Output Gap and its Determinants: Evidence from Pakistan ( ) Saadia Sherbaz, Faiza Amjad and Naheed Zia Khan

Transcription

1 Oupu Gap and is Deerminans: Evidence from Pakisan ( ) by Saadia Sherbaz, Faiza Amjad and Naheed Zia Khan Faima Jinnah Women Universiy, Rawalpindi, Pakisan Absrac This sudy primarily aims a measuring he oupu gap for Pakisan s economy. The PF approach is applied for his purpose. The poenial oupu of he economy is esimaed by using poenial employmen and poenial TFP. The analysis of he ime-series daa, , reveals ha for many of he years he acual employmen and TFP in Pakisan have been higher han heir poenial levels, bu he rend is no refleced in he acual oupu of he economy which, very ofen, appears o be falling shor of is poenial level. In recen years, barring , he oupu has for he mos par been less han is poenial level, despie higher han poenial levels of employmen and TFP. The sudy proceeds o deermine he facors responsible for he oupu gap of Pakisan s economy. The oupu gap series is generaed by using he esimaed acual and poenial oupu values. A regression model is formulaed o regress he oupu gap agains he macroeconomic variables which are believed o have a significan impac on he economy as a whole. The resuls show ha money supply and impors significanly conribue o he escalaion of he oupu gap, while expors and public secor invesmen help reduce he gap. Finally, he findings lead o he conclusion ha macro managemen of Pakisan s economy does no appear o ensure he consisency of he inervenions.

2 Inroducion The major focus of his sudy is o pin down he facors responsible for he exisence of he oupu gap in he economy of Pakisan. The oupu gap is concepually defined as he difference beween he acual and poenial oupu of an economy, measured as a percenage of he laer. Poenial oupu is essenially condiional o opimal allocaive efficiency of he resources. A negaive or posiive oupu gap is indicaive of inefficien resource uilizaion since he opimal oucome mus generae a zero or close o zero value of he gap. The oupu gap measure helps design he inervenions o sabilize he economy when i is overheaed or i needs a kick in he back. Alhough he Classical economiss denied he exisence of oupu gap, he phenomenon has coninued o be an imporan par of he pos World War II macroeconomic heory which for quie a long ime was dominaed by Keynes s hough. Since 1980s, he neoliberalis challenge o Keynesian economics and he New Keynesian response o i also include he debae on he exisence of oupu gap and he policies o curb i. The debae has produced a sizeable body of lieraure recenly conribued on he phenomenon. This paper makes an aemp o esimae he oupu gap for he economy of Pakisan. The analysis is furher exended o deermine he relaionship of he esimaed gap wih he macro variables conribuing o i. The sudy is srucured around hree pars. Par I provides a brief of he exising body of heoreical and empirical lieraure on he oupu gap. Par II conains he informaion on he daa uilized in his sudy and also explains he mehodology applied for he empirical analysis. Finally, Par III presens he resuls and discusses he major findings. I. The genesis of he oupu gap may be raced back o Ricardo (1817), who discussed he variables ha parake in deermining economy s naural level of oupu and employmen in he long run. Ricardo s posiion on he naural oupu, which may be aken as a proxy for he poenial oupu, appears o be an exension of Say s Law of Markes which is based on he famous dicum ha supply creaes is own demand. 1 Alhough he Classical economiss did appreciae ha markes do no always compleely clear up and someimes, for cerain duraion, he acual oupu eiher exceeds or falls shor of is poenial or naural level, hey considered hese flucuaions a 1 The gis of he Say s Law of Markes is ha producs are paid for by he producs, see Blaug (1962). 2

