Output Gap and its Determinants: Evidence from Pakistan (1964-05)

This study primarily aims at measuring the output gap for Pakistan s economy. The PF approach is applied for this purpose. The potential output of the economy is estimated by using potential employment and potential TFP. The analysis of the time-series data, 1964-2005, reveals that for many of the years the actual employment and TFP in Pakistan have been higher than their potential levels, but the trend is not reflected in the actual output of the economy which, very often, appears to be falling short of its potential level. In recent years, barring 2004-05, the output has for the most part been less than its potential level, despite higher than potential levels of employment and TFP. The study proceeds to determine the factors responsible for the output gap of Pakistan s economy. The output gap series is generated by using the estimated actual and potential output values. A regression model is formulated to regress the output gap against the macroeconomic variables which are believed to have a significant impact on the economy as a whole. The results Show that money supply and imports significantly contribute to the escalation of the output gap, while exports and public sector investment help reduce the gap. Finally, the findings lead to the conclusion that macro management of Pakistan s economy does not appear to ensure the consistency of the interventions.