Pakistan Economy DSGE Model with Informality

In this paper we develop a closed economy DSGE model of Pakistan with informality both in the labor and product markets. We try to remain consistent with the micro-foundations of Pakistan’s economy for the purpose of estimation of the model parameters. However a couple of them have been calibrated to match the long-run features of the Pakistan economy. We introduce exogenous shocks of technology, fiscal spending and nominal interest rate in our model. Despite having to rely on annual data our model performs relatively better than existing DSGE literature on emerging markets. We find good degree of evidence of crowding out of private investment due to increases in government spending as well as spillover effects in the informal sector due to relatively lower intensity hinting at its possible shock absorbing role at the level of sustenance. The impulse response functions, in general, exhibit theoretically correct and empirically sound results.