MACROECONOMIC POLICIES AND BUSINESS CYCLES IN NIGERIA:
1970-2004
PHILIP OLASUPO ALEGE
CU03GP0011
2008 i

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) iii

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 iv

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. v

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 overemphasized. 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. vi

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 vii

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.
viii

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 ix

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 x

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 xi

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 xii

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 xiii

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 xiv

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.
The DSGE model developed in this study to capture business cycle facts is perturbed by three exogenous shocks namely technology, monetary and export supply in line with the New-Keynesian analysis. The Bayesian method of estimation is applied on the hybrid DSGE-VAR model and the results are presented and discussed and its empirical performance xv

evaluated. The impulse response functions and the variance decomposition are also discussed. The solution of the model is facilitated by the use if
DYNARE v3 (Matlab version): a software package designed to solve DSGE models. From the atheoretical statistical method it is found that business cycle fluctuations exist in Nigeria and the observed stylized facts are comparable to those recorded elsewhere. The results suggest the existence of about two complete cycles from one trough to another, which is 1970-
1989 (20 years) and 1990-2004 (15 years). These two cycles do not exhibit the same resemblance nor do they happen at constant or predictable internals. From the DSGE-VAR approach, the results show that productivity shock, money supply growth shock and export supply growth shock contributed in the statistical sense in explaining that the Nigerian business cycle is driven by both real and nominal shocks. Finally, a major finding of the study is the fact that the export sector which is supposed to be the engine of growth of the economy is exhibiting weak linkages with the rest of the economy. This suggests a major challenge of policy.
In spite of the initial suspicion that business cycles do not exist in the
Nigerian economy, this study has shown that they occur and quite at irregular intervals as predicted in the literature. The study also shows the degree of pro-cyclicality or counter-cyclicality between the gross domestic product and a number of its main components. The application of a DSGE model helps in affirming the fact that the Nigerian economy is buffeted by productivity, money supply and terms of trade shocks. Above all, the study shows that this family of models can be applied for policy analysis in
Nigeria. In particular they could be used for monetary policy analysis and prescriptions as well as designing value addition export policies. It could also be used to understand some phenomena that may be influencing the course of the economy such as the Dutch-Disease syndrome. This study recommends that documenting business cycles, their dating and turning points, as well as analysis of the periods of booms and bursts should xvi

become major research efforts in the immediate future in the economy. It is suggested that the study’s approach could become a candidate model for understanding the Nigerian economy. Based on the limitations of the study, a certain number of areas for future research are highlighted.
This study has contributed to knowledge in the following ways: First, there have been few studies to unravel the existence and characteristics of business cycle fluctuations in Nigeria. This study has shown that there is business cycle in Nigeria. Second, this study has contributed to quantitative macroeconomic assessment of the Nigerian economy based on the characterization and analyses of business cycles in a Dynamic Stochastic
General Equilibrium (DSGE) framework. Third, econometric models provide tools for forecasting, understanding an economy and policy analysis. In this respect, this study has made attempt at providing an alternative and useful contribution to existing short-run macro-economic models particularly in the area of policy analysis. Finally, this study adopts the Bayesian method in the estimation of the DSGE model constructed for the Nigerian economy. xvii