© 2013 Research Academy of Social Sciences http://www.rassweb.com 416 International Journal of Management Sciences Vol. 1, No. 10, 2013, 416-426 Relationship between Macro-Economic Variables and Budget Deficit Onuorah Anastasia Chi-Chi 1 , Odita Anthony Ogomegbunam 2 Abstract Few are the econometric studies which have examined the relationship between budget deficit and microeconomic variables-interest rate, exchange rate, inflation and money supply. This study analyses empirical relationship among interest rate, exchange rate, inflation, money supply and budget deficit in Nigeria over a period of 31 years from 1981 to 2012. The data were sourced from the World Bank Statistics (2013). In order to clarify whether exchange rate, money supply, interest rate and inflation rate cause budget deficit or vice versa, a vector autoregressive model is developed. Moreover, Granger causality technique is used to assess the direction of causation. The results show that bilateral causal relationship in the long run from exchange rate to budget deficit and from budget deficit to exchange rate while there is no causation between interest rate, money supply and inflate rate. The study recommended that the presence of a causal link between exchange rate and budget deficit has implications of great importance on development strategies for developing countries in the world such as Nigeria. The findings provide evidence to support the exchange rate-led budget deficit hypothesis. Thus, exchange rates are important in contributing to economic growth via budget deficit. Inflation and interest policy should be implement as they are capable of reducing budget deficit in Nigeria by more thousands percentage index. Fiscal policy measures can be changed and checked in tax rate, government consumption and public expenditures. Keywords: Budget Deficit, Fiscal deficit, Macroeconomic variables, Causation, VEC. 1. Introduction Budget is a tool for managing the economy and also a key instrument of Fiscal Policy. A budget deficit arises from Fiscal operations of the government. This can arise whenever expenditure surpasses revenue derived. The main objective of Nigeria budget deficit could be seen as achieving efficient distribution of natural resources and income between the public sectors and private sectors. The government does this with the use of fiscal policy which focuses on the way the revenues and expenditures accruing to the government are utilized for a given period. In an attempt to achieve these objectives, the government may spend more money than the revenue derived and this results to what we call budget deficits. Budget deficit could be seen as a situation where total expenditure exceeds the total revenue for the fiscal year. If government projected revenues exceed projected outlays, the government has a budget surplus. If projected outlays exceed projected revenue the government has a budget deficit, if both are equal, government has a balance budget (Osiegbu and Onuorah, 2010). Budgeted deficits when exhausted are supplemented with borrowings from CBN, engage in short term securities like treasury bills, treasury certificates and use of cash reserve deposits. If budget deficits are used for long term productivity investment like importing and exporting of capital goods and services, capital intensive goods, training and manufacturing new technology and technical expertise, the deficit will result to long term investment growth and will foster high economic growth, achieve and accelerate economic activities and stability. It was argued in world economics (2013) that budget deficit implies an increase in the supply of government bonds. In order to improve the attractiveness of these bonds, the government offers them at a lower price which leads to higher interest rate and the increase in interest rate discourages the issue 1 Department of Accounting, Banking and Finance, Delta State University, Asaba Campus 2 Department of Accounting, Banking & Finance, Faculty of Mgmt. Sc., Delta State, University Asaba Campus