoclassical argument in the literature
that budget deficit slows the growth rate of the economy through resources crowding-out. The
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policy implication of the findings is that the selected macroeconomic variables are negatively
affected by budget deficits in both economies of Nigeria and Ghana.
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CHAPTER FIVE
SUMMARY, CONCLUSION, AND POLICY RECOMMENDATIONS
5.1 Summary of Findings
The study was carried out to empirically address three research questions on the fiscal deficits in
Nigeria and Ghana for the period from 1970 to 2013 inclusive. The motivation and justification
behind the study and selection of the economies of Nigeria and Ghana were as a result of:first,
the centrality of role of fiscal imbalances in determining the economic growth and stability in
both economies. Second, the similarities in socio-economic and political structures in both
economies. Hence, the study broadly aimed to test for the effects of budget deficits on interest
rates, inflation and economic growth in Nigeria and Ghana.
After testing for these effects of budget deficits on the selected macroeconomic variables in both
economies, the empirical results have shown that there exists negative and statistically
significant effects of budget deficits on interest rate, inflation and economic growth in Nigeria
and Ghana.
5.2 Policy Implications of Findings The results from the study clearly show that budget deficits in Nigeria and Ghana are responsible
for macroeconomic imbalances. An ever rising inflation and interest rates are not desirable and
they could be instrumental for disaster if they reach unsustainable levels. Inflation and interest
rates are unsustainable if they cannot be controlled and their effects are not consistent with
adequate growth, price stability and the countries’ ability to service fully their external debt
P a g e | ix
obligations, (IMF, 1995). Similarly, high interest rates crowd out the private sector and thus
negatively affect national savings and investment. It is therefore necessary for the governments
of Nigeria and Ghana to reduce the size of the budget deficits to a level that will not affect other
macroeconomic variables through fiscal consolidation and boosting domestic production.
Fiscal Consolidations in Nigeria and Ghana
Fiscal consolidation is a policy aimed at reducing government deficits and debt accumulation.
For Nigeria and Ghana the policy should focus on both short term and long term measures. In the
short term the government should aim at gradually reducing the budget deficit by raising
domestic revenue mobilization. In Nigeria and Ghana, revenue from tax (tax to GDP ratio) has
stagnated between 11 and 13 percent over the years yet government spending have continued to
grow (NBS, 2013; BoG, 2014).
5.3 Policy Recommendations
Financing of the growing expenditure has therefore been through foreign aid and government
borrowing both externally and internally; these as noted, have negative consequences. In order to
mitigate the above consequences, governments should institute actions that increase its revenue
collections. Such actions should aim at increasing economies’ tax revenue collections by
adopting efficient and effective methods of tax collections. Such measures include but are not
limited to the following:
i. Reducing the size of the informal sector which has proved hard to tax as this will improve
the revenue collection in the economies that can be used to finance budget deficits rather
than depending on external borrowing for financing of fiscal deficits. Similarly, reducing
the number of unproductive tax exemptions as well as combating tax evasion in the
economies will equally improve the revenue base of the governments.
P a g e | x
ii. Interest rates should be further reduced through appropriate policy and macroeconomic
environments to ensure credit availability and accessibility to the private sectors in both
economies. Furthermore, there is need to support growth in the real sectors of the
economy by encouraging investors to have access to investible funds from banks through
lowering of interest rate.
iii. Appropriate policy to ensure high levels of financial deepening should be pursued in both
economies as there exist the positive nexus between the level of financial deepening and
economic growth in both economies.
iv. Exchange rate depreciation should be discouraged in both economies as it has negative
consequences on growth in Nigeria and Ghana.
v. Appropriate policies should be pursed with vigour by the monetary authorities in both
economies to curtail inflation through suitable money supply. However, the regional
blocks at which the economies of Nigeria and Ghana belong should be mindful of
uniformed policy adoption across country members as this has implication on inflation.
vi. On the expenditure side, government should reduce its overall recurrent expenditure bill,
this could be done by revising the administrative structures created under its
decentralization plan. Also, governments of both economies should maintain the number
of states and local autonomies it had created as rapid growth in the number of districts,
states and local autonomies have contributed to increase in administrative costs which
worsens the budget imbalances.
vii. The economies should pursue policies that will boost production of goods for both
domestic consumption and exports in the long run through a combination of import
P a g e | xi
substitution and export promotion strategies as this will have a positive improvement on
the countries exchange rate, reduce inflation and thus lead to growth.
viii. Finally, the government of Nigeria and Ghana should be mindful of the sources of
financing the budget deficits so as to effectively manage the economic fluctuations and
increase activities in the real sector. Similarly, there is need to entrench fiscal discipline
in government operations at all levels that will ensure management of public finances,
improve budgetary processes, including openness in the budget preparation, execution
and reporting is been advocated.
