ABSTRACT
Fiscal policy and output gap is important to tinker the economy on the path of growth and development. Fiscal policy is implemented by the government through the Ministry of finance. Fiscal policy entails government management of the economy through manipulation of income and spending power, by controlling taxes and government expenditure, to achieve desired macroeconomic objectives. Output gap is the difference between potential output (production capacity) and actual output (actual production). The study addressed the contribution of fiscal policy and output gap to Nigerian economy from 1981-2015. The variables captured in the course of the study’s statistical analysis are Gross domestic product (GDP) gap, Inflation, Government (Public) expenditure, Interest rate. From the estimated regression result it can be seen that in the period under review, fiscal policy proxied by government expenditure has a significant and negative impact on output gap at impact and lag one. This means that within this period, fiscal policy is an effective tool in remedying adverse output gap. If for instance actual output is far below expected output, an increase in government expenditure will reduce the gap and the reverse will occur when actual output is above expected output. This finding is in line with Keynesian theories of government intervention in the economy. This finding is also in line with the works of Adeniyi (2010) .The relationship between government expenditure and GDP gap is however positive at lag two and three. Turning to the control variables it was found that interest rate has a positive but insignificant impact on output growth in Nigeria as shown by the very low p value. On the other hand, inflation rate was negatively related to output growth in Nigeria within this period. Its impact was however shown to be statistically insignificant. Taking a look at the group statistics we find that the R2 Value of 0.52 indicate that the independent variables as a group explains about 52% of the variations in economic development in Nigeria. The probability of the F- statistic which stands at 0.04 indicates that the jointly, the independent variables are statistically significant at the 5% significant level. From the estimated granger causality test, it can be seen that there exist a unidirectional causality from GDP gap to government expenditure (p value is 0.00007). However there is no reverse causality from government expenditure to GDP gap. On the other hand, there is no causal relationship whatsoever between GDP gap and the other control variables namely: inflation and interest rate. From the estimated Breusch Godfrey serial correlation test, it can be seen that the null hypothesis of no serial correlation cannot be rejected as the probability of the F- statistic arising from the LM test is very high. It is above the 0.05 threshold level for serial correlation to be accepted. Finally, the absence of autocorrelation was indicated by the Durbin Watson statistic which stands at about 2.0