Sources to Finance Fiscal Deficit and Their Impact on Inflation: A Case Study of Pakistan
Author: Kashif Ali

Fiscal deficit is good as well as bad for the economy. Along with other side effects, one of the major side effect of fiscal deficit is inflation. Theoretically, fiscal deficit is inflationary but the sources of financing fiscal deficit may vary in terms of their inflation impact. The question arises then what should be the least inflation cost source of financing then? This study attempts to answer the question as well as try to find out the long run relationship among the sources to finance fiscal deficit and inflation. To fulfill the desired objectives, after a careful literature review and theoretical considerations the estimation has been done in four stages on the basis of categorization of the deficit financing heads. In the very first stage it is been tested that fiscal deficit along with money supply are inflationary. In the second stage fiscal deficit is bifurcated into two components, domestic borrowing and external borrowing for fiscal deficit. In the third stage, domestic borrowing is further divided into two heads, bank and non-bank borrowing. While in the fourth and last stage, bank borrowing is further categorized into two parts borrowing from schedule banks and central bank, and, non-bank borrowing only comprises of National Saving Scheme borrowing for budgetary support. On the basis of time series properties of data, i.e. stationarity of data, Johansen Cointegration Technique is used for the stage of estimation while Auto Regressive Distributed Lag Model is employed for the rest of the three stages. This study finds that there is a long run relationship among sources of financing fiscal deficit and inflation. Inflation is positively affected by domestic borrowing, bank borrowing and borrowing from central bank, while central bank borrowing is more inflationary in nature. On the basis of the findings recommendations regarding financing are put forward. Fiscal deficit should be financed through external sources, non-bank and schedule bank borrowings. Supervisor:- Dr. Mahmood Khalid

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Keywords : Fiscal Deficit, Inflation, Pakistan, Sources of Finance
Supervisor: Mahmood Khalid

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