5.4 Conclusion
The review of the study has shown that while vast growing volumes of research were being
carried out in the developed economies, little attention has been paid to the issue of how the
fiscal deficits affect interest rate, inflation, and economic growth in both economies. Based on
this empirical analysis, appropriate policies can then be drawn given insight to how budget
deficit can perform its roles without necessarily leading to inflation.
In order to achieve high and sustained long-run economic growth when budget deficit is used as
fiscal policy instrument, then, monetary policy, industrial policy and commercial policy must be
strengthened to act as checks and balances in Nigeria and Ghana. Relevant measures to enhance
policy coordination among various arms of government should be put in place. Most especially,
monetary policy should be made to complement fiscal policy measures. Also, fiscal discipline
should be strongly adhered to at every level of government. Furthermore, since inflation has been
established as monetary phenomenon in both Nigerian and Ghanaian economies; for budget
deficit to be effective, some fundamental changes in the productive base of the economy need be
made.
P a g e | xii
REFERENCES
Abel, A. B., & Bernanke, B. S. (2001). Macroeconomics (4thed.). New York: Addison Wesley
Longman, Inc.
Ackah, C. G, Aryeetey, E. B, & Aryeetey, E. (2009). The Impact of Global Economic Crisis on
Ghana. Labour Institute and Labour Research, Discussion Series Paper 5. Retrieved
SOURCE: Bank of Ghana Statistical Bulletin of various years, IMF, WEO, and WDI 2014 NIGERIA AUGMENTED DICKEY-FULLER (ADF) STATIONARITY TEST RES ULTS AS GENERATED FROM EVIEWS 8. AT LEVEL Null Hypothesis: BD has a unit root Exogenous: Constant, Linear Trend Lag Length: 0 (Automatic - based on SIC, maxlag=9)
t-Statistic Prob.* Augmented Dickey-Fuller test statistic -4.099735 0.0125
C 0.135832 0.816397 0.166379 0.8687 @TREND("1970") 0.005902 0.032035 0.184245 0.8548
R-squared 0.480650 Mean dependent var -0.008869
Adjusted R-squared 0.454016 S.D. dependent var 3.395744 S.E. of regression 2.509139 Akaike info criterion 4.746506 Sum squared resid 245.5354 Schwarz criterion 4.870625 Log likelihood -96.67662 Hannan-Quinn criter. 4.792000 F-statistic 18.04691 Durbin-Watson stat 1.977379 Prob(F-statistic) 0.000003
GHANA PHILLIP-PERRON (PP) STATIONARITY TEST RESULTS AS GE NERATED FROM EVIEWS 8. AT LEVEL Null Hypothesis: BD has a unit root Exogenous: Constant, Linear Trend Bandwidth: 3 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -4.250001 0.0085
C -12.75599 14.08480 -0.905656 0.3705 @TREND("1970") 1.954681 0.727263 2.687722 0.0104
R-squared 0.270003 Mean dependent var 2.971429
Adjusted R-squared 0.233503 S.D. dependent var 50.05131 S.E. of regression 43.81984 Akaike info criterion 10.46526 Sum squared resid 76807.13 Schwarz criterion 10.58814 Log likelihood -222.0032 Hannan-Quinn criter. 10.51058 F-statistic 7.397359 Durbin-Watson stat 1.894760 Prob(F-statistic) 0.001847
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AT FIRST DIFFERENCE Null Hypothesis: D(GEX) has a unit root Exogenous: Constant, Linear Trend Bandwidth: 2 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -6.472818 0.0000
C -110891.6 68902.43 -1.609400 0.1156 @TREND("1970") 10277.64 3221.966 3.189868 0.0028
