Nexus between Fiscal Deficit and Economic Growth: An Empirical Evidence of Pakistan

Abstract

The study's main objective is to analyze the nexus between fiscal deficit and economic growth. A comprehensive review of the literature has been reviewed to address this objective, which presented different other intertwined factors resulting impact due to fiscal deficit, thereby economic growth. Data regarding all the variables such as GDP Growth (GDP), Fiscal Deficit (FD), Public Investment (PI), Inflation Rate (INF), Exchange Rates (EXR), and Debt to GDP Ratio (GDP) has been collected from different secondary sources such as World Bank (WB), State Bank of Pakistan (SBP) and Ministry of Pakistan (MOP) for the period between 1979 and 2019 for Pakistan. Due to the time-series nature of the dataset, the trend in the data was initially assessed. After confirming the trend, the unit root test has been performed to test the stationarity in the dataset. The results revealed a unit root in the dataset at a level for each variable. A cointegration test has been performed to check if there are any cointegrating equations for the data. The results revealed the presence of two (2) cointegrating equations in the dataset. Because of the cointegrating vectors, a vector error correction model has been performed to normalize the effect of cointegrating equations. Additionally, the VECM provided both the short-run and long-run effects of the variables. Both the long and short VECM model run outcomes revealed that the fiscal deficit, public investment, and inflation rate have a strong negative impact on economic growth while exchange rate and debt to GDP ratio have a strong positive impact on economic growth in the long run.