EFFECT OF EXCHANGE RATE & FISCAL POLICY ON OIL PRICE VOLATILITY AND ITS IMPACT ON ECONOMIC GROWTH: PAKISTAN A CASE-IN-POINT.

Abstract

Oil is an important international commodity and the basic units of important sectors like industries, transportation, energy etc. of the economy. That‟s why it is considered as the crucial and important factor of economical development of the country. The fluctuations in crude oil prices are highly unpredictable so that many companies and economies faced various challenges for making future policies. Oil price changes not only effect economic activities but they also effect the prediction for the future stability of economic growth. This research is analysis the effect of exchange rate variation (fluctuations in Pakistani currency exchange rate with respect to US dollar) and the fiscal policy changes (increase and decrease in taxes, subsidies and government expenditure) on the oil price volatility (short term variations) of Pakistan. Furthermore, this research also analysis the impact of oil price volatility and the macroeconomic variables on economic growth (economic development) of Pakistan.Secondary data is collected from 1973 to 2014 and used for estimation of coefficients from Institute of Economic Affair (IEA), International Financial Statistics (IFS), World Bank (WB), Ministry of Petroleum & Natural Resources of Pakistan and Pakistan Bureau of Statistics.Unit root test, Correlation test, GARCH (1,1) test,multiple linear regression, Johenson co integration test,Granger Causality test,Vector autoregression (VAR), Impulse Response function and Variance decomposition test are used for estimation of the results. GARCH (1,1) test define the exchange rate has not a significant relation with the local oil price but fiscal policy effect and foreign oil price has a significant relation on the local oil price. Afterward, linear regression describes the Public sector investment and Trade Balance has significant and oil price volatility and private sector investment has insignificant effect on gross domestic production of Pakistan. Johenson co integration test described the long run relation among the variables. Granger Causality test indicate that oil price volatility does not Granger cause on public sector investment and gross domestic production does not Granger cause on public sector investment is significant. Except these relationship, all other variables relationship exist and possible. Afterward, vector autoregression , impulse response function and variance decomposition describe its value and conclude that the effect of other variables was stable within 10 years and the major part on the variable is due to itself rather than other variables. Keywords: Exchange Rate; Fiscal Policy; Oil Price Volatility; Economic Growth.