Determinants of Business Cycle in Nigeria: an Econometric Analysis

MACROECONOMIC POLICIES AND BUSINESS CYCLES IN NIGERIA:

1970-2004

PHILIP OLASUPO ALEGE

CU03GP0011

2008

Macroeconomic Policies and Business Cycles in Nigeria:

1970-2004

By

Philip Olasupo Alege

CU03GP0011

Department of Economics and Development Studies

College of Business and Social Sciences

Covenant University

Being

A Thesis Submitted in Partial Fulfillment of

The Requirements for the Award

of Ph.D. (Economics) of

Covenant University

Ota.

ii

CERTIFICATION

We certify this work was carried out by Philip O. Alege in the Department of Economics and Development Studies, Covenant University, Ota, Ogun State, Nigeria.

______

Professor Cyril S. Ige

(Supervisor)

______

Dr. P.A Olomola

(Co-Supervisor)

______

Professor Cyril. S. Ige

(Head of Department)

AUTHORISATION

COVENANT UNIVERSITY, OTA, OGUN STATE, NIGERIA

CENTRE FOR LEARNING RESOURCES

Postgraduate Thesis

Authorisation to copy

AUTHOR: ALEGE, Philip Olasupo

TITLE: Macroeconomic Policies and Business Cycles in Nigeria: 1970-2004

DEGREE: Ph.D

YEAR: 2008

I ALEGE, Philip Olasupo hereby authorize the Centre for Learning Resources, Covenant University, Ota, Ogun State, Nigeria to copy my thesis in whole or part, in response to requests from individual researchers or organization for the purpose of private study or research.

______

Date Signature

DEDICATION

Dedicated to the Holy Spirit, without whose help and power I am naught. I also dedicate this study to the memories of my mothers: Madam Victoria Folasade Alege, the one who gave birth to me and Madam Tojola Abeni Alege, the one who brought me up and my father, Mr. Jacob Kehinde Alege. This work is especially dedicated to Dr. David O. Oyedepo whose obedience to God birthed Covenant University that gave me the privilege to do my PhD.

ACKNOWLEDGMENTS

I give thanks to the Almighty God for His mercies over me and for helping me to successfully finish this study. I do testify to his grace at every stage of my life particularly during the period of this research. Were it not for His grace, this work would not have been possible. For all His enablement, for Divine Wisdom, and Divine Strength I return all praises to Him. I deeply appreciate Dr. David Oyedepo, the Chancellor of Covenant University and the Visioner of Living-Faith Commission for answering to the call of God. Without his obedience to God I would not be where I am today. May the lord continue to shower him with uncommon wisdom.

My profound gratitude to my Supervisor Professor C.S Ige whose meticulousness, criticisms, corrections and suggestions to the entire work gave me the impetus to work very hard even in the presence of other academic and administrative work load. As the head of the department, the administrative responsibilities on this work are demanding. In this respect I sincerely thank you for your efforts. I am also very grateful to my Co-Supervisor Dr. Philip A. Olomola, for his patience and painstaking inputs throughout the period of this research. He constantly assured me that this work could be done and his inspiration during the period cannot be over-emphasized. I also thank Dr I.O. Ogunrinola under whose departmental headship this study started for his positive approach to this work.

I also want to thank our associate Lecturers namely, Professors Oladeji and Taiwo and Doctors Ekanem and Olomola. Their various lectures led me into the choice of the research topic. I appreciate Dr Ekanem for his inputs into the earlier copy of the Proposal of this study. Prof. Oladeji spent his precious time reading and correcting every draft of this work. I thank you for the interest shown in my work. Equally of deserved recognition are Prof. Aize Obayan and Prof. Prince Izedonmi. Thank you all for being of positive influence in my academic pursuit.

The moral support and encouragement emanating from Professor M.A. Ajayi is unparalled. There were several instances when I thought I could not continue with the demand of the study. However, his interventions, on a continuous base resulted into the successful completion of this work. I also like to thank Professor J.A.T Ojo, Professor Olusola Ojo and Dr. Adelusi for their keen interest at seeing to the successful completion of this research work. You are deeply appreciated Sirs.

