Impact of Public Policy Shocks on Components of Aggregate Demand in Pakistan

Abstract

Fiscal policy has strong distributional effects as the alteration in tax rates and spending decisions cause different sectors of the economy to respond differently. Correct information about this reaction and understanding transmission mechanism is essential to create policies that can have development and growth effects. The study analyzed the impact of fiscal policy on disaggregated data of Pakistan in a SVAR setting. The analysis reveals an uneven distribution of fiscal policy shocks across different sectors of Pakistan with varying degrees of responsiveness. There is heterogeneity in the response of different sectors as well as components of aggregate demand in Pakistan to fiscal policy shocks as revealed in impulse response functions. It is results reveal that tax revenue shock generated a higher response in different sectors than the government expenditure shock conforming to the theoretical expectation that tax changes impact the agents faster than the expenditure decisions. This regressive behavior in Pakistan seems mostly due to higher spending on debt servicing and maintaining a large public sector with huge spending on pensions and social security networks.