3 emporary phenomenon which only exised in he shor run. The Classical economiss also suggesed ha he marke, if lef o is own devices, will fix he oupu back o is poenial or naural level. The views of he Classical economiss prevailed in he 19 h cenury which alernaely experienced he ex book peaks and roughs of he business cycles along wih he shor lived and infrequen bous of depression. In he 20 h cenury, he echnological breakhrough idenified wih he Ford Assembly Line was followed by he breakdown of he world economic sysem. Afer 1929, he onse of he Grea Depression shook he foundaion of he producion-driven paradigms of economics and he criics of he self-correcive marke mechanism moved o he forefron. Keynes s recipe globally championed he pos World War II macro managemen of he counries belonging o he so called free world during he firs wo decades of he cold war. Keynes (1936) urned he argumen of he Classical economis on is head by posulaing ha in he long run we all are dead. According o him, he equilibrium level of oupu does no always reflec an economy s poenial and, insead of he supply, i is he effecive demand ha needs o be coured, moniored and conrolled. Keynes held ha, raher han leaving i o he indifferen marke forces, governmens should find soluions o he shor run problems which may cause irreparable social, if no maerial, damage. Keynesian revoluion was widely in vogue during 1950s and 1960s, bu he sabilizaion policies recommended by he School los effeciveness in he 1970s, as he Wesern world was exposed o oil price shocks. Unforunaely, he Keynesian failed o provide an adequae explanaion of he phenomenon of sagflaion and he New Classical counerrevoluionaries who opposed inervenion in he marke were back in he arena. 2 Indeed, he moneariss headed by Milon Friedman had held posiion agains Keynesian economics long before is validiy was undermined by he performance of he Wesern economies in he 1970s. Specifically, he moneariss refused o share Keynesian faih in he effeciveness of fiscal policy o help economy reach he naural level i.e. where acual oupu is equal o is poenial level. The monearis raher placed heir opimism on he effeciveness of moneary policy for ensuring ha he size of he nominal oupu reflecs he presence of sound money while considering he real side of he economy [Friedman and Schwarz 1971; Friedman 1994]. On he oher hand, he challenge 2 The mos cied of he New Classical counerrevoluionary are Lile e al. (1970), Bhagwai (1978) and Krueger (1978). 3

4 posed by he New Classical counerrevoluionaries had already eroded he foundaion of he Keynesian revoluion. They promoed he viewpoin ha only unexpeced or unanicipaed changes in economic variables affec he economy and, as he individuals are raional, he sysem should be regulaed eiher by unexpeced inervenions or by rigid policy rules. In so far as he laer did no imply he use of discreionary fiscal and moneary policies, he New Classical economiss of he modern imes did no see, like heir predecessors, for he governmen much of a role in he economy [See, Fischer1980]. However, he views held by boh he moneariss and he New Classical counerrevoluionaries also failed o pass he ime es. In 1982, he world economy slipped ino ever wors recession ha i had experienced since he dreadful decade of he 1930s. The changed circumsances provided he Keynesian an opporuniy o develop a more viable heoreical explanaion of he inerplay of economic parameers in he conemporary world. The New Keynesian, hus, presened a convincing case for governmen inervenion by synhesizing he ap conceps of boh he moneariss and he New Classicals ino a pragmaic heoreical framework [Gregory 1991; Gregory and Romer 1991; Julio 1987]. The belief ha he inabiliy of he markes o clear coninuously causes he exisence of a negaive or posiive oupu is essenially knied ino he New Keynesian heoreical framework. Finally, according o he New Keynesian economiss, sysemaic fiscal and moneary policies would help sabilize he economy by reducing he oupu gap, even under he assumpion of raional expecaions. The heoreical conroversy on he oupu gap has been followed by he empirical sudies of he phenomenon boh for he developed and he developing counries. However, he work done so far is no even nearly enough. Mos of he sudies have focused on he measuremen and deerminans of he gap. The findings of hese sudies undoubedly provide useful insigh and guideline o he researchers and he policy makers. For example, a sudy conduced on Norwegian economy discovered ha in some periods some measuremen mehods diverge from he ohers wih regard o he degree of flucuaion in he oupu gap [Bjornland e al. 2005). 3 The auhors herefore warn agains he risk of misjudging he economic siuaion, if he assessmen of pressures in he economy is solely based on developmens in he oupu gap as measured by one mehod. Musso and Wesermann (2005) appear o share he apprehensions of Bjornland e al. 3 The average value, from , of oupu gap using he Hoderick Presco (HP) Filer and Band-Pass (BP) Filer is By applying Producion Funcion (PF) approach he esimaed average oupu gap is 0.70, while he average values of he gap obained by using Mulivariae Unobserved Componen (MVUC) mehod and Srucural Vecor Auo Regression (SVAR) mehod is 0.17 and 0.10 respecively. 4

