Fiscal Deficit-Inflation Nexus in Pakistan, 1977-2018: Dynamic ARDL Approach

Abstract

The prevailing view in the macroeconomic literature is that persistent fiscal deficits are inflationary. Pakistan’s economy has experienced an increasing inflation rate and a slowdown in GDP growth. The current study empirically investigates this contradiction for the period 1977- 2018 by using Dynamic ARDL (Bounds, 2017) co-integration technique. The results of the study demonstrate a long-term positive relationship between fiscal deficit and inflation, with severe implicationsforgrowthinthelongrun.However,fiscal deficit does not pose inflationary threat in the short run. Interest rate and inflationary expectations are important short run determinants of inflation inPakistan.