| Summary: | Government expenditure and financial development among other things can be used to achieve the economic growth of a country. As such, this study attempts to propose a framework that determine the impact of government expenditure and financial development on economic growth; identify the long-run and short-run relationships between government expenditure, financial development and economic growth and direction of causality among these variables. The study used annual time series data in Nigeria for the period 1970-2012. In proposing the framework that determine the impact of government expenditure and financial development on economic growth, we first employed a Principal Component Analysis to develop Financial Development Index, and two cointegration tests were employed (i.e. ARDL bound test and Johansen-Mosconi-Nielsen test) to test the long-run relationship among the variables. Autoregressive distributive lag with error correction model (ARDL-ECM) are employed to identify the long-run and short-run relationships between government expenditure and financial development. Finally, linear and non-linear Granger causality tests are used to test the direction of causality. The findings of the study revealed that there is a long-run relationship between government expenditure, financial development and economic growth in both approaches of cointegration. This suggests that, with proper government expenditure and effective financial sector, the macroeconomic problems will be solved. However, the ARDL-ECM estimates indicates that financial development is the only variable that has significant impact on economic growth in both the long-run and short-run. This implies that, the financial sector development contributes more to the economic growth. Furthermore, the Granger causality test indicates unidirectional causality running from government expenditure to economic growth and from financial development to economic growth. Meanwhile, the Dicks and Panchenko nonlinear Granger causality test show unidirectional causality among government expenditure and financial development on economic growth. This indicates that, government expenditure and financial development are the causes of economic growth in Nigeria. The study therefore, recommends that government needs to cut down its recurrent expenditure and increases it capital expenditure. Moreover, government should ensure that all funds appropriated are used for such purposes. Lastly, government should come up with a new financial policy that will enable private sectors to have long-term loan with a single digit interest rate.
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