Fiscal multipliers, policy coordination, and growth

Pakistan’s economy has been in downturn for a number of years now. This has negatively impacted employment and poverty situation, where based on poverty line determined at USD 4.20, World Bank reportedly indicated around last June that close to forty-five percent of the population lives below the poverty line. Given the lack of economic growth, that number would have likely only increased.

Not only that but frequent employment of monetary, and fiscal austerity policies as a standard recipe to manage unsustainable twin-deficit situation has not only kept economic growth subdued, but also led to significant deterioration of income inequality situation.

The reason behind the latter is mainly because of both lack of economic growth meaning less income on average for all, but also higher interest rate, and less opportunities to make profits in the real sector due to lack of growth also tilting the balance of incomes in the financial sector.

Overall, lack of inclusivity and, in general, little push to both improve economic institutional quality, and orient economic policy away from neoliberal policies favouring market fundamentalism has, in turn, not allowed bringing sustainability to macroeconomic stability and economic growth.

Practice of standard neoclassical-based economic thinking, both under International Monetary Fund (IMF) programmes, and otherwise, has rendered a lop-sided macroeconomic policy.

This has meant placing inordinate focus on denting aggregate demand, both in terms of domestic consumption, and import demand – both of which provide greater incentive, and larger capacity to produce, and overall positively contribute to economic growth, exports, and investment incentivisation – while aggregate supply more broadly has not been enhanced in terms of putting in place mission-oriented, purpose-driven, market-shaping, non-neoliberal, governance, and incentive structures to neither increase quantity (productive efficiency), nor composition (allocative efficiency).

It is high time economy moved away from this narrow policy framework, especially given the fast-unfolding nature of climate change crisis that calls for quickly, and deeply enhancing resilience against shocks produced by ever-increasing climate catastrophes, including that caused under the related ‘Pandemicene’ phenomenon – Covid-19 pandemic, and rising scare of ‘Nipah virus’.

A more democratic, pluralistic approach to economic policymaking needs to be adopted instead. This means, for instance, to give way to adopting non-neoliberal philosophical underpinning, like guided through institutional economics literature, where a meaningful role of public sector is envisioned in collaboration with the private sector to reach better price discovery by both reducing transaction costs – that is ‘search, and information costs’ – and by introducing price controls to bring greater predictability to consumption, and investment decisions.

Also, rather than adopting ‘austerity’, greater ‘ambition’ needs to be shown by pursuing more heterodox policies, in an overall creative mindset. Moreover, it is only fair, for instance, as to why the brunt of macroeconomic instability caused by years of wanting policy including documenting the economy, increasing tax base, and expenditure rationalization is inordinately borne by the working class – may that be in factories, or on farms, both of whom are already suffering from high transaction costs, due to highly sub-optimal governance, and incentive structures – in the shape of high tax rates, poor price discovery for their efforts.

Hence, instead of harping the same path of adopting monetary, and fiscal austerity policies, perhaps by design to favour the buildup of wealth in the coffers of a tiny politico-economic elite through interest earnings, from tax savings, from investment ending up in a narrow stock exchange due to lack of incentivisation in the real sector, or amassed by transferring wealth to safe havens abroad by utilizing the neoliberal mantra of liberalized capital controls, along with elites supporting neoliberal, and related austerity policies, since fiscal consolidation policies reduce political voice, otherwise needed to push elites to undo such policies.

In addition to the apparent moral hazard, and adverse selection aspect of neoliberal, and austerity policies, as indicated above, in the first instance, these policies result in an unjustifiably high level of economic growth sacrifice, given in the absence of deeper non-neoliberal institutional reforms that helps bring sustainability, and greater resilience to shocks, these policies only produce short-lived macroeconomic stability at best.

Moreover, fiscal consolidation effort suffers from lack of precision in terms of properly estimating fiscal multipliers so that fiscal austerity does not reduce more growth than desired. But more on this later in the article.

Also, lack of monetary, and fiscal policy coordination in a non-austerity way has also only doubled-down on the suppression of growth, and contributed to producing significantly lopsided distribution consequences. In this regard, the standard argument that austerity inevitably is essential in the wake of managing unsustainable twin deficits, and debt only holds ground if policy does not hold ambition, and creativity.

This is because austerity policies do not allow sustainable solution of twin deficits, and high debt distress situation, given high interest rate and lack of public investment keep overall investment low, negatively impacting, in turn, domestic production, exports, and foreign investment prospects, while contributing ever so more to the debt repayment needs under higher interest rates.

With regard to the coordination aspect, while central bank and treasury have been hand in glove, more often than not, except during election cycles primarily when monetary austerity mostly continues to get adopted by central bank, while government proceeds with expansionary fiscal policies, has only resulted at best in a zero-sum game in terms of economy growth.

