Abstract
This paper explores the impact of fiscal spending on key macroeconomic indicators for Pakistan economy using an estimated open economy new Keynesian dynamic stochastic general equilibrium (DSGE) model. Results show that a positive shock to government consumption leads to fall in private consumption, private investment and exports owing to negative wealth effect, rise in interest rate and domestic currency appreciation, respectively. Imports and inflation also rise. Estimated values of present value fiscal multipliers are 0.54, 0.29 and 0.18 after 1 year, 5 years and 10 years, respectively. These results show that although positive in the short run, yet the magnitude of the fiscal multiplier is very low in the case of Pakistan. Sensitivity analysis shows that the value of the multiplier marginally rises with rise in degree of price stickiness. Transitory shocks have a substantially higher multiplier relative to persistent shocks.
Highlights
Objective of this study is to explore fiscal policy transmission mechanism in Pakistan
We focus upon expenditure side of fiscal policy and assess how variations in government expenditure affect key macroeconomic variables like GDP, inflation, employment, consumption, investment, imports, exports, interest rate and exchange rate1
Our results show that fiscal spending positively affects GDP in the short run yet, size of output multiplier is very small in the long run (0.18)
Summary
Objective of this study is to explore fiscal policy transmission mechanism in Pakistan. Stochastic general equilibrium model (DSGE) presented in Ahmad and Haider (2019) Using this estimated DSGE model, we study fiscal policy transmission mechanism by analyzing impulse response functions (IRFs) of important macroeconomic variables to government consumption shock. Our study of fiscal policy transmission through a DSGE model is motivated by following reasons: First, Pakistan has been persistently facing problem of high budget deficit that has led to gradual buildup of high level of sovereign indebtedness. Our study of fiscal policy transmission through a DSGE model is motivated by following reasons: First, Pakistan has been persistently facing problem of high budget deficit that has led to gradual buildup of high level of sovereign indebtedness2 This expansionary fiscal policy stance, as represented by persistently high deficits, complicates macroeconomic management in several ways.
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