Fiscal Deficit and Trade Deficit Nexus in Pakistan: An Econometric Inquiry

Abstract

This study is an attempt to explore the short-term and long-term effects of the fiscal deficit along with other macroeconomic variables on the deteriorating trade deficit of Pakistan from 1980 to 2018 by using time series estimation techniques. The result of the autoregressive distributed lag (ARDL) bounds testing approach and error correction term revealed the existence of cointegration among variables of interest. The estimated long-run and short-run results of the ARDL approach showed a significant positive effect of fiscal deficit on Pakistan's trade deficit in the short-run, whereas a significant adverse effect is observed in the long-run. The findings validated the twin deficit hypothesis in the short-run, whereas twin divergence proposition is observed in the long run. The study suggests prudent fiscal and monetary policies to make macroeconomic conditions favorable for the development and competitiveness of domestic production sectors engaged in the international trade. 

Keywords: Trade deficit, Fiscal deficit, Granger causality, ARDL, Pakistan.

JEL: E62, F14, H62