ABSTRACT

There has been a shift in scholarly focus from understanding the determinants of inequality to understand the role of government in mitigating the inequality. The rise in inequality due to various crisis worldwide has caused the surge in understanding this role further. This study aims to estimate the dynamic effects of government spending shocks on income and consumption inequality in Pakistan. Using Household Integrated Economic Survey data (HIES) from Pakistan, for the time 1999-2019, the study first analyzes the evolution of inequality in Pakistan, followed by estimating the effects of government spending shocks on inequality measures over time using the impulse response functions. The results of the study reveal that inequality in total income and expenditure follows a consistent trend, rising almost equally over time. The effect of spending shock on income and consumption inequality indicate that while consumption and expenditure inequality decline after the positive spending shock, there is no significant impact on the reduction in income inequality. Similarly, for the income components, there is decline in financial inequality while the other components of income largely remain unaffected. There is also a significant decline in a reduction in inequality in interest-sensitive expenditures in response to spending shock. The results indicate that fiscal policy is largely ineffective in reducing income inequality in Pakistan. The government should, thus, focus on providing the targeted subsidies to low income groups, and reform the taxation system. Investment in human capital can have nuanced impacts on reducing the inequality in the long run. The countercyclical policies during the contractionary period can further enhance the economic activity and prevent the economically vulnerable groups to be susceptible to the poor living conditions.