Mirza Faizan AHMED*, Shabbir AHMED* and Talha Ahmed SIDDIQUI**
Abstract
This paper augments a model developed for the government spending for a closed economy by introducing
foreign loans, foreign reserves and exchange rates, which are of vital importance for
budgeting in an open economy. It suggests that government expenditures are a function of taxes,
domestic debt, foreign debt in domestic currency, foreign reserve in domestic currency, high-powered
money, and real interest paid on domestic and foreign debt. All factors are found to have a positive
impact on government expenditures in mathematical modelling, except for foreign reserves
interest payments on domestic and foreign debt, which have a negative impact on the expenditures.
The model is estimated by employing yearly data from 1976 to 2020 for Pakistan’s economy and
incorporating the impact of change in the exchange rate regime on government expenditures. The
model, estimated with the Auto Regressive Distributed Lag (ARDL) model, suggests that current
government expenditures depend on the current and previous period taxes, current domestic loans,
current and earlier periods of foreign debt, current high-powered money, and foreign reserves. In
addition, the empirical findings indicate that around 55 per cent of government expenditures have
been financed through tax revenues, 21 per cent through high-powered money and 17 per cent
through government bonds. The paper applies a dummy variable to measure the impact of the
change in the exchange rate regime in 1999; it suggests that the change has positively impacted
government expenditures. This paper concludes that the government has been preferring printing
money and foreign loans, after taxes, for financing expenditures in Pakistan. At the policy level, the
paper recommends that the government needs to rationalise the financing of its expenditures by focusing
more on taxes. Further, it needs to avoid tapping foreign reserves held by the private sector.