Given especially the developing country context of inflation being equally a fiscal phenomenon, and by approaching policy with ambition to do broad-basing of non-neoliberal reform, and policy implementation, what is needed instead is mostly adopting countercyclical monetary, and fiscal policies, that is, reducing interest rates during downturn, increasing public investment – while rationalizing non-productive expenditures – in a non-neoliberal, co-shaping markets with the private sector, enhancing tax base, shifting taxation from consumption to income, and providing broad-based subsidies – unless institutional capacity has enhanced enough to provide targeted subsidies – in essential areas of economy for domestic production, and exports, along with that for welfare, and protecting essential private investment.

Having said that, in addition to Pakistan having a highly developing country context with lot of unutilized capacity calling for adopting counter-cyclical policies, research highlights the benefits of adopting unconventional monetary policy.

This will likely allow all the more investment incentivisation, which is needed, given for resilience against shocks in the face of country being highly vulnerable to climate change crisis, and ‘Pandemicene’ phenomenon, and to shift away from being highly import dependent, to protect against commodity shocks for instance, requiring the economy to be greened all the more quickly.

Moreover, as will be highlighted subsequently in the article that not only unconventional monetary policy is supported, research all calls for it coming together with expansionary fiscal policy to overall enhance the positive impact of fiscal multipliers on economic growth.

Although the sample under study for research alluded to above is for OECD, or developed countries, the approach being recommended holds likely similar consequences for developing countries, for instance Pakistan, given this approach is complemented by developing countries adopting a focused, and ambitious mindset.

Moreover, the context of research being indicated above if for the time period around the time of the ‘Great Recession’ that happened during and after the Global Financial Crisis 2007-08, which is similar to deep downturns being faced by Pakistan, for instance, from time to time, and where austerity policies only prolong, and worse, perpetuate these downturns in a systemic way.

Here, coordination on these lines, in the first place, requires reining in the overboard independence of central bank independence by appropriately reversing the overall neoliberal policy framework being adopted, in general, for decades now, both under IMF programmes, and ‘Chicago boys’-styled domestic policymakers’ mindset.

Among important prerequisites to adopting unconventional monetary policy, would in turn mean firstly that government will have to apply strict price controls, putting in place effective import restrictions, and quickly transitioning from consumption-based to income-based taxation in an overall broad-based way, to not allow channeling of borrowed money to enhance unproductive domestic consumption, and from creating sub-optimal import demand.

This needs to be coupled with providing a meaningful role of government through improved governance, and incentive structures, that is bringing overall improved economic institutional quality, which would also mean purpose-driven, and one broad-based public service with ‘general’ and ‘fast’ streams rewarding effort and capabilities of public servants, and which covers all aspects of economy, including law-and-order administration.

As indicated above, an important piece of research brings forward economic benefits of applying unconventional monetary policy, in coordination with expansionary fiscal policy to break away from downturns in OECD countries; which, as indicated above, also holds significant promise if applied in developing countries under the influence of greater ambition, and not austerity.

Hence, a (2025) published article ‘The fiscal multiplier in presence of unconventional monetary policy: evidence for 17 OECD countries’ in the research journal ‘Economic Modelling’ pointed out in this regard the following: ‘This paper investigates the impact of unconventional monetary policy on the fiscal multiplier during the period of 1978–2019.

Our analysis shows a persistent impact of fiscal consolidation on GDP, with multipliers exceeding one, indicating that fiscal policy can have lasting stimulative effects…The results indicate that when unconventional monetary policy operates against fiscal policy, it reduces the fiscal multiplier without significantly affecting its size. Conversely, when unconventional monetary policy [UMP] accommodates fiscal policy, the fiscal multiplier increases significantly, ranging from 2 to 5 in horizon 3. Differentiating before and after the Global Financial Crisis, the usual multiplier is higher in all horizons during the Global Financial Crisis. This research contributes to the availability of fiscal policy to offset the negatives consequences of recessions…’

Hence, not only fiscal multipliers have an enhanced impact during downturn, they positively impact economic growth all the more when they are adopted in collaboration with unconventional monetary policy which, in turn, calls for in addition to coordination of monetary, and fiscal policy to also have monetary policy that is unconventional, that is, for instance, it adopts quantitative easing pathway for greater investment incentivisation.

The same paper indicated in this regard ‘…this study provides valuable insights into the relationship between unconventional monetary policy and the fiscal multiplier. The findings suggest that there is a need for coordination between monetary and fiscal policy to achieve optimal outcomes and maximise the impact of monetary–fiscal measures.’

