Fiscal Reaction Functions and Public Debt Sustainability in Nigeria: An Error Correction Mechanism Approach.

Abstract

The study determined the tendency for public debt sustainability in Nigeria by examining the responsiveness of fiscal authorities to rising debt accumulation. The study employed the error correction methodology to estimate the fiscal reaction functions used in the study. The Johansen cointegration tests revealed the existence of long run relationship between public debt and primary balance among other variables in the models estimated. The existence of cointegrating relationship in all models revealed that the necessary condition of achieving debt sustainability is satisfied. However, the sufficiency condition for a sustainable debt could not be met. The violation of the tenet of the intertemporal budget constraint, in the long run, suggested that fiscal authorities could not generate enough surpluses in reaction to public debt increases. The primary balance exhibited a negative response towards all contemporaneous values of public debt components thereby corroborating the long run findings. However, the response of primary balance to the lagged values of external, domestic and total debt in the short run was positive in line to the government budget constraint; a signal of a sustainable public debt in the short run. The study concluded that the fiscal operations of Nigerian government could not sufficiently allow for a sustainable debt; hence, the consistent running of this fiscal stance could either spur harsh adjustment measures in the long run or result to insolvency and default.