My thanks also go to my mentor, Elder Paul A. Ogunjimi; my sister Mrs. Ebun Awoyemi, my brothers, Dr Benjamin Oluwole Alege, and Mr. Samson Ayodeji Alege, for their role in my upbringing. I do appreciate my younger brother Mr. Oladimeji Babatunde. I thank my friend Reverend James Abe for his ceaseless prayers over me. My gratitude goes to Deacon Yemi Nathaniel for standing by me during those difficult times. I thank Pastor (Engr.) Mike Ogboluchi and Pastor Rotimi for their love and keen interest in my study. I also benefited from the prayers of a group of students at the department and Bro. ’Wole Afolabi. I do give thanks to a large number of friends, relations and acquaintances too numerous to be mentioned for their supports and best wishes. Without these spiritual supports, this study might have not seen the light of the day.

I equally acknowledge Professors C. Zimmermann and Tommaso Griffoli. The former introduced me to various links in DSGE analysis while the Dynare Users’ Guide prepared by the latter provided the technical support for the study. I also wish to thank Professor Michel Juillard of CEPREMAP, Paris, France for his assistance in the use of DYNARE.

I also want to acknowledge my colleagues both at the department and in the College for their words of encouragement. In this respect, I specially thank Mr. Akin Craig of the department of Petroleum Engineering, College of Science and Technology for his kindness to me. He assisted me in obtaining the needed MATLAB software package for the study and helped me in downloading most current textbooks in the area of optimization and dynamic economics. He also gave me the initial technical support. Mr Henry Okodua was equally helpful in this regard. Without this I would not have been able to use the highly technical method I used in the simulation and estimation of the model of the study. I do appreciate my friend, brother and colleaque, Mr. Ese Urhie who was there for me at all seasons.

I want to thank the Covenant University authorities for their magnanimity in funding and providing the enabling environment for my post graduate studies and particularly this research work.

I also want to acknowledge the help of Messrs. Okunrinboye and Adeyemi for providing secretarial assistance. They both put in long hours so that I can come up with a presentable and admirable study report. You are deeply appreciated.

Finally, I am indebted and grateful to my wife, Dr. Mrs. Taiwo Adefunke Alege and my children, Damilare, Demilade and Dolabomi (Tripple D) for their prayers, kindness and understanding during the period of writing this work. They bore the burden of my long hours at work and even at home during the period of this study and without whose tolerance the work could hardly have been successfully completed.

As usual, I remain solely responsible for whatever imperfections or errors that may still be contained in this work.

