Fiscal Policy and Output Gap: A SVAR Analysis for Pakistan

Abstract

The dynamic effect of fiscal policy shocks on Pakistan's output gap is investigated in this paper,
moreover, this paper attempts to assess the output gap by employing the production function
technique. The goal of this research is to learn how fiscal policy instruments affect the output gap
for long and short-run. This study employed a five-variable Structural Vector Auto-Regressive
hereinafter SVAR) model that covered the years 1975 to 2019. Blanchard and Perotti's recursive
technique and Blanchard and Perotti's identification approach are used to solve the SVAR
model's identification challenge. Interestingly, this research reveals that impulse responses from
both identification methods behave similarly, yet the coefficients calculated by Blanchard and
Perotti (2002) approach are quite significant. This research demonstrates that both government
spending and taxation have a substantial role in explaining changes in the production gap. Based
on the findings, this study suggests that increasing government expenditure is a good policy
choice during a recession period.