IMPACT OF FISCAL AND MONETARY POLICIES ON STOCK MARKET PERFORMANCE: AN EMPIRICAL STUDY OF PAKISTAN STOCK EXCHANGE

Abstract

The purpose of this study is to investigate the impact of fiscal and monetary policy actions on stock market performance along with the identification of moderating role of political stability in Pakistan. For the purpose of research, Govt, expenditure, tax revenue and budget deficit has been identified as measures of fiscal policy and interest rate and money supply as measures of monetary policy, and impact of both the policies on stock market performance has been analyzed by using robust econometric techniques on the time series data of Pakistan for the period 1981 to 2016. Multiple econometrics techniques have been employed using EVIEWS. Stationary analysis has been performed through Augmented Dickey Fuller (ADF) and Phillips-Perron (PP) unit root tests. Confirmation of long run relationship has been done through Johansen co-integration analysis. The study has employed Flierarchical regression method to analyze the impact of fiscal and monetary policy measures on stock market capitalization given the moderating role of political stability. Ordinary least square method (OLS) of regression analysis has been employed to analyze the nature of relationship. Error correction model has been used for analyzing short run relationship. Causal relationship amongst variables has been tested through granger casualty test. The findings of research indicate the existence of long run relationship between both policies and stock market performance, while short run relationship exists only between monetary policy measures and stock market performance. Statistical findings also indicate that Government expenditures, budget deficit and money supply depict significant positive impact, while tax revenue and interest rate depict significant negative impact on stock market capitalization in the long run. Further, the estimation indicated that political stability moderates only the relationship between interest rate and stock market capitalization, while other relationships are not moderated by political stability. The presence of short run co-integration and causality has been found between monetary policy measures and stock market performance, but not between fiscal policy measures and stock market capitalization. The findings of the research imply that it would be prudent on part of policy makers to devise such policies which positively affect the stock market performance in Pakistan. The investors should draw inferences about the market efficiency with respect to government policies and adjust their investment decisions accordingly. The current study has contributed to the already existing literature by focusing on the unresolved research area in the context of Pakistan