Inflation and Govt Expenditure

Topics: Economics, Public finance, Macroeconomics Pages: 7 (2255 words) Published: March 28, 2012

1.1 Background of the Study
Persistent public expenditure and inflation have become major concerns in both developed and developing countries. Extensive theoretical and empirical literatures have been developed to examine the relationship between Public expenditure and macroeconomic variables. The monetarists share the view that fiscal deficits are harmful to an economy. While some of the increases in the public expenditure have been associated with declining tax revenue resulting from the recession, others relate to the increase in debt service payments on public debt. The relevance of public expenditure is often traced to the Keynesian inspired expenditure-led growth theory of the 1970s. Most countries of the world adopted this theory that government has to motivate the aggregate demand side of the economy in order to stimulate economic growth. However, its consequences on macroeconomic variables cannot be underestimated in most countries of the world, Nigeria inclusive (Olomola and Olagunju, 2004).

Over the years, there has been a persistent rise in private consumption expenditures and developments in the external sector have also impacted strongly on the size of public expenditure. Government’s narrow revenue base, vis-a-vis its expenditure, is likely to have serious consequences for the government’s budget balance (Cebula, 2000). Most analysts therefore argued that deficit reduction is crucial to the future growth of an economy, although, economists are divided over its impacts. It is expected that lower budget deficits will lower real interest rates, increase investment, and thereby increase productivity, growth and real income. A country experiences deficit in her budgetary system when its expenditure exceeds its revenue while budget deficit financing reflect the means of operating budget deficit of the country. However, the source of finance has varying impact of a growing public expenditure on inflation. The major outcomes of empirical studies examining the relationship between raising public expenditure and inflation showed strong evidence that the raising public expenditure financed through monetization and a rising money supply could lead to inflation. The Nigerian government has greater influence on the nation’s economic activities through the use of fiscal instruments amongst which is public expenditure operation. However, this has effect on macroeconomic variables such as interest rate, exchange rate, inflation, consumption, investment, etc which serve as media through which economic development is achieved. In Nigeria, for example, high incidence of projected budget deficit persists and the risk of severe adverse consequences must be taken very seriously, although it is impossible to predict when such consequences may occur. For instance, Oyejide (1972) established that Nigeria started experiencing raising public expenditure in her budgetary system since 1957 and became persistent in the 1970s prior to the civil war of 1967 to 1970, and up till date. Inflation has become a leading topic of discussion in Nigeria families and press as its effects penetrate more deeply into nation’s life due to prevailing increase in prices. Continuous increases in prices are among the most serious economic problem in Nigeria as well as Africa. Considering the urban, rural and combined consumer price index in Nigeria, all components of price index rose at generally higher rate than previous years. The index for food dominated the increase in the aggregated index for most of the period. This could be due to the fact that inflation has a general effect on farm economy compared to any other sector since it (agricultural sector) is highly competitive, most of the outputs are perishable and that is the least sector able to pass input cost increases directly into higher output prices (Obasi, 2007) . Other major components of consumer outlay which record substantial higher rates of price...
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