FISCAL DEFICITS AND MACROECONOMIC DYNAMICS IN PAKISTAN: EVIDENCE FROM COINTEGRATION AND CAUSALITY ANALYSIS

Abstract

Persistent fiscal deficits remain a major macroeconomic challenge for developing economies, with potential implications for economic growth and external-sector performance. This study examines the relationship between fiscal deficits and key macroeconomic indicators in Pakistan over the period 1981–2014, focusing on economic growth, exports, and the balance of payments. Using annual time-series data, the study employs Ordinary Least Squares (OLS), a Vector Autoregression (VAR) model, impulse response analysis, and Granger causality tests to investigate both the dynamic relationships and direction of causality among the variables. The OLS estimates indicate a statistically significant negative relationship between fiscal deficits and economic output, while the relationships between fiscal deficits, exports, and the balance of payments are positive but statistically insignificant. The Granger causality results reveal no significant causal relationship between fiscal deficits and either output or the balance of payments. However, a unidirectional causal relationship is identified between fiscal deficits and exports. The impulse response analysis further illustrates the dynamic responses of macroeconomic variables to fiscal deficit shocks. The findings highlight the importance of sound fiscal management and a broader revenue base in improving macroeconomic stability. Strengthening direct tax collection, improving export performance, and addressing persistent trade imbalances may contribute to sustainable economic growth and improved external-sector stability in Pakistan.