Optimal Macroeconomic Policies after the Global Recession: A Case Study for Slovenia

In this paper, we study the optimal reactions of fiscal and (to some extent) monetary policy after the financial and economic crisis of the last two years. We consider the case of a small open economy that is part of the Economic and Monetary Union (EMU), namely Slovenia. Using an econometric model of the Slovenian economy, we simulate the effects of a global crisis under the assumption of no-policy reactions, i.e. assuming macroeconomic policies being conducted in the form of “business as usual”. Next, we investigate the optimal reaction of fiscal policies under the assumption that Slovenian policy-makers behave as maximizing an objective function. We use a new version of the algorithm OPTCON for the optimal control of nonlinear econometric models to obtain optimal paths of fiscal policies under different assumptions about monetary policy design by the European System of Central Banks. We show that optimal policies call for an active countercyclical role of fiscal policies, but also a strong policy reaction of European monetary authorities is called for if excessive unemployment and a sharp decline of real GDP are to be avoided. Optimal policy reactions are also determined for alternative scenarios of the global economy during the next few years, largely confirming the superiority of the European (more cautionary and restrictive) policy stance over the U.S. (more aggressive, expansionary) policy stance.