The Effect of Financial Deepening and Borrowing Cost on Aggregate Output in Nigeria and its Policy Implications

Abstract

This study examines the effect of financial deepening and borrowing costs on aggregate output using secondary data from 1986 to 2022. The effect of financial deepening and borrowing costs on aggregate output is expressed in an autoregressive distributed lag (ARDL) model. The findings of the study indicate that the state of financial deepening in Nigeria is not sufficient to drive production to optimal levels, indicating that there are unrealized gains in the business of providing financial intermediation services in the economy. The result of the estimated models shows among other things that aggregate output is inelastic to changes in lending rate, indicating that raising policy interest rate will lead to minimal losses in output. It also shows that financial deepening has the potential to contribute significantly to output growth. It is concluded that financial deepening in the short run may not be achieved by relying totally on market equilibrium where it is expected that the market for credit and other financial services will clear and produce optimal macroeconomic outcomes. Rather, policies (reforms) should be made to heighten the demand and supply of credit in the economy to support real sector production activities.