Fiscal Consolidation and Pakistan’s Economy: A DSGE Approach

Abstract

This thesis makes use of calibration to study the consequences of various fiscal consolidation strategies for the economy of Pakistan. Fiscal consolidation refers to policies undertaken by the government to reduce fiscal burden in the shape of fiscal deficit and debt. To assess the impact of the fiscal adjustment plan on Pakistan's economic indicators, specifically gauge its impact on GDP, investment and consumption, and examine the distributional impact of such policies upon heterogeneous economic agents, a structural macroeconomic DSGE model has been used by incorporating heterogeneous forward-looking households and firms. In this thesis, we consider a fiscal consolidation strategy that brings the budget to balance by gradually reducing government spending. We distinct out the impact of a reduction in government purchases and transfer, and allow for curtailment in both government debt and distortionary taxation. According to the model simulation, GDP rises in the short run upon announcement and implementation of fiscal consolidation strategy remains higher in the long run. It explored the role of the mix of expenditure cuts and tax reduction as well as the degree of gradualism to achieve fiscal consolidation policy outcomes.