Public Sector Financial Sustainability and External Shocks: The Mediating Role of Monetary Policy in Nigeria's Fiscal Stability

Abstract

Nigeria’s dependence on crude oil and exposure to exchange rate and commodity price shocks continue to pose challenges to public sector financial sustainability and fiscal stability. This study examines the mediating role of monetary policy in the relationship between external shocks and public sector financial sustainability in Nigeria. Using annual data covering 2006–2023, the study examines inflation rate (IFR), exchange rate (EXR), crude oil price (COP), and Monetary Policy Rate (MPR). The study employs the Autoregressive Distributed Lag (ARDL) model, with mediation analysis used to assess the role of MPR in the transmission of external shocks to fiscal stress, proxied by inflation. The findings indicate that EXR significantly influences inflation in both the short and long run, while COP is statistically insignificant in both periods. With MPR included, EXR remains significant in the short and long run, while MPR exhibits a delayed short-run effect but remains statistically insignificant in the long run. The study also finds no evidence of a stable long-run cointegrating relationship among the variables. These findings suggest that exchange rate instability represents a more immediate and persistent source of fiscal stress, while monetary policy provides only a limited and delayed stabilising effect. The study recommends adopting a transparent, market-driven exchange rate regime, diversifying the economy beyond oil, and strengthening monetary policy effectiveness through improved forecasting and proactive interventions.

Keywords: Public sector financial sustainability; External shocks; Monetary Policy Rate; Exchange rate volatility; Fiscal stability.