Politicians, policy makers and economic managers want to spur economic growth, bring economic stability and to create jobs. Economic growth is not only affected by macroeconomic policies but it is also prone to various types of shocks. Appropriate and timely policy response can at least minimize, if not completely escaped, the distortions and loses associated with shocks. Optimization of economic growth and its sustainability demands the execution of good macroeconomic policies in general and fiscal and monetary policy in particular. Some time fiscal policy seems to be more effective while the environment is more favorable for monetary policy in other times. We also know that both fiscal and monetary policy have different objective with different policy instruments. The macroeconomic situation of Pakistan’s is very depressing and the situation demands stark assessment of its macroeconomic policies particularly fiscal and monetary policy. The objective of this thesis is to investigate the interaction between fiscal and monetary policy using small scale open economy dynamic stochastic general equilibrium model. This thesis explores the responsiveness of monetary policy to fiscal policy vis-à-vis explore the fiscal implications of monetary policy. As we assume a small scale open economy, we also explore the responses of fiscal and monetary policy interaction to technology and foreign output shocks. We also countercheck few results using the techniques of autoregressive distributive lag model. Our findings reveal the existence of interaction between fiscal and monetary policy in Pakistan. The response of interest rate to fiscal policy, particularly to tax shock is positive. Fiscal and monetary policy behaves as a strategic complements. This is not a good sign for a crippling economy like Pakistan’s as two important macroeconomic policies are contractionary simultaneously. Similarly when it comes to spending component, interest rate negatively responds when government increases spending. Both fiscal and monetary authority adopts expansionary policies simultaneously. We also find that higher interest rate discourage government borrowing. Inflation responds negatively to interest rate in DSGE set up while the phenomenon of price puzzle exists in ARDL schemes of things. The response of inflation is positive to both higher taxes and government spending. Government spending reduces in response to a monetary policy shock. Tax revenue also reduces when interest rate shock occurs in the economy. Inflation also raises the revenue from taxes but is very short lived. Supervisor:- Dr. Abdul Qayyum