5 (2005) from anoher perspecive. They measured he poenial oupu growh of he Euro area counries from Their findings show ha he esimaes of poenial oupu growh will usually ineviably display some variaions characerizing unsusainable developmens and, in order o avoid misleading resuls, hese variaions mus be aken ino accoun. The recommendaions of hese auhors differ from Billmeier (2004) who also applied various alernaive mehods while esimaing he oupu gap of he Finnish economy. 4 However, he ime period in ha sudy varied from mehod o mehod depending on he availabiliy of he required daa. Alhough he average values of he oupu gap vary significanly for differen mehods, he auhor is of he view ha he mos appealing mehod is he Producion Funcion (PF) approach, as i specifically focuses on he derivaion of full capaciy labor inpu and oal facor produciviy (TFP). Indeed, an earlier sudy for he Euro area counries applies he PF approach o esimae he poenial oupu of he region [Willman 2002]. The producion funcions used are Cobb-Douglas Producion Funcion and Consan Elasiciy of Subsiuion (CES) Producion Funcion. The auhor has repored almos similar oupu gaps esimaed by boh of he PFs. The PF approach has also been used o measure he oupu gap of Cyprus. Ineresingly, he poenial oupu growh of Cyprus, from , urned ou o be higher han ha of he fifeen European Union (EU) member counries of ha ime [Harouunian e al. 2003]. Noneheless, he problem of measuremen error coninues o cause concern for he researchers. The resuls of a sudy carried ou for he Japanese economy sugges ha he counry s oupu gap is considerably larger han a simple Hoderick Presco (HP) Filer mehod would generae [Halmaier 2001]. Similar findings have been made by Cayen and Norden (2004) who invesigaed he reliabiliy of curren esimaes of he oupu gap in Canada. They applied a variey of measures and obained a broad range of oupu gap esimaes. 5 The auhors conclude ha measuremen errors in Canadian oupu gap esimaes may be more severe han i has been suspeced before. Empirical sudies on he oupu gap have also been conduced for he economies of he Ausralian Coninen. Two of he sudies, conduced for he New Zealand s economy, provide imporan insigh ino he facors responsible for he exisence of oupu gap [Claus e al. 2000; 4 The mehods applied by Billmeier(2004) include Linear Trend (LT), Quadraic Trend (QT), and Exponenial Trend (ET) approaches; HP Filer; Frequency Domain (FD) Filer; Beveridge-Nelson Decomposiion (BND); Blanchard- Quah (BQ) approach; and he PF approach. 5 The mehods used are LT; QT; HP Filer; BP Filer; MVUC; SVAR; BND; and PF approach. 5

6 Fox e al. 2003]. Though widely differen in erms of mehodology and suggesions, common focus of boh sudies happens o be he relaionship of he oupu gap wih he general price level. Claus e al. (2000) conclude ha he oupu gap provides a link beween he real economy and inflaion hus remains an imporan indicaor of fuure inflaionary pressures. 6 On he oher hand, Fox e al. (2003) rea he general price level as an explanaory variable. They conclude ha, in some years of heir sample period, he deviaion of domesic prices from long-run rend was mos responsible for he shorfall of he oupu from is poenial level. 7 The relaionship beween he oupu gap and inflaion has also been empirically invesigaed for he Chinese economy [Gerlach and Peng 2006]. The findings sugges ha he movemens in inflaion are a leas parially riggered by he movemens in aggregae demand as capured by he oupu gap. 8 A previous sudy on China by anoher auhor derived quarerly oupu gap series from [Scheibe 2003]. The auhor alernaively applied boh univariae and mulivariae mehods. All mehods showed ha a he end of 2002, China had enered a period of economic upswing. Oher sudies focusing on he oupu gap in he developing counries have empirically relaed he oupu gap wih quie differen macro variables. A sudy conduced for Israel, for example, has relaed he oupu gap wih migraion [Scacciavillani and Swagel 1999]. The auhors sugges a high growh rae of poenial oupu in periods of heavy migraion. Similarly, anoher sudy on Israel has deermined he relaionship of he oupu gap wih he impor surplus and he resuls show a posiive relaionship beween he wo phenomena [Menashe and Mealeem 2000]. However, mos of he sudies for he developing counries economies are mainly limied o deermining he oupu gap by esimaing he poenial oupu [DeSerres e al. 1995; Bauisa 2000; Arora and Bhundia 2003; Filho 2004; Njuguna e al. 2005]. Ineresingly, he scope of he span of hese sudies exends o hree larges coninens of he world, namely; Asia, Africa and Souh America. The findings by Bauisa (2002) include he cross-counry comparisons of he oupu gaps, from , esimaed for four Asian counries. 9 The work done by Filho (2004) 6 For esimaing poenial oupu hey used HP Filer, SVAR approach and MVUC model. 7 The mehods applied included a Modified Diewer-Morrison Decomposiion (MDMD) and a new Fisher-index decomposiion. 8 The auhors have fied he Philips curve model for he period The oupu gap is measured by using MVUC mehod and he HP Filer. 9 The sample counries are Thailand, he Philippines, Indonesia and Malaysia. The auhor has used a Generalized Hamilon (GH) model o derive he oupu gaps. 6

