Abstract: Empirical studies in Europe, America and Asia have shown overwhelming evidence in support of the view that more volatile financial development raises industrial output volatility. The pertinent question is, does this evidence hold in the context of a mono economy such as Nigeria, driven by exogenous oil prices and high macroeconomic policy volatility? Accordingly, this paper investigates whether industrial growth volatility is principally caused by volatility of financial sector development in Nigeria. Total industrial output volatility was decomposed into the effects of financial development volatility, fiscal volatility, trade openness volatility, and oil price volatility using the vector auto-regressive (VAR) mechanism. All volatility measures are standard deviations of the various variables. Results suggest that about 24 per cent of the variations in industrial output volatility are caused by industrial output volatility itself, about 5 per cent and 38 per cent by financial institutions and financial markets volatilities respectively, representing a sum of 43 per cent attributed to financial sector development volatility, while 28 per cent are caused by volatility in openness to international trade, 2 per cent by fiscal policy (government expenditure) volatility and about 4 per cent by oil price volatility. The estimates also suggest that, on the whole, about 32 per cent of volatility in Nigeria’s industrial sector was associated with exposure to external shocks while 68 per cent was attributed to domestic factors (especially domestic capital market development). The implication of these results is that industrial output instability is relatively determined more by volatility in the domestic financial sector, and less by oil price and other external related volatility. Hence, volatility in the domestic capital market raised a major concern. The consequence of high output volatility is underdevelopment, as evident in low investment and widespread poverty in Nigeria.

JEL classification: C23; E32, G2; O43
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