Objective: This study aims to conduct investigation on fiscal response to oil price volatility in Nigeria, and simultaneously comparing two hybrid methods of econometric analysis.
Methods: The theoretical model was derived from the consumption theory, and two hybrid methods (OLS-ARMA and 2SLS-GMM) of estimation were adopted to form the methodologies of the study. OLS and ARMA were combined in order to control for autocorrelation and heteroskedasticity in the model. While 2SLS and GMM were combined in order to accurately account for endogenous regressors.
Findings: The findings from model estimation shows that government responds insignificantly to oil price shocks. Consequently, the study recommends that Nigeria should increase her productive capacity, especially on crude oil in order to generate more revenue, in turn influencing government expenditure. It was observed from the computation conducted on data series of government expenditure, which was obtained from organization of petroleum exporting countries (OPEC) statistical bulletin, such that Government expenditure has been on a decline over the years. This raises some questions on the capacity of its determinants which are responsible for influencing the trending pattern. In other words, productivities for exportation and other sources of government revenue are insufficient to ignite government expenditure desirably. Evaluation on methodologies adopted shows that 2SLS-GMM is superior and more efficient than OLS-ARMA based on the econometric criteria used in the diagnostic tests
Application: Evidences from literature reviewed show that government revenue is the major determinant of government expenditure. Therefore, it adds to knowledge to investigate the effect of oil price volatility on government expenditure.