7 on Brazilian economy meris he credi for having he larges number of observaions, , amongs all he sudies reviewed by he auhors of his paper. The Filho recommends a demandled increase in invesmen o raise he effecive and poenial oupu levels of he counry. 10 On he oher hand, he analysis by DeSerres e al (1995) sands ou for uilizing he quarerly daa, from , of Mexico o esimae he oupu gap of is economy. 11 Furhermore, he poenial oupu hey have calculaed generaes he oupu gap by aking ino accoun he impac of he world oil shocks on Mexican economy. Finally, he mehodology adoped by Arora and Bhundia (2003) and Njuguna e al.(2005) is similar o ha of Bjornland e al.(2005) and Filho(2004). Arora and Bhundia (2003) have esimaed he oupu gap of he Kenyan economy from , while he Njuguna e al.(2005) have carried ou he work on he pos-aparheid Souh Africa from Boh sudies have repored significan variaions in he sign and size of he average oupu gap, as esimaed by applying differen mehods. II. This sudy applies he PF approach o esimae he poenial oupu of Pakisan s economy. The process involves he deerminaion of he full employmen level of oupu using he naural rae of unemploymen or NAIRU. The analysis is based on ime series daa, from , accessed from differen secondary sources provided by naional and inernaional agencies. 12 Addiionally, he sudy also uilizes Pakisan s capial sock series generaed by Nehru e al. (1993), afer having convered he daa from calendar year o he fiscal year of he counry. Since his series is available only up o 1990, he values for subsequen years, , are generaed by he auhors by using Perpeual Invenory Mehod as given in he following equaion: K = I + (1 δ)k 1 10 The mehodology of he auhor appears o be similar o he approach adoped by Bjornland e al. (2005) i.e., checking he flucuaions in he poenial oupu by alernaively applying various mehods of esimaion. 11 The auhors have applied SVAR mehod for esimaion of he poenial oupu. 12 Because of he unavailabiliy of a single daa source for all he variables included in he analysis, he sudy has uilized hree annually published daa sources including Economic Survey of Pakisan (published by he Governmen of Pakisan), Handbook of Saisics on Pakisan s Economy (published by he Sae Bank of Pakisan [SBP]) and Inernaional Financial Saisics (IFS), Published by he Inernaional Moneary Fund (IMF). 7

8 Where I sands for inflaion adjused Gross Fixed Capial Formaion (GFCF) in he curren year, K -1 is he capial sock in he previous year and δ is he depreciaion rae, which in Pakisan s case is 0.05 or 5%. 13 The funcion given above is, herefore, rewrien as: K = I + (0.95)K 1 The general form of he PF is: Q = f (A,L,K ) Where, Q is he GDP, A is oal facor produciviy (TFP), L is he employed labor force and K is he oal capial sock. The basic form of he Cobb-Douglas producion funcion used in his sudy is: Q = AL β K α Where, α and β, are he shares of capial and labor in oal producion respecively. In order o esimae PF, he firs assumpion applied on he model is ha of consan reurns o scale, ha is: β + α = 1 Or β = 1 α The PF herefore becomes: Q = A L 1- α K α Afer having divided boh sides by L, he PF is convered ino an inpu share equaion of he following form: 13 The value of depreciaion rae is adoped from Hjerppe e al. (2005), Norris e al. (2002), Forsner e al. (2001) and Evenson (1997). 8

