Rent-seeking and optimal fiscal-monetary policy rules in Nigeria: A DSGE approach

Abstract

This study examines the conduct of optimal fiscal and monetary policy in Nigeria under the assumption of a rent-seeking government. To answer this question, a Dynamic Stochastic General Equilibrium (DSGE) model featuring a rent-seeking fiscal authority is calibrated. The study also conducted a sensitivity analysis to compare the welfare effect of optimal simple policy rules under a corrupt versus benevolent regime. The results from the study showed that optimal monetary policy should target the double mandate of price and output stabilization when the government is a rent-seeker. The study also found that it is optimal for the Central Bank to commit to an active monetary stance. The optimal fiscal policy rule in a rent-seeking economy is passive and pro-cyclical. Furthermore, welfare is negligibly better off in the benevolent economy. From a policy perspective, rent-seeking activities are triggered by the proportion of rent-seeking agents. This induces inefficiencies in government spending, which constrains growth in a developing economy. Furthermore, rent-seeking can “coerce” the Central Bank of Nigeria to focus on a double mandate to stabilize both prices and output. Therefore, it is desirable for the monetary authority to possess due independence in controlling prices without interference from the fiscal authority.