Author:Vanessa Ushie,Oluwatosin Adeniyi &Sabastine Akongwale

Publication Date:March, 2012

JEL Classification: Q13; Q32; Q33:F10; C10

Keywords: Resource rents; Institutions; Impulse response functions; Variance Decomposition; Nigeria

Document Size: 23 pages

The influx of massive revenues during periods of abnormally high oil prices creates enormous challenges for policymakers in oil producing countries. In Nigeria, the prudent utilisation of oil revenues has remained elusive for policymakers over time. While the country has earned sizeable oil revenues from its natural endowment, poverty and income inequality have been persistent. This study offers an elaborate econometric analysis which tests the sensitivity of a number of key macroeconomic indicators to oil revenue shocks, using the Impulse Response Functions (IRFs) and Variance Decomposition (VDC) techniques within a Vector Autoregressive (VAR) framework. The sensitivity analysis offers a novel contribution to the academic and policy literature on the macroeconomic responses to oil windfalls in Nigeria by testing for an institutional quality variable. The inclusion of this variable is in recognition of the important role played by the domestic institutional context in shaping the policy responses adopted by successive Nigerian governments to oil windfalls over time. The sensitivity analysis supports the general view that fluctuations in oil revenues have resulted in inflation, lower output growth and real exchange rate appreciation in Nigeria. Importantly, the institutional variable was found to be significant. This finding is consistent with the general assessment of fiscal performance in Nigeria during oil windfalls as being driven by domestic institutional dynamics, as ostentatious public consumption widened fiscal deficits, and government spending was highly pro-cyclical during windfall episodes. In conclusion, the study offers appropriate policy recommendations, which involve a combination of economic, socio-political and institutional actions that may be adopted to enhance the management of future oil windfalls in Nigeria.