Team Details:

 Theme/Relevant Ministry:

TAXATION/ FISCAL MANAGEMENT:
Federal Board of Revenue of Pakistan/State Bank of Pakistan

Project Brief:

In this paper, I developed a closed economy DSGE model which features Ricardian and Non-Ricardian consumers, supply side effects of both government expenditures and taxes, sluggish movement of real wages, government budget deficit, and Taylor rule etc.  My basic research question is about the impact effect of an unanticipated increase in government expenditures on key economic variables such as output, inflation, private consumption, real wages, and employment when government finance its deficit through taxation only. I consider two types of taxes for this purpose, (i) tax on consumption, (ii) tax on labor income.  My research idea is very pertinent to a typical LDC, which is increasingly facing strict IMF conditionalities on further borrowing both domestically and internationally.  In this situation, I would like to find out whether an increase in government expenditure can provide any relief to the economy if it is facing problems such as unemployment, low private consumption, and inflation etc. Intuitively, in the presence of non-Ricardian consumers and positive supply side effects of government spending, an increase in government spending is expected to have favorable effects on the economy in terms of higher output and low inflation. The model is also expected to determine the conditions under which a fiscal puzzle may occur i.e., higher private consumption and lower inflation. I will conduct this study in two stages.  In the first stage, I will solve the model for analytical results and prove numbers of propositions.  In the second stage, on the other hand, using suitable parameter values of the model, I will calibrate the model in the event of a shock to government spending of varying degrees and analyze the impulse responses of output, consumption, and inflation etc.  I will also explore the relative suitability of taxes (income tax viz-a-viz consumption tax.

 Public Policy Relevance:

Pakistan is one of the countries which is facing with twin deficit problem i.e., government budget deficit and balance of payment deficit.  Above all, for last couple of years the country is facing with a record high inflation rate.  In the presence of already sizeable budget deficit, Pakistan has very little fiscal space.  Moreover, due to binding IMF conditionalities, Pakistan left with no choice but adhere to balanced budget policy.  In this situation, Pakistan must choose very carefully the scope and nature of its spending.  For example, should government focus more on productivity enhancing spending (which helps in reducing inflation) or follow the old suite of demand boosting expenditures (which may cause an increase in employment at the expense of further inflation).    Similarly, Pakistan must think prudently about the method of financing its deficit.  For example, should government use tax on consumption to raise revenues or choose tax on labour income as its major source of revenues.  Given the positive supply-side effects of government spending and negative supply-side effects of taxes, the decision is not quite simple and require a rigorous study on this subject.