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The Effects of Fiscal Policy on Economic Growth: Empirical Evidences Based on Time Series Data from Pakistan

Shahid Ali () and Naved Ahmad

The Pakistan Development Review, 2010, vol. 49, issue 4, 497–512

Abstract: This study investigates the effectiveness of fiscal policy and its impact on macroeconomic activities in Pakistan during the period 1972–2008. It examines the role of fiscal policy under democratic and military regimes. Recognising the shortcomings of traditional procedures, this study adopts modern econometric techniques to identify the effects of fiscal policy on macroeconomic activities. The sensitivity analysis procedure has been carried out to select the robust variables, which are not sensitive to different econometric techniques. Dynamic simulations have also been performed to observe the reaction of unexpected structural and policy shocks. Using Auto Regressive Distribute Lag (ARDL) model, we find that the overall fiscal deficit exerts a negative effect on economic growth in the long run. Hence, this study concludes that expansionary fiscal contraction occurs in Pakistan. In order to estimate short-run dynamics, we use the Error Correction Mechanism (ECM). In the short run, the overall fiscal deficit has a significant impact on economic growth. The study recommends that the budget deficit should be in the narrow band of 3 to 4 percent of GDP. Beyond this limit, the unsustainable budget deficit could have undesirable macroeconomic costs and the government’s macroeconomic objectives such as low inflation and high economic growth might be in jeopardy. The government should also curtail non-productive expenditures. Particular attention should be given to the Public Sector Development Plan (PSDP), as it is the complementary of private investment and has a long-term impact on macroeconomic activities.

Keywords: Fiscal Policy; Economic Growth; ARDL (search for similar items in EconPapers)
JEL-codes: C32 E62 O4 (search for similar items in EconPapers)
Date: 2010
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Handle: RePEc:pid:journl:v:49:y:2010:i:4:p:497-512