This study investigates the comparative effect of fiscal and monetary policy on economic growth in Pakistan using annual time series data from 1981 to 2009. The cointegration result suggests that both monetary and fiscal policy have significant and positive effect on economic growth. The coefficient of monetary policy is much greater than fiscal policy which implies that monetary policy has more concerned with economic growth than fiscal policy in Pakistan. The implication of the study is that the policy makers should focus more on monetary policy than fiscal to enhance economic growth. The role of fiscal policy can be more effective for enhancing economic growth by eliminating corruption, leakages of resources and inappropriate use of resources. However, the combination and harmonization of both monetary and fiscal policy are highly recommended.Monetary Policy, Fiscal Policy, Economic Growth.

Arif, Imtiaz

Jawaid, Syed Tehseen

Naeemullah, Syed Muhammad

English

Research Papers in Economics

Comparative Analysis of Monetary and Fiscal Policy: A Case Study of Pakistan
1 
Syed Tehseen Jawaid
2, Imtiaz Arif 
3 and S.M. Naeemullah
4  
ABSTRACT 
This study investigates the comparative effect of fiscal and monetary policy on economic 
growth in Pakistan using annual time series data from 1981 to 2009. The cointegrtion result 
suggests that both monetary and fiscal policy have significant and positive effect on economic 
growth. The coefficient of monetary policy is much greater than fiscal policy which implies that 
monetary policy has more concerned with economic growth than fiscal policy in Pakistan. The 
implication of the study is that the policy makers should focus more on monetary policy than 
fiscal to enhance economic growth. The role of fiscal policy can be more effective for enhancing 
economic growth  by eliminating corruption, leakages  of  resources  and inappropriate use of 
resources. However, the combination and harmonization of both monetary and fiscal policy are 
highly recommended. 
Key Words: Monetary Policy, Fiscal Policy, Economic Growth. 
1.  Introduction 
 
In Pakistan, the average GDP growth rate in 1980 it was 6.5% and cut down in 1990 to 4.8% 
and the grew up the in current decade to 8%. On the other hand the fiscal deficit in 80‟s it was 
7.1%, in 90‟s was 6.9% and in running decade the average rate of fiscal balance was 10% as 
                                                           
1 For Citation: NICE Research Journal Vol. 3, pp. 58-67 
2 Lecturer, IQRA University Gulshan Campus, Karachi, Pakistan. For correspondence: stjawaid@hotmail.com   
3 Assistant Professor, IQRA University Gulshan Campus, Karachi, Pakistan.  
4 Business Graduate, IQRA University Gulshan Campus, Karachi, Pakistan percentage of GDP. Conversely the average growth of money supply (M2) in 80‟s was 13.2%, in 
90‟s it was 16.8% and in next decade it is 15.61% respectively
5. 
In previous studies, the comparative affect of fiscal and monetary policy on economic 
growth is discussed. But there are few time series studies on the subject in context of Pakistan. 
Moreover, this study examines the comparative effect of monetary and fiscal policy on economic 
growth by using long term annual time series data in Pakistan. 
This paper is organized as follows. Following Introduction, section 2 discussed literature 
reviews.  Section  3  classifies  modeling  frame  work.  Section  4  reports  results  and  section  5 
discussed conclusion and recommendation.  
2.  Literature Review 
The literature on the relationship between monetary and fiscal policy with economic growth, 
there are well establish theories that can clearly identify the channels through which monetary 
and fiscal policy affects economic growth.  
 
2.1 Theoretical Framework 
The  monetarists‟  view  is  expressed  by  making  reference  to  the  "Quantity  Theory  of 
Money” as in equation (1) below: 
MV=PY                                                                         (2.1)                                                          
Where P, an index of the price level and Y, the income; V, velocity of circulation; M 
stands for money stock. The right-hand side of equation (2.1) is the value of nominal national 
                                                           
5  See Pakistan Economic Survey 2009-2010 (Economic and Social Indicators) income. If V is constant then equation (2.1) let know us that there is a positive relationship 
between changes in the stock of money and changes in the value of national income. 
M = kPY                                (2.2) 
If, in accumulation, as in the current context of our discussion of monetary and fiscal 
policy, The price level P were remain fixed , after that the only way that can change Y if M 
changes.  According  to  equation  2.2  the  several  other  changes,  such  as  a  fluctuation  in 
government expenditure will not affect the level of real income. Therefore, fiscal policy must be 
incapable while monetary policy will affect real output 
According to Keynesian the government purchases (G) are one of the components of the 
aggregate expenditures.  An increase in  government  purchases  which increases the  aggregate 
expenditures which is also give increase in the economic growth. This shows in equation 2.3.  
Y=C+I+G                                                                       (2.3) 
Where Y as the gross domestic product, C as the total consumption, I is the investment and G is 
the government expenditures.
6  
2.2 Empirical Studies 
Economic theory postulates a very clear role of monetary and fiscal policy to improve 
economic  growth.  However,  the  empirical  findings  in  this  regards  have  been  mixed.  Some 
selected studies have been discussed in this section. 
 
