ABSTRACT

This study mainly investigates fiscal policy transmission channels in the context of Pakistan. Aiming to understand how components of fiscal policy like government expenditure and taxes affect different macro-economic variables of the economy. The study adopted the Three Stage Least Square SUR estimation method to investigate transmission channels of fiscal policy. This model is basically used when the study has some common explanatory variables and have the problem of endogeneity. As this study have government expenditure and taxes as common variables in all transmission channels of fiscal policy that are investigated. Independent variables of this study is Investment, Exchange rate, Trade deficit, consumption, inflation, Stock market, and Employment. This study uses time series data from Pakistan. The time span of the given study is 1979-2022. The major findings of the study reveal that fiscal stimulus has a positive relation with the interest rate, exchange rate, trade deficit, consumption, inflation, and the stock market. On the other hand, fiscal stimulus has a negative relation with investment and employment. When government expenditure increases and taxes decrease then government borrowing increases this leads to an increase in interest rate and a decrease in investment then as a result employment also decreases. An increase in interest rate also attracts foreign investment due to which domestic currency appreciates, the exchange rate increases, and the trade deficit also goes up. On the other side when government expenditure increase and taxes decrease then the disposable income of individuals also increases which lead to an increase in consumption, saving, and aggregate demand due to this two effects happen if we have constant supply then inflation increase otherwise increase in aggregate demand lead to an increase in investment which boosts the stock market. This study suggests that Policymakers should carefully balance government expenditure and taxes to avoid excessive government borrowing and rising interest rates. The aim should be to stimulate economic growth without crowding out private sector investment. This balance is crucial for maintaining macroeconomic stability.