9 Q L L = A L 1 α K α Q = A L K L α Taking naural log on boh sides ransforms he above funcion as: ln Q L K = ln A + α ln (1) L Equaion (1) is esimaed for he value of α, which is he share of capial in oal GDP relaive o labor. 14 Nex sep is calculaion of he TFP and his is performed, as given in he following, by using he esimaed value of α, and acual values of L, K and Q: l na Q = ln αln L K L ln A = lnq lnl α ( lnk lnl ) lna = lnq lnl + α ln L α ln K ln A = lnq (1 α )lnl α ln K (2) For esimaing he poenial level of TFP (fp * ) and NAIRU, he rend values of he wo series are derived by using he HP Filer, 15 symbolically: 14 The funcion is esimaed afer having checked he enire daa se for saionariy. The ADF Tes is performed on boh he original and firs differenced values of he variables on boh sides of he equaion. The resuls of he ADF es are repored in Appendix. 15 The HP Filer derives rend values for he variables by minimizing weighed average of he gap beween acual values and rend values and he rae of change in rend values [see, Njuguna e al. 2005; Harouunian e al. 2003]. 9

10 [( ) ( )] 2 lny * * * * + 1 lny lny lny 1 1 T λ T 1 min * lny lny + T = 1 T = 2 Where, T is he number of observaions and λ is he facor deermining he smoohness of rend and penalizing shocks. For annual daa, i is generally 100 [Scheibe 2003; Filho 2004]. Y is he acual variable and Y* is he rend value. Poenial employmen is derived by using he following formulaion: PE * = (1 U )lbf (3) Where, PE is poenial employmen, U * is he NAIRU and lbf is he oal labor force. This is followed by he esimaion of he poenial Gross Domesic Produc (GDP) by using he following formulaion: 16 PGDP * β fp (PE ) α = (K ) (4) Where, PGDP is he poenial GDP, TFP * is poenial oal facor produciviy, K is oal capial sock and PE is he poenial employmen. Finally, he oupu gap is deermined for he economy of Pakisan by using he following formula: OG Q PGDP = 100 (5) PGDP The las sep in mehodology is he deerminaion of he relaionship of oupu gap wih heoreically relevan macro variables. Following specific form model is esimaed for his purpose: The underlying assumpion of his formulaion is ha poenial capial sock is he same as he acual capial sock. 17 The value of each explanaory variable is aken in erms of is growh rae. 10

11 OG α (6) 5 = + β PI β EE β IE β HE β MS µ Where, PI = EE = IE = public secor invesmen expor earnings impor expendiure HE = higher secondary enrollmen MS = money supply µ = sochasic error erm III. Compuer package E-View 5 is used for all esimaions repored in his sudy. The esimaed values of he PF equaion are given in Table 1. 11

12 Table: 1 Esimaed Cobb-Douglas Producion Funcion Pakisan: Q Dependen variable = ln L No. of observaions = 41 Variable Coefficien -Saisics Consan ** K ln L *** R 2 =0.395 Adjused R 2 =0.379 D.W.= ** Significan a 5%, *** Significan a 1%. The esimaed coefficien for he share of capial lised in Table 1 appears o sugges ha, relaive o he share of labor, share of capial in he oal oupu of Pakisan is higher. Alhough he finding conforms o previously repored resuls on he subjec, [Senhadji 2000; Naqvi 2003; Sabir and Ahmed 2003], i is quesionable for a labor abundan developing counry like Pakisan. I may, however, be argued ha he relaive size of he esimaed coefficiens reflecs definiional problems in ha a large number of producers in Pakisan are self-employed in pey businesses. The pey self-employmen very ofen disors he deerminaion of he relaive share of capial and labor in he oupu, especially, if he funcional disribuion of oupu fails o adjus he opporuniy cos of producion of he resources conribued by he self-employed person. The opporuniy cos of producion mus ake ino accoun he reurn on he personal labor of he selfemployed producers, which is very ofen calculaed as profi, hus erroneously inflaing he relaive share of capial in he oupu. This aspec, hough beyond he scope of presen sudy, is very imporan for a labor abundan counry like Pakisan, hence meris researchers aenion. Afer obaining he values of α and β, Equaion (2) is used for calculaing he TFP. The values hus obained are repored in he Appendix by ploing Figure A1 which compares he TFP growh rae of he economy of Pakisan wih he growh rae of her GDP. A high degree of consisency observed in he relaive movemen of he wo variables helps endorse he validiy of he mehod applied for calculaing he TFP. Furhermore, he observed increasing rend of TFP for he recen years also conforms o he findings of Khan (2006). 12