                                                           
6 See Stiglitz and Walsh (2002) pp. 536-537 and pp. 642-643.  The findings that monetary action will leads to an increase in economic growth than 
fiscal policy are consistent with the findings of Andersen and Jordan (1968), Ajayi (1974) and 
Elliot (1975). 
Darrat (1984) investigates the relative influence of fiscal and monetary actions with in a 
modified St. Louis single-equation in 5 Latin American countries.
7 The annual time series data 
was taken during the time period from 1950 to 1981 of. Gross national Produ ct, money stock, 
government spending and exports are used. The  results suggest that fiscal policy significantly 
lead monetary policy in explaining changes in nominal income.  
Olaloye and Ikhide (1995) investigate the role of fiscal and monetary policy to improve 
economy from recession in case of Nigeria. They acquired monthly data from 1986 to 1991. They 
used modified form of St. Louis equation. Result suggests that fiscal policy is more effective in 
Nigeria in depression.      
Ajisafe (2002) investigates the relative effectiveness of monetary and fiscal policy on 
economic growth in context of Nigeria using annual time series data during the year 1970 to 
1998. M1 and M2 are used as proxies of money supply and government revenue, government 
expenditures and budget deficit as the proxies of fiscal policy. Result shows that monetary policy 
has significant affect on economic growth rather than fiscal policy. 
Ali,  Irum  and  Ali  (2008)  examine  that  whether  fiscal  stance  or  monetary  policy  is 
effective for economic growth in case of South Asian countries
8 using annual data series during 
                                                           
7 Brazil, Chile, Mexico, Peru and Venezuela. 
8 Pakistan, India, Srilanka and Bangladesh 
 1990 to 2007. Gross domestic product, broad money (M2) and fiscal balance were considered.  
Auto Regressive Distributed Lag (ARDL) and error correction model (ECM) have been used to 
determine the relative effectiveness of monetary and fiscal policy on economic growth. Results 
suggest that the monetary policy rather than fiscal policy has greater influence on economic 
growth in South Asian countries.    
Khosravi and Karimi (2010) investigate the relationship between monetary, fiscal policy 
and economic growth in Iran. The annual time series data was taken from 1960 to 2006. Gross 
domestic product, narrow money (M1), Government expenditures, exchange rates and consumer 
price  index  have  been  considered.  Bound  testing  (ARDL)  approach  and  co-integration  were 
used.  Results  confirm  that  there  exists  cointegration  relation  between  growth,  monetary  and 
fiscal  policy.  The  results  identify  the  effect  of  inflation  and  exchange  rates  on  growth  are 
negative, government expenditures have significant and positive effect on economic growth. It is 
suggested that the policy makers must have to diminish inflation rate and exchange rates to find 
the stability in the future. 
Adefeso (2010) re-examines the relative effectiveness of monetary and fiscal policy on 
economic growth in Nigeria by annual time series data during the year 1970 to 2007. Gross 
domestic product, broad money (M2), Government expenditures (G.E) and degree of openness 
(DOP) have been considered. Error correction and cointegration have been used. Result suggests 
that the effect of monetary policy is dominant than fiscal policy on economic growth in Nigeria. 
They analyzed that degree of openness exclusion does not weak the result. It is recommended 
that they should more focus on monetary policy in Nigeria for economic stabilization.     
 3. Modeling Framework 
  On the basis of empirical studies, the model to examine the effect of monetary and fiscal 
policy on economic growth examined through the following equation: 
t t t t FB MS GDP         2 1 0       (3.1) 
The εt is the error term. In equation 3.1 the coefficient of money supply (MS) used as a proxy of 
monetary policy
9 and fiscal balance (FB) used as a proxy of fiscal policy
10 are expected to be 
positive. The model estimated using annual time series data of Pakistan from the period of 1981 
to 2009. All data are required from various issues of Pakistan economic survey, government of 
Pakistan. The gross domestic product (GDP), money supply (MS) and fiscal balance (FB) are in 
Logarithm form. 
4.  Estimation and Results 
  To find out the existence of the long run relationship between variables of equation 3.1. 
First we performed stationary analysis by using Dickey and Fuller (1979) and Phillips Perron 
(1988) tests. The results of both the test are given in the table 4.1 
Table 4.1: Stationarity Test Results            
 
 
 
 
 