R-squared 0.500953 Mean dependent var -9790.337
Adjusted R-squared 0.475361 S.D. dependent var 274125.8 S.E. of regression 198554.7 Akaike info criterion 27.30427 Sum squared resid 1.54E+12 Schwarz criterion 27.42839 Log likelihood -570.3896 Hannan-Quinn criter. 27.34976 F-statistic 19.57448 Durbin-Watson stat 1.562010 Prob(F-statistic) 0.000001
AT FIRST DIFFERENCE Null Hypothesis: D(INF) has a unit root Exogenous: Constant, Linear Trend Bandwidth: 18 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -11.52751 0.0000
C 0.672960 1.371470 0.490685 0.6264 @TREND("1970") -0.016317 0.053577 -0.304550 0.7623
R-squared 0.506900 Mean dependent var 0.012697
Adjusted R-squared 0.481613 S.D. dependent var 5.840546
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S.E. of regression 4.205141 Akaike info criterion 5.779242 Sum squared resid 689.6453 Schwarz criterion 5.903361 Log likelihood -118.3641 Hannan-Quinn criter. 5.824737 F-statistic 20.04572 Durbin-Watson stat 1.998933 Prob(F-statistic) 0.000001
AT FIRST DIFFERENCE Null Hypothesis: D(RGDP) has a unit root Exogenous: Constant, Linear Trend Bandwidth: 5 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -4.966708 0.0012
C -9.267837 4.402235 -2.105257 0.0416 @TREND("1970") 0.367696 0.173198 2.122984 0.0400
R-squared 0.554804 Mean dependent var 0.780783
Adjusted R-squared 0.532544 S.D. dependent var 19.23099 S.E. of regression 13.14837 Akaike info criterion 8.057686 Sum squared resid 6915.181 Schwarz criterion 8.180561 Log likelihood -170.2403 Hannan-Quinn criter. 8.102998 F-statistic 24.92406 Durbin-Watson stat 1.936052 Prob(F-statistic) 0.000000
AT FIRST DIFFERENCE Null Hypothesis: D(SAV) has a unit root Exogenous: Constant, Linear Trend Bandwidth: 1 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -6.002668 0.0001
Phillips-Perron Test Equation Dependent Variable: D(SAV,2) Method: Least Squares Date: 08/27/15 Time: 16:33 Sample (adjusted): 1972 2013
P a g e | xxxvi
Included observations: 42 after adjustments Variable Coefficient Std. Error t-Statistic Prob. D(SAV(-1)) -0.964605 0.160726 -6.001551 0.0000
C 0.135832 0.816397 0.166379 0.8687 @TREND("1970") 0.005902 0.032035 0.184245 0.8548
R-squared 0.480650 Mean dependent var -0.008869
Adjusted R-squared 0.454016 S.D. dependent var 3.395744 S.E. of regression 2.509139 Akaike info criterion 4.746506 Sum squared resid 245.5354 Schwarz criterion 4.870625 Log likelihood -96.67662 Hannan-Quinn criter. 4.792000 F-statistic 18.04691 Durbin-Watson stat 1.977379 Prob(F-statistic) 0.000003
GHANA AUGMENTED DICKEY-FULLER (ADF) STATIONARITY TEST RES ULTS AS GENERATED FROM EVIEWS 8. AT FIRST DIFFERENCE LEVEL Null Hypothesis: D(BD) has a unit root Exogenous: Constant, Linear Trend Lag Length: 0 (Automatic - based on SIC, maxlag=9)
t-Statistic Prob.* Augmented Dickey-Fuller test statistic -6.249993 0.0000
C 3.199397 1.596396 2.004137 0.0519 @TREND("1970") 0.024792 0.049394 0.501924 0.6185
R-squared 0.257149 Mean dependent var -0.108150
Adjusted R-squared 0.220006 S.D. dependent var 4.547604 S.E. of regression 4.016319 Akaike info criterion 5.685823 Sum squared resid 645.2327 Schwarz criterion 5.808697 Log likelihood -119.2452 Hannan-Quinn criter. 5.731135 F-statistic 6.923296 Durbin-Watson stat 1.962423 Prob(F-statistic) 0.002618
