External Debt, Domestic Debt and Inflation in Nigeria: A Multivariate Granger-Causality Test

Abstract

Most recent studies have established a significant link between public debt and inflation. However, limited studies dealt with the direction of causality between these variables. Since external public debt relief in 2005, the Nigerian government has pursued public debt management strategy aimed at restoring macroeconomic stability. Yet, inflation rates remain high compared to the Central Bank’s single digit policy target range of 6\% to 9\%. It is unclear whether the high inflation rate is related to the renewed contributions of external and domestic public debt in the funding of the budget deficit, and if it is, what could be the direction of the causality? Therefore, this study examines the dynamic Granger-causality between public external and domestic debt and inflation in Nigeria using annual data for the period between 1986 and 2019. The study introduces interest rate and economic growth as intermittent variables alongside key variables to create a multivariate Granger-causality model to account for omission-of-variable bias. Using the Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration and the error correction model (ECM)-based Granger-causality test, the results show a distinct unidirectional causal flow from inflation to external debt. The findings further show a feedback relationship between domestic debt and inflation in the short run, but causality runs from domestic debt to inflation in the long run. The findings of this study have important policy implications.

Keywords

• Domestic Debt
• External Debt
• Inflation
• Nigeria
• Granger-Causality