Empirical Analysis of the Effectiveness of Fiscal and Monetary Policy Tools in Stabilizing Economy: Evidence from Pakistan

Fiscal and monetary policy plays a vital role in macroeconomic stability. The Keynesians have emphasized the fiscal policy whereas the Monetarists supported interventions under monetary policy. In fact, these policies are interrelated and influence each other. The expansionary fiscal policy overheats the economy and reduce the effectiveness of monetary policy. The use of the appropriate mix of tools under fiscal and monetary policy is of immense importance for economic stability under country specific economic conditions. Therefore, the instant study was meant to look at the effectiveness of monetary and fiscal policy instruments in stabilization of Pakistan’s economy. The data was collected from secondary sources of Government of Pakistan from 1986 to 2022. The government expenditure was analyzed to be a proxy for fiscal policy whereas money supply for monetary policy. The study employed Impulse Response Function (IRF) and Variance Decomposition (VDC) in Vector Autoregressive (VAR) Model. The findings of IRF confirmed the impact of money supply on economic growth in Pakistan. At first, the money supply affected the GDP negatively but after 3rd year, its impact was changed to be positive and it was rising sharply. It indicated that the expansionary monetary policy was effective in the medium and long run in Pakistan. It was concluded that the fiscal policy appeared to be relatively more effective for its contribution towards economic growth as compared with monetary policy.