GHANA PHILLIP-PERRON (PP) STATIONARITY TEST RESULTS AS GE NERATED FROM EVIEWS 8. AT FIRST DIFFERENCE Null Hypothesis: D(BD) has a unit root Exogenous: Constant, Linear Trend Bandwidth: 11 (Newey-West automatic) using Bartlett kernel
Adj. t-Stat Prob.* Phillips-Perron test statistic -7.440796 0.0000
C 3.199397 1.596396 2.004137 0.0519 @TREND("1970") 0.024792 0.049394 0.501924 0.6185
R-squared 0.257149 Mean dependent var -0.108150
Adjusted R-squared 0.220006 S.D. dependent var 4.547604 S.E. of regression 4.016319 Akaike info criterion 5.685823 Sum squared resid 645.2327 Schwarz criterion 5.808697 Log likelihood -119.2452 Hannan-Quinn criter. 5.731135 F-statistic 6.923296 Durbin-Watson stat 1.962423 Prob(F-statistic) 0.002618
NIGERIA ENGEL-GRANGER COINTEGRATION RESULT AS GENERATED FRO M EVIEWS 8. AT LEVEL Null Hypothesis: RESID01 has a unit root Exogenous: Constant Lag Length: 0 (Automatic - based on SIC, maxlag=9)
t-Statistic Prob.* Augmented Dickey-Fuller test statistic -5.936582 0.0000
C 0.429302 0.509156 0.843165 0.4040 R-squared 0.462246 Mean dependent var 0.135706
Adjusted R-squared 0.449130 S.D. dependent var 4.477150 S.E. of regression 3.322969 Akaike info criterion 5.284990 Sum squared resid 452.7271 Schwarz criterion 5.366906 Log likelihood -111.6273 Hannan-Quinn criter. 5.315198 F-statistic 35.24301 Durbin-Watson stat 1.702978 Prob(F-statistic) 0.000001
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GHANA ENGEL-GRANGER COINTEGRATION RESULT AS GENERATED FRO M EVIEWS 8. AT LEVEL RESIDUAL Null Hypothesis: RESID01 has a unit root Exogenous: Constant, Linear Trend Lag Length: 0 (Automatic - based on SIC, maxlag=9)
t-Statistic Prob.* Augmented Dickey-Fuller test statistic -3.825501 0.0246
Mean 0.298047Median 0.575728Maximum 10.51545Minimum -7.279739Std. Dev. 3.479563Skewness 0.350590Kurtosis 3.653747
Jarque-Bera 1.684903Probability 0.430654
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GHANA NORMALITY TEST RESULT AS GENERATED FROM EVIEWS 8.
0
1
2
3
4
5
6
7
8
-15 -10 -5 0 5 10 15 20
Series: ResidualsSample 1970 2013Observations 44
Mean 2.46e-14Median -0.188538Maximum 20.41152Minimum -13.03041Std. Dev. 8.155610Skewness 0.626790Kurtosis 3.054182
Jarque-Bera 2.886401Probability 0.236171
NIGERIA SERIAL CORRELATION RESULT Breusch-Godfrey Serial Correlation LM Test:
F-statistic 6.913589 Prob. F(2,35) 0.0029
Obs*R-squared 12.46014 Prob. Chi-Square(2) 0.0020
Test Equation: Dependent Variable: RESID Method: Least Squares Date: 08/28/15 Time: 22:41 Sample: 1970 2013 Included observations: 44 Presample missing value lagged residuals set to zero.
Adjusted R-squared 0.119342 S.D. dependent var 2.277742 S.E. of regression 2.137510 Akaike info criterion 4.537410 Sum squared resid 159.9132 Schwarz criterion 4.902358
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Log likelihood -90.82302 Hannan-Quinn criter. 4.672750 Durbin-Watson stat 1.946273
GHANA SERIAL CORRELATION RESULT Breusch-Godfrey Serial Correlation LM Test:
F-statistic 1.136370 Prob. F(2,37) 0.3319
Obs*R-squared 2.546311 Prob. Chi-Square(2) 0.2799
Test Equation: Dependent Variable: RESID Method: Least Squares Date: 08/29/15 Time: 00:39 Sample: 1970 2013 Included observations: 44 Presample missing value lagged residuals set to zero.