Impacts of budget deficit on output, inflation and balance of trade

This paper tries to analyze the impacts of budget deficit on macroeconomic aspects of Pakistan. In fact the ways through which budget deficit is financed, can affect money supply, output, exchange rate and then foreign trade. Annual data for the period 1970-2010 has been taken for analysis. ADF test used for stationarity test, 3-Stage Least-Square method is adopted for estimation by using STATA-10 software. The study revealed the Output changes are positively related to BCP and Government expenditures but negatively with interest rate. Money supply is positively related to GBD, BCP and foreign reserves(R). So money supply does increase whenever we try to finance budget deficit through Government, private or external borrowing. On the other hand, changes in Exports and Imports depend on changes in ER and their relative prices respectively which are affected by money supply. But the changes in imports are bigger than changes in exports, pushing the balance of trade towards deficit. Our study has also measured the negative relation between Balance of Trade and Output. Study concludes that when government tries to use government expenditures to get higher output, deficit may come into existence and then financing the budget deficit results in inflation, trade deficit and afterwards affects output.