Optimal macroeconomic policies in a financial and economic crisis: a case study for Slovenia

In this paper, we study different and, in particular, “optimal” reactions of fiscal (and to some extent monetary) policies to the financial and economic crisis of 2007–2009 in Slovenia, a small open economy that is part of the Economic and Monetary Union (EMU). Using an econometric model of the Slovenian economy, we simulate the effects of the global crisis under the assumption of no-policy reactions, i.e. assuming that macroeconomic policies are conducted without attempting to deal with the effects of the crisis. Next, we study the possibilities of fiscal policy reducing or even annihilating the effects of the crisis. We also investigate the optimal reaction of fiscal policies based on the assumption that Slovenian policy-makers behave as though they were optimizing an objective function. We show that optimal policies call for only a very modestly active countercyclical role of fiscal policies. There are strong trade-offs between countercyclical fiscal policies and the requirements of fiscal solvency. (author's abstract)