Interrelationship Between Fiscal Deficit, Aggregate Savings and Investment: A Test of Ricardian Equivalence Hypothesis in Nigeria

Abstract

Conflicting results on the relationship between government fiscal deficit, savings and investment behaviour of households remains unresolved. Some authors have argued that households might unconsciously play out adherence to the dictates of the Ricardian equivalence hypothesis (REH) because they practice an infinite consumption horizon. Relying on the vector autoregression (VAR) technique and the impulse response function (IRF), this study examines the validity of the REH and the interactions between fiscal deficit, aggregate savings, and private investment in Nigeria within a 48-year period. The results reveal that government fiscal deficit exerts negative effects on gross domestic savings and investment, which is further affirmed by the impulse response function (IRF). These findings rather uphold the neoclassical literary arguments that economic growth is retarded due to crowding out effects resulting from fiscal deficits; hence opposing the REH. Thus, policy-makers should adhere to the fiscal deficits benchmark of less than 40 percent of GDP as proposed by the International Monetary Fund (IMF) to maintain stable macroeconomic conditions.

Keywords: fiscal policy, saving-investment, neoclassical theory

JEL Classification: E62, E21-E22, E23