Fiscal Policy and Financial Depth in Nigeria: An Application of Threshold Regression Modeling

Abstract

The study examines Nigeria's non-linear relationship between fiscal policy and financial depth. In essence, the study is concerned with the impacts of fiscal deficit, domestic debt, and government expenditure on financial depth. The study uses four indicators of financial deepening: liquid liabilities, credit to the private sector, deposit money banks’ assets and financial system deposits (all indicators are expressed as percent of GDP). In particular, the government is the threshold variable expected to have a threshold effect on Nigeria's financial depth. The study covers 60 years between 1961 and 2020 and employs a threshold regression model to achieve the research objectives. A linear regression model is employed for the robustness test by including the government expenditure square to test the significance of non-linearity. The study's findings establish fiscal policy's significance in driving financial depth. Beyond the threshold of 8.11 percent, government expenditure significantly increases financial deepening. This is consistent across the indicators of financial depth and the overall financial depth. It further shows the important role of fiscal deficit and domestic debt in deepening the financial market as the threshold value exceeds 8.11 percent. However, fiscal may have a negative, though insignificant, effect on financial depth when the threshold of government expenditure is no more than 8.11%. Real per capita is also a key factor in promoting financial depth. Therefore, higher income is important for a financially deeper financial system. Therefore, attaining minimum government expenditure is crucial for accelerating financial development in Nigeria.