13 As menioned earlier in Par II, he HP Filer is used for esimaing he poenial level of TFP and NAIRU. Trend values of he wo series are derived. These rend values are also considered poenial values since hey, in he absence of shocks and insabiliy, represen he seady sae of TFP and unemploymen. Trend values of NAIRU helped calculae he poenial employmen in Pakisan by numerically solving Equaion (3). Once he values on boh poenial TFP and poenial employmen were available, he numerical soluion of Equaion (4) became possible, hus providing he esimaes of poenial oupu for he economy of Pakisan. Finally, he formula given by Equaion (5) was applied o deermine he oupu gap of he counry. The average annual oupu gap urned ou o be The average figure appears o sugges close proximiy of he acual and he poenial oupu, hence no warraning a correcive policy inervenion. However, a close look a Figure 1, which graphically depics he yearly oupu gap from , ells quie anoher sory. I is observed ha 24 of he 42 observaions, lying boh in he posiive and negaive zones, regiser he oupu gap higher han one percen. Two highes values of he series, boh posiive, are observed for and , 4.13% and 4.16% respecively. On he oher hand, he closes comparable proximiy of he negaive oupu gap is observed for he year , -3.17%. Oupu gap, as depiced in Figure 1, appears o be a persisen phenomenon in he economy of Pakisan; hence i meris o be probed furher in erms of is deerminans. This is accomplished by esimaing Equaion (6) which regresses he fiscal policy, exernal rade, moneary policy and educaion on he oupu gap of Pakisan. The fiscal policy is represened by he public secor invesmen, PI. In developing counries conex, laer happens o be one of he mos sraegic macro variables in erms of is impac on aggravaion or diminuion of he oupu gap. I is basically he par of governmen revenue spen on infrasrucure developmen and oher criically required invesmen venures where privae invesors are eiher hesian or fail o deliver he social opimum of he physical capial. The impac of human capial is also esimaed in he model by including higher secondary enrollmen as one of he explanaory variables of he formulaion. Expor earnings and impor expendiure are used as proxies o capure he impac of exernal secor on he oupu gap. Theoreically, expors are expeced o conrol and reduce he negaive oupu gap, while an increase in impors may widen i. Finally, money supply is included as a regressor o es he monearis view regarding he role moneary policy plays in he 13

14 economy. Theoreically, money supply also aggravaes or reduces he oupu gap by failing or succeeding respecively o provide he sound money in he economy. 18 The resuls are repored in Table 2. Table: 2 Deerminans of Oupu Gap in Pakisan ( ) Dependen Variable = OG, No. of observaions = 41 Variable Coefficien -Saisics Consan PI *** EE * IE *** HE MS *** R 2 =0.32 Adjused R 2 =0.22 D.W.=1.89 * Significan a 10%, ** Significan a 5%, *** Significan a 1%. Barring higher secondary enrollmen, HE, all variables urn ou o be significan in he esimaed Equaion (6). The significan variables happen o carry heoreically expeced signs, hough he size of each coefficien is quie small which is consisen wih he small size of he average annual oupu gap in Pakisan. The sign of he esimaed coefficien of public invesmen, PI, is negaive and significan a one percen level, showing ha each one percen increase in public invesmen reduces he oupu gap by percen. This appears o suppor he findings by Naqvi (2003) who compared he produciviy of public and privae capial in Pakisan. His resuls show ha public capial is more producive han he privae capial since an exogenous shock o he laer akes almos wice as long o subside as an equivalen shock o he former. The lower vulnerabiliy and higher reliabiliy of he public secor invesmen makes i a favorable simulus for oupu, hus helps reduce he oupu gap For his purpose daa on curren moneary aggregae (M2) is accessed. The M2 is composed of currency in circulaion, oher deposis wih SBP, demand deposis, ime deposis and Residen Foreign Currency Deposis of he scheduled banks[see, Khan and Hussain 2005] 19 Findings by Naqvi (2003) appear o negae he significance of he crowding ou hypohesis advanced by he Classical economiss. The hypohesis happens o be in vogue in he conemporary world ruled by he neoliberlais views. 14

