This study investigates the asymmetric impact of fiscal deficit on inflation under the framework of Fiscal Theory of Price Level (FTPL) in the context of Pakistan. To test the FTPL, keeping in view the characteristics of Pakistani economy for the sample period, the empirical estimation has been calibrated on the New-Keynesian model of small economy. Specifically, the calibration has been made on the models of Gali and Monacelli (2008) adopted by Çekin (2017) and the model of Cerisola and Gelos (2009). The estimates of the Non-Linear ARDL are found reliable as the model does not suffer from the degenerate problems. Remarkably, the finding conforms with the view of the FTPL and therefore evidences that the theory holds in the long run. However, the tests of asymmetry show that the impact of the fiscal deficit on inflation is likely to be asymmetric only in the long run. Our analysis also reveals that the impact of money supply and exchange rate depreciation becomes insignificant when the influence of the fiscal deficit is allowed to be asymmetric under the framework of NARDL model. Their signs are however in line with the expectations of their respective theories. Besides fiscal deficit, this study finds external factors as the main cause of inflation in the country. The estimates show that the current account deficit and the international oil prices have a significant positive impact on the domestic inflation in Pakistan. To reduce domestic inflation, fiscal austerity measures would work and such impact would become more visible if other associated policies are accommodative.
|Pages||207 - 236|
|Published||December 31, 2020|
|Department of Economics, University of the Punjab, Lahore|
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