Fiscal Policy and Current Account Dynamics in Case of Pakistan

The study empirically investigates the effects of fiscal policy or government budget deficit shocks on the current account and the other macroeconomic variable: real output, real interest rate and exchange rate for Pakistan over the period 1960-2009. The structural Vector Autoregressive model is employed; the exogenous fiscal policy shocks are identified after controlling the business cycle effects on fiscal balances. The results suggest that an expansionary fiscal policy shock improves the current account and depreciates the exchange rate. The rise in private saving and the fall in investment contribute to the current account improvement while the exchange rate depreciation. The twin divergence of fiscal deficit and current account deficit is also explained by the output shock which seems to drive the current account movements and its comovements with the fiscal balance.