Abstract:
This study revisits the relationship between the fiscal deficit and economic
growth in Pakistan to determine whether there exists a threshold fiscal deficit that
might serve as a benchmark for policymakers aiming to promote growth through
fiscal expansion. We apply the smooth transition autoregressive model to time-series
data for the period 1972–2014. The empirical analysis shows that the threshold level
of fiscal deficit is 5.57 percent of GDP, above which the deficit has a negative impact
on growth. Overall, the fiscal deficit has a negative impact on economic growth,
mainly because it has tended to remain above the threshold level. However, there is
room for fiscal policy to promote growth, provided the fiscal deficit is kept below the
threshold level and public spending is channeled into productive investments that
raise the country’s long-term growth potential.
