Examining the Impact of Economic Policy Shocks on Investment: Evidence from Pakistan and its Trade Partners

Abstract

The objective of this study is to investigate the effect of both internal and external policy ambiguity on aggregate investment in Pakistan and its bilateral trade partners from the fourth quarter of 2010 to the fourth quarter of 2021. To achieve this, study uses economic policy uncertainty index for each country as a proxy for internal policy volatility. External policy volatility is measured by constructing a compound index that accounts for the trade weight of each country's policy uncertainty index. Further to find out the relationship, Panel PMG-ARDL model used and findings indicate that investment decrease with increase in uncertainty. Additionally, the research delves into the nonlinear relationship between investment and uncertainty and results demonstrate a U-shaped relationship between uncertainty and investments. Furthermore, Specific values were calculated to determine whether the effects of policy shocks are positive or negative, showing that internal policy shocks are more harmful than external ones. The study also provides policy implications based on these findings. Since internal policy insecurity has a stronger negative impact on investment than external factors, it is essential for policymakers in Pakistan to prioritize reducing ambiguity in internal policies. Implementing clear, consistent, and stable economic policies can help alleviate the negative effects of uncertainty on investment.