15 The variable for growh in expor earnings, EE, also carries a negaive sign in esimaed Equaion (6). The size of is coefficien is, however, larger han ha of he public invesmen, PI, suggesing ha a one percen increase in expor earning reduces he oupu gap by abou 0.03 percen. This resul is significan a en percen level. The esimaed coefficien of he variable for impor expendiure, IE, is he larges of all significan variables. I carries a posiive sign wih a significance level of one percen, showing ha a one percen increase in impors of Pakisan increases he oupu gap of he counry by percen. Keeping in view he size of he coefficien of EE, his is an alarming resul since Pakisan is increasingly liberalizing is exernal secor, largely under he pressure of inernaional financial insiuions and oher donor agencies. Finally, he resuls sugges ha he moneary policy in Pakisan has failed o provide he sound money o he economy, as he variable for growh of money supply, MS, is also significan a one percen level and is posiive sign indicaes ha every one percen increase in money supply is responsible for increasing he oupu gap by abou percen. The resuls repored in Table 2 do no provide he evidence of a srong relaionship of he dependen variable wih he righ hand side variables. The size of he adjused R 2 is 0.22, much less han he accepable level of he goodness of fi, showing ha only 22% of he variaions in he oupu gap of Pakisan is explained by he explanaory variables discussed above. Tha said, he esimaed fi mus be considered while keeping in perspecive ha, given he complexiy of he phenomenon, i is no possible o concepualize and/or operaionally define all he variables responsible for he exisence of he oupu gap. Finally, esimaed Equaion (6) has been checked for all specificaions. The resuls repored in Table 2 appear o be highly reliable, as no evidence of misspecificaion was found in he esimaed model. Conclusion Though heoreically conroversial, oupu gap is one of he mos criical macro indicaors widely applied o depic he sae of an economy. Hardly any school of hough denies he undesirabiliy of he oupu gap, may i be posiive or negaive. In so far as i provides he informaion regarding he economy s posiion on he business cycle, he esimaion of oupu gap grealy helps improve macro managemen of a counry. The findings repored in his sudy show ha he acual oupu growh in Pakisan frequenly and inconsisenly deviaes from he esimaes of he poenial oupu growh of her economy. 15

16 Unforunaely, hose responsible for macro managemen of he counry appear o have been engineering he policy prescripions which very ofen happen o be inkering disguised as fine uning. This is mos eviden by he relaive sizes and signs of he coefficiens of he variables for expors and impors. The posiive coefficien of he laer happens o be almos double of he negaive coefficien of he former. The finding suggess ha liberaliss soluion of rusing auo-correcive mechanism of he marke should no be relied upon in Pakisan s case: The counerweigh of he aggravaion in oupu gap caused by increase in impor expendiures happens o be almos wice as much as he diminuion of he gap resuling from an increase in expor earnings. On he oher hand, he saisically significan observed role of public invesmen in Pakisan meris he mirh promised by he Keynesian economiss. Tha said, he performance of public invesmen in Pakisan mus be weighed agains he fac ha public savings of he counry happen o be negaive since he early 1970s, and he enire capial budge is financed by borrowing boh inernally and exernally. Resulanly, he size of deb services appears o be increasingly becoming unsusainable: Alhough some furher moraorium was recenly graned o Pakisan on her exernal liabiliies, he deb services accoun for abou a quarer of he curren expendiure of he naional budge. Finally, he sudy also lends suppor o he moneariss views which warran o be aken seriously, especially in he conemporary milieu where he headlong financial liberalizaion of he las quarer of a cenury now appears o be loaded wih he promise of compromising he growh of world economy. Therefore, hose responsible for providing sound money o he economy of Pakisan mus ensure he consisency of moneary regulaions. 16

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