 Note: The critical values for ADF and PP tests with constant (C) and with constant and trend                  
(C&T) at 1%, 5% and 10% level of significance are -3.68, -2.97, -2.62 and -4.33, -3.58,  -3.22 
respectively. 
               Source: Authors‟ estimation. 
                                                           
9 See Adefeso and Mobolaji (2010) 
10 See Ali, Irum and Ali (2008) 
Variables  ADF test statistics  PP test statistics 
  I(0)  I(1)  I(0)  I(1) 
  C  C & T  C  C & T  C  C & T  C  C & T 
GDP  -1.78  -2.22  -3.43  -3.55  -1.62  -2.23  -3.42  -3.56 
MS  -0.30  -2.59  -3.28  -3.22  -0.91  -1.97  -3.37  -3.31 
FB  -1.07  -2.64  -5.87  -5.75  -1.06  -2.66  -5.87  -5.75  
The results show in the table 4.1 confirm that all series are stationary at first difference 
this entails that combination   of one or more series way reveal a long run relationship. 
Therefore, we move for cointegration test. 
  The test result shows the presence of autocorrelation in the estimated model. This implies 
that the coefficients are no longer efficient.
11 To remove auto correlation, C ochrane-Orcutt
12 
iterative  procedure  has  been  used.  The  result  of  estimated  equation  after  removing  auto 
correlation are shown in table 4.2 
Table 4.2: Long run Determinants of Economic Growth. 
Variables  Coefficient  t-statistics  Prob. 
Constant  4.76  105.89  0.000 
MS  0.30  19.08  0.000 
FB  0.04  2.52  0.018 
Adj. R
2  0.98  F-statistics  1235.12 
D.W  1.66  Prob.  0.00000 
                                         Source: Authors‟ estimations 
The estimated results of equation 3.1 are super consistent. The long run coefficient of MS 
and FB have expected and highly significant. The coefficient of FB is fewer than coefficient of 
MS. This implies that monetary policy has more effect than fiscal on economic growth. This is 
due to leakages and improper use of resources in fiscal channels. 
    Johanson and Juselius (1990) co-integration procedure is applied to estimate the 
long run relation among the variable in the model. They have two tests statistics for cointegration 
namely Trace statistics and Maximum Eigen value statistics. The calculated Trace and Maximum 
Eigen value test statistics and their parallel critical value are presented in table 4.3. 
                                                           
11 See Gujrati (2004) p. 454 
12 See Cochrane and Orcutt (1949)                    Table 4.3: Cointegration Test Results. 
Null Hypothesis 
No. of CE(s) 
Trace 
statistics 
5% critical 
values 
Max. Eigen 
value statistics 
5% critical 
values 
None  24.33  24.27  20.51  17.79 
At Most 1  3.81  12.32  3.79  11.22 
At Most 2  0.02  4.12  0.02  4.12 
                        Source: Authors‟ estimations 
 
Starting with null hypothesis of no cointegration among the variable. Table 4.3 shows 
that  both  test  statistics  reject  null  hypothesis  at  5%  level  of  significance  in  favor  of  their 
alternative that there is one cointegrating vector. Thus, results from Trace and Maximum Eigen 
test statistics show that there exists only one steady positive equilibrium relationship between the 
considered variables. 
5. Conclusion and Implications 
  In  modern  literature,  the  comparative  effect  of  monetary  and  fiscal  policy  on 
economic growth had been widely discussed. The cointegration tests confirm positive long run 
relationship  between  monetary  and  fiscal  policy  with  economic  growth.  However,  monetary 
policy has more concerned with economic growth than fiscal policy. The implication of the study 
is that the policy makers should focus more on monetary policy than fiscal to enhance economic 
growth.  The  role  of  fiscal  policy  can  be  more  effective  for  enhancing  economic  growth  by 
eliminating corruption, leakages of resources and inappropriate use of resources. However, the 
combination and harmonization of both monetary and fiscal policy are highly recommended. 
 
 
 .References 
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Nigeria: Further Empirical Evidence”, Pakistan Journal of Social Sciences, 7(2):137-142. 
Ajayi, S.I. (1974). An Econometric Case Study of the Relative Importance of Monetary and Fiscal 
Policy in Nigeria. The Bangladesh Economic Review, 2(2):559-576. 
Ajisafe, R.A., and Folorunso, B.A. (2002), “The Relative Effectiveness of Fiscal and Monetary 
Policy in Macroeconomic Management in Nigeria”, The African Economic and Business 
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Ali, S., Irum, S. and Ali, A. (2008) Whether Fiscal Stance or Monetary Policy is Effective for 
Economic  Growth  in  Case  of  South  Asian  Countries?,  The  Pakistan  Development 
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Comparative analysis of monetary and fiscal Policy: a case study of Pakistan

Comparative analysis of monetary and fiscal Policy: a case study of Pakistan

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