Does Fiscal Policy Matter? Evidence for Pakistan

Abstract

The role of fiscal policy in affecting economic activity has been on the theoretical and applied research agenda for both academicians and policy makers since the evolution of macroeconomics. This thesis attempts to identify the fiscal policy effectiveness with respect to different budgetary components towards aggregate economic activity and its components using the data from 1960-2010. We employ the structural VAR estimation method to identify the impact of fiscal policy instruments on the aggregate and disaggregated economy for Pakistan. Government expenditures as a policy instrument appear to be more effective as compared to taxes. Three possible reasons for such an outcome appears; low tax base, less elastic taxes and ratchet up effect on government expenditures. Private investment is supplemented with government expenditures; hence increase in development is inevitable for increasing the pace of economic growth. Finally aggregate indicators of policy intervention variables; here the Fiscal policy, such as budget deficit and the outcome variable, here the economic activity (such as the GDP) may give a picture which is different from what is happening at the disaggregate level for both the intervention and outcome variables. Hence fiscal policy conduct may incorporate the disaggregated level of instrumentation and outcome variables should also be seen in component wise effects.