Moreover, with regard to the methodology being employed the paper pointed out: ‘The estimation of the monetary–fiscal multiplier is a crucial aspect of macroeconomic analysis, and it requires the use of adequate methods to capture its behavior over time.

To achieve this goal, we will adopt the approach of local projections [LP]… To address the identification issues arising from the Great Recession (2016–2019), we employ both the local projections approach and the Kitagawa Blinder-Oaxaca decomposition, and a novel narrative database of fiscal consolidation. Additionally, we perform simulations to explore different scenarios that consider the interaction between fiscal and unconventional monetary policy.’

Hence, it is important to increase accuracy with regard to removing the internalizing behaviour of fiscal multipliers, which means other influences on growth may be implicitly accompanying fiscal multiplier estimation.

To overcome this issue, for instance, this paper adopts ‘Kitagawa Blinder-Oaxaca decomposition,’ which allows for decoupling non-fiscal influences on growth from fiscal multipliers, allowing in turn, reaching appropriately precise estimation of fiscal multiplier. Absence of such exercises contributes to errors in estimation of fiscal multipliers, which can then likely result in undesired impact on economic growth.

It needs to be highlighted that both the government and the International Monetary Fund (IMF) have apparently not identified the choice of methodology to properly assume restrictions on the model, and an appropriate identification strategy to bring greater precision to a fiscal multiplier estimation, which can go wrong, as was pointed out in a (2014) research paper ‘Learning about fiscal multipliers from growth forecast errors’ published in ‘IMF Economic Review’ as ‘With many economies in fiscal consolidation mode, there has been an intense debate about the size of fiscal multipliers.

At the same time, activity has disappointed in a number of economies undertaking fiscal consolidation. A natural question therefore is whether forecasters have underestimated fiscal multipliers, that is, the short-term effects of government spending cuts or tax hikes on economic activity. …economies with larger planned fiscal consolidations tended to have larger subsequent growth disappointments. …Investigating the degree of learning about fiscal multipliers is challenging given that forecasters often use models in which fiscal multipliers are implicit. Nevertheless, a number of policy documents provide informal evidence that forecasters revised upward their multiplier assumptions. For example, IMF (2013) notes that, in the case of Greece (p. 21), “The [2010] programme initially assumed a multiplier of only 0.5…Recent iterations of the Greek program have assumed a multiplier of twice the size.”’

Moreover, information on the choice of a methodology, given their particular strengths, and weaknesses, as pointed out in a (2025) research article ‘Empirical literature on fiscal multipliers: a bibliometric approach 2002-2023’ published in ‘Journal of Economic Surveys’ highlights the ascendancy of using LP methodology over usually used methodologies, where it pointed out: ‘The growing diversity of methodological approaches illustrates the extension of the debate around measuring fiscal multipliers.

According to Ramey (2011, 2019), studies on fiscal multipliers have mainly used autoregressive vectors (VAR) or dynamic general equilibrium (DSGE) models. …DSGE-type models allow researchers to account for specific characteristics of an economy (e.g., Batini et al. 2014). However, the estimates obtained for the multipliers are conditioned a priori since they depend on the model’s assumptions and calibration (Leeper et al. 2012). …The VAR structure is also restrictive, as fiscal shocks may not have linear effects on the economy (e.g., Asteriou and Hall 2021; Canova 2007; Pereira and Wemans 2013). …More recently, Jordà’s (2005) semi-parametric local projections (LP) method has been increasing in popularity (Plagborg-Møller and Wolf 2021). …Barnichon and Brownlees (2019) reinforce: (i) it does not impose specific dynamics on the variables in the system, (ii) it does not suffer from the dimensionality issue, and (iii) it is more flexible in accommodating nonlinearities.’

In this regard, one wonders if some study has been carried out in the case of Pakistan, where different methodologies have been compared in terms of both estimating fiscal multipliers based on the known performance of methodologies in research literature to bring forth their efficacy, and in estimating their efficiency through bringing forth the use of identification strategy (or justifying its absence), for the current, or any number of previous IMF programmes with Pakistan? Indeed, improvement in IMF programme design for Pakistan, for instance, or any programme country for that matter, and transparency requires such exercise, and disclosure.

Moreover, this policy approach overall helps generate and foster anti-high-inflationary expectations – as against the case in Pakistan, where inflationary expectations have been apparently consistently built up due to weak market regulation under application of neoliberal policy mindset, and austerity emphasis of policy over the years in general – through an ambitious role being taken by government in collaboration with central bank, while in the process narrowing down twin deficits and bringing sustainability to managing debt – and together with tax base rationalization, and shifting from consumption- to income taxation achieving sustainable macroeconomic stability – through higher, inclusive, and overall sustainable growth.

Copyright Business Recorder, 2026