ABSTRACT

This study examines how government spending shocks affect output and prices in Pakistan using quarterly and annual data from 1981Q1 to 2023Q4. Government spending shocks are identified through a narrative approach based on Romer & Romer (2010), using official budget documents and economic surveys to determine the size, timing, and motivation of fiscal actions. This method distinguishes between anticipated and unanticipated spending changes, minimizing endogeneity bias. The analysis applies both the Local Projection method (Jorda, 2005) and Structural VAR to estimate impulse responses. Results show that unanticipated spending shocks significantly raise GDP in annual data, while inflation initially falls and then becomes insignificant. Conversely, anticipated spending negatively affects output, with inflation remaining positive but insignificant. At the quarterly level, unanticipated shocks have delayed positive effects on GDP and a temporary rise in inflation, while anticipated shocks mainly increase inflation without influencing output. The findings suggest that unexpected, well-targeted fiscal expansions can effectively boost growth. To reinforce these effects, the government should limit commercial bank borrowing to avoid crowding out private investment. Secondly,  Research  and  development  (R&D) spending has  declined sharply in recent years. Strengthening support for R&D across both public and private sectors is essential to transform production structures and processes in line with evolving demand patterns, changing consumer preferences, and rapid technological advancements.