Abstract:
This study has adopted a new-Keynesian dynamic stochastic general equilibrium framework developed by (Bhattarai & Treziciakiewicz, 2016) to analyze the business cycle effects of fiscal policy shocks within the economy of Pakistan. We identified the most effective fiscal policy tools for controlling debt to GDP ratio, budget deficit and stabilization of economy. We have used calibration method to generate impulse response functions using the parameters available for the economy of Pakistan and followed the propagation mechanism of the shocks that are given to the economy through expenditure and revenue side of fiscal policy. In our results, we have found that government investment, consumption and income tax play the most important role in controlling for debt to GDP ratio. Income tax and government investment has procyclical response to GDP. In short run, government consumption and investment shocks are most effective while in long run government investment and income tax shock are found to be most effective. Our results also indicated that real and nominal frictions play an important part in transmission mechanism of fiscal policy.
