Public debt shocks and macroeconomic stabilization in Nigeria: A new Keynesian approach

Abstract

The study examined the impact of public debt shocks on Nigeria’s macroeconomic stability. This study aimed to evaluate the role of increasing public debt on macroeconomic variables in Nigeria using a New Keynesian approach to evaluate the effect of both external and domestic debt on macroeconomic stability and the impact of debt service on revenue on Nigerian macroeconomic stability. The dynamic stochastic general equilibrium model was adopted as an analytical tool using the Bayesian approach in a Matlab R2021a in a Dynare 4.6.4 environment to determine the influence of public debt shock on macroeconomic stability in Nigeria. It was discovered that a positive relationship exists between output (economic growth) and foreign debt in Nigeria within the period under review. It was also found that debt service to revenue ratio, interest rate, and domestic debt have a negative relationship with output (economic growth). As a result, an increase in external debt will positively impact output (economic growth). In contrast, an increase in the debt service to revenue ratio, interest rate, and domestic debt will have a negative transmission effect on Nigeria’s macroeconomic stability. High debt service would impede growth by reducing public resources and productive investment that would otherwise be used to encourage growth. According to this result, external debt is the best option for capital projects rather than domestic debt, which is likely to affect the business environment negatively. This study is practically relevant to government, investors, scholars, and policymakers, especially those around fiscal policy, to guide them in advising the government on where to borrow for its capital projects when needed.