IDENTIFICATION OF ACTIVE AND PASSIVE REGIMES OF FISCAL AND MONETARY POLICIES IN PAKISTAN

Abstract

Fiscal and monetary policies are two important macroeconomic policies which work by adopting different policy regimes to achieve the desired objectives. The present study is an endeavor to identify active and passive policy regimes and attempts to reveal the relatively more dominant policy in case of Pakistan. The study by utilizing time series annual data from 1972 to 2022 uses monetary and fiscal policy reaction functions to reveal the overall active or passive behaviors of fiscal and monetary policies. The study further uses recursive estimation technique and empirically estimates the fiscal and monetary policy reaction functions to identify the year-to-year policy regimes adopted by authorities in Pakistan. Money market rate in taken as proxy for monetary while budget deficit as a percent of GDP is taken for fiscal policy. Output gap, inflation rate, debt as a percentage of GDP, and nominal exchange rate are the study variables. The study finds that both policies interact 40 times out of which monetary policy remained active for 29 and passive for 11 times. Similarly, fiscal policy remained active for 30 and passive for 10 times. Both policies remained pro-cyclical for 19 and counter- cyclical for 21 times. Using the max-min and min-max criteria of pay- off matrix, it is found that monetary policy is Pakistan is more dominant policy as compared to fiscal policy. To ensure the increasing effectiveness of both policies, it is recommended that the authorities should adopt the optimal policy mix by working in coordination while formulating the policies.