Assessing the Neutrality and Non-Neutrality of Fiscal Policy in Pakistan

Abstract

The objective of this paper is to assess the neutrality and non-neutrality of fiscal policy in Pakistan. We use Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan economy. We examine the impact of fiscal policy, particularly government spending, taxes and borrowing on output growth, inflation and interest rate. Findings of this research paper show the non-neutrality of fiscal policy with respect to inflation, interest rate and economic growth. We find supportive evidences for the existence of fiscal theory of price level indicating the significant impact of fiscal policy on price level. Interest rate also positively responds to fiscal policy. Findings further revealed that economic growth is negatively affected by increase in government spending and tax rate. The findings of this study provide empirical supports for cohesive and increased coordination between fiscal and monetary policy.