The Three Gaps Phenomenon in Pakistan: Evidence and Implications

Abstract

The study analyzes the three gap trends namely the trade deficit, fiscal deficit, and saving-investment gap, and their implications for the Pakistan economy using time series data from 1976 to 2020. The three gaps have interlocking transmission mechanisms that become difficult to devise a prescription for them separately. The stabilization reforms needed then are supposed to have simultaneous reactionary forces that can correct or at least curtail these deficits. This two-pronged analysis first workout the evidence of the link among these three balances/deficits and then draws out the implications on the economy of the twin deficits and saving investment gap over time to achieve sustained growth and economic development. For this purpose, there have been estimated ARDL and cointegration carried out for causality analysis. The results reveal the presence of short-run. A bi-directional causality is supported between external debt, current account, and fiscal balances/deficits. These two deficits are also closely associated with macroeconomic variables.