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TABLE OF CONTENT

Title Page ………………………………………………………………….…ii

Certification………………………………………………………………….iii

Authorization………………………………………………………………...iv

Dedication…………………………………………………………………….v

Acknowledgments……………………………………………………………vi

Table of Content……………………………………………………………..ix

List of Tables………………………………………………………………….xii

List of Figures……………………………………………….………………xiii

List of Annexes……………………………………………………………….xv

Abstract………………………………………………………………………vii

Chapter One: Introduction

1.1  Background………………………………………………………………1

1.2 Statement of the Research Problem………………………………………4

1.3 Scope of the Study………………………………………………………10

1.4 Significance of the Study………………………………………………..11

1.5 Statement of Key Research Questions……………………………………11

1.6 Research Objectives………………………………………………………12

1.7 Research Hypotheses……………………………………………………..12

1.8 Methodology……………………………………………………………...13

1.9 Data Sources…………………………………………………………...…14

1.10 Plan of Thesis……………………………………………………………..15

Chapter Two: Literature Review

2.1 Introduction……………………………………………………………..17

2.2 Review of Theoretical Literature……………………………………...17

2.2.1 Background………………………………………………………………17

2.2.2 The Great Depression ………………………………………………….18

2.2.3 Business Cycle Theories…………………………………………………24

2.3 Review of Methological Literature……………………………………31

2.3.1 Some Methods for Business Cycle Analysis ……………………………31

2.3.2 Methods for Identifying Business Cycles………………………………..41

2.3.3 Business Cycle Models and the Stylized Facts………………………….43

2.3.4 Estimation Techniques for Business Cycle Models ……………………44

2.4 Review of Empirical Literature…………………………………….….49

2.4.1 Introduction………………………………………………………………49

2.4.2 Business Cycles in Industrial Economies ………………………………49

2.4.3 Review of Studies from Asia…………………………………………….53

2.4.4 Review of Studies from Latin America………………………………….55

2.4.5 Brief Review of Studies from Africa……………………………………57

2.5 Macroeconomic Policies, Shocks and the Nigerian Economy ………63

2.6 The Road Ahead in this Study…………………………………………67

Chapter Three: Theoretical Framework and Research Methodology

3.1 Introduction……………………………………………………………77

3.2 Theoretical Framework……………………………………………….81

3.3 The Research Methodology …………………………………………89

3.3.1 Introduction……………………………………………………………89

3.3.2 A Model of Business Cycle for Nigeria……………………………….89

3.3.3 The Solution of the Model…………………………………………….103

3.3.4 Equations to be estimated…………………………………………….107

3.3.5 Techniques of Estimating DSGEM of Nigeria…………………….…111

3.3.6 Univariate Detrending Technique……………………………………112

3.4 Sources and Measurement of Data…………………………………114

Chapter Four: Characterizing Business Cycle Fluctuations in Nigeria

4.1 Introduction…………………………………………………………..117

4.2 A Review of the Performance of the Nigerian Economy ………….118

4.3 Restating the Atheoretical Tools of Business Cycle Research ……127

4.4 Business Cycle Fluctuations in Nigeria………………………….…129

4.4.1 Introduction…………………………………………………………..129

4.4.2 The Unit Root Test……………………………………………………129

4.4.3 Cyclical Behavior of the Data…………………………………………132

4.5 Business Cycle Stylized Facts……………………………………..…147

4.6 Conclusion…………………………………………………………....150

Chapter Five: Estimation of the DSGEM of the Nigeria Economy

5.1 Introduction………………………………………………………….152

5.2 Presentation of Results…………………………………………...…154

5.2.1 Calibration……………………………………………………………154

5.2.2 Results………………………………………………………………..156

Chapter 6: Policy Analysis of Shocks to Business Cycles in Nigeria

6.1 Introduction………………………………………………………….173

6.2 Productivity and Business Cycle in Nigeria……………………….175

6.3 Monetary Policies and Business Cycle……………………………..181

6.4 Export Policies and Business Cycles in Nig………………………..183

6.4 Conclusion…………………………………………………………..189

Chapter 7: Summary, Findings, Conclusions and Recommendations

7.1 Summary…………………………………………………………….197

7.2 Findings………………………………………………………………200

7.3 Concluding Remarks………………………………………………..201

7.4 Recommendations …………………………………………………..202

7.5 Contributions to Knowledge of the Study…………………………203

7.6 Limitations and Future Lines of Research ………………………..203

` References……………………………………………………………………..206

List of Tables

Table 1.1: Second National Development Plan. Comparison of Plan Forecast with

Actual estimates for selected variables. (Millions of Naira)………...... 6

Table 1.2: Percentage Change between Plan and Actual...... 7

Table 2.1: Summary of Empirical Evidences of Business Cycles……………….72

Table 3.1: Parameters of the Model……………………………………………109

Table 3.2: Definition of Variables……………………………………………..110

Table 4.1: Annual and Average Growth Rates from 1970-2004……………...121

Table 4.2: Abbreviation of Variables…………………………………………122

Table 4.3: Unit Root Test……………………………………………………..131

Table 4.4: Cyclical Behaviour of Real GDP and its Main Components in Nigeria

and Other Countries……………………………………………….135

Table 4.5: Cyclical Behaviour of Real GDP and Other Key Variables………142

