Abstract
This study analyses the effects of changes in government spending on aggregate economic activity and the way these effects are transmitted in case of Pakistan for the period 1971-2008. To analyse the transmission mechanism of government spending innovations, the Vector Autoregressive Model is estimated for following five variables: government spending per capita, GDP per capita, consumption per capita, debt to GDP ratio, long term interest rate and real exchange rate. The consumption and output respond negatively to the innovation in government spending which is consistent with the standard neoclassical model. The interest rates increase in the face of expansionary fiscal spending. As government debt builds up with fiscal expansion, the rising risk of default or increasing inflation risk reinforce crowding out through interest rates. The real exchange rate tends to appreciate in response to rise in government spending. This finding is according to the open economy literature and also with the conventional literature. JEL classification: E21, E62, E63 Keywords: Government Spending, Vector Autoregressive Model, Impulse Response Function, Neoclassical Model
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