Abstract

This study investigates the effect of fiscal deficits on nominal interest rate in Nigeria. Cointegration techniques and structural analysis were adopted for the study. Empirical evidence emerges that the coefficient of fiscal deficit variable is positive and statistically significant. This indicates that the elasticity of fiscal deficit with respect to income is 0.114, an indication that large deficit causes higher interest rates. In addition, money supply has an inverse relationship with interest rates in Nigeria, but there exist a positive and significant relationship between inflation and interest rate. The coefficient of government expenditure is positive with a short run effect of 0.229. It is recommended that government should consider the option of bond financing of budget deficit as an alternative to monetary financing.

Key words: Fiscal deficit, nominal interest rate, cointegration, Nigeria.