Table 4.6: Cyclical Behaviour of Real GDP, Monetary Aggregates and Prices.146

Table 4.7: Business Cycle Stylized Facts for Nigeria………………………….149

Table 5.1: Estimated Parameters using Bayesian Method……………………156

Table 5.2: Steady State Results ………………………………………………159

Table 5.3: Results from Posterior Maximization……………………………..160

Table 5.4: Standard Deviation Shocks……………………………………….168

Table 5.5: Estimation Results………………………………………………..169

Table 5.6: Comparing Estimation Results……………………………………171

Table 6.1: Matrix of Covariance of Exogenous Shocks……………………..174

Table 6.2: Policy and Transition Functions………………………………….179

Table 6.3: Theoretical Moments……………………………………………..180

Table 6.4: Variance Decomposition (in percentage) ………………………..186

Table 6.5: Matrix of Correlations…………………………………………….187

Table 6.6: Coefficient of Autocorrelation……………………………………188

Table 6.7: Summary of Results of the Study …………………………………191

List of Figures

Figure 1.1: Plan Forecast and Actual Estimates for Selected Variables…….....7

Figure 1.2: Graph of Real GDP of Nigeria...... 8

Figures in Chapter 4

Figure 4.1: Annual Growth Rate of Real GDP (1970-2004)…………………120

Figure 4.2: Average Growth Rates of Real GDP and some other Macroeconomic

Variables………………………………………………………….124

Figure 4.3: Combined Average Growth Rate…………………………………125

Figure 1: Real and HP Filtered GDP…………………………………………134

Figure 2: Private Consumption and Real GDP Cycle………………………..134

Figure 3: Gross Fixed Investment and Real GDP Cycles……………………134

Figure 4: Govt. Consumption and Real GDP Cycles ……………………….134

Figure 5: Govt. Revenue and Real GDP Cycles…………………………….134

Figure 6: Total Imports and Real GDP Cycles………………………………134

Figure 7: Total Exports and Real GDP Cycles………………………………134

Figure 8: Narrow Money Supply (M1) and Real GDP Cycles………………145

Figure 9: Broad Money Supply (M20 and Real GDP Cycles………………..145

Figure 10: Prime Lending Rate and Real GDP Cycles………………………145

Figure 11: Average Wage Rate and Real GDP Cycles………………………145

Figure 12: Inflation Rate and Real GDP Cycles…………………………….145

Figure 13: Naira Exchange Rate and Real GDP Cycles…………………….139

Figure 14: Industrial Output and Real GDP Cycles…………………………139

Figure 15: Agricultural Production and Real GDP Cycles………………….139

Figure 16: Unemployment Rate and Real GDP Cycles……………………..139

Figure 17: Crude Oil Production and Real GDP Cycles…………………….139

Figure 18: Non-Oil Export and Real GDP Cycles………………………….139

Figure 19: Crude Oil Export and Real GDP Cycles………………………..140

Figure 20: Non-Oil Imports and Real GDP Cycles…………………………140

Figure 21: Oil Imports and Real GDP Cycles………………………………140

Figure22: Fiscal Impulse and Real GDP Cycles……………………………140

Figures in Chapter 5

Figure 5.1: Priors Distribution of the Parameters…………………………..161

Figure 5.2: MCMC invariant diagnostic……………………………………162

Figure 5.3: Multivariate diagnostic…………………………………………165

Figure 5.4: Priors and Posteriors……………………………………………166

Figure 5.5: Smoothed Shocks……………………………………………….167

Figures in Chapter Six

Figure 6.1: Orthogonalized Shock to Productivity…………………………176

Figure 6.2: Orthogonalized Shock to Money Supply………………………182

Figure 6.3: Orthogonalized Shock to Export Supply……………………….184

List of Annexes

Appendix 1: Derivation of the FOC and Log-Linearization of the Export

Equation …………………………………………………………………….225

Appendix 2: Annual Data: 1970-2004…………………………………………231

Appendix 3: Quarterly Data: 1970:01 - 2004:04………………………………232

Appendix 4: DYNARE Codes for Estimation and Simulation of the Model..235

Abstract

This thesis examines macroeconomic policy and business cycles in Nigeria over the period 1970 to 2004. The study is set to fill gaps in three important areas: in-depth study of business cycles in Nigeria; application of dynamic stochastic general equilibrium (DSGE) model using Bayesian technique of solution, this complements the existing system-of-equations and the computable general equilibrium (CGE) models; and the investigation of the role of productivity, money supply, and external trade play in business cycle. Thus, three objectives are associated with this work namely establish and characterize the existence of business cycle in Nigeria, analyze the sources of business cycle fluctuations, and measure the impact of shocks. The literature review carried out in this study is divided into three parts: the theoretical; methodological; and the empirical literature using experiences of industrial economies, the Latin American countries, the Asian economies and Africa.Two approaches are used: atheoretical and the DSGE model which is based on the New Keynesian analysis. The first establishes the stylized facts in relation to the existence of business cycles in Nigeria establishing varying periodicity and volatility. The second method adopts the works of Nason and Cogley (1994) and Scorfheide (2000), but goes beyond these works by incorporating an optimizing export sector.