How should Slovenia design fiscal policies in the european debt crisis?

In the paper we will analyze the effects of different reactions of fiscal policies to the “Great Recession” in Slovenia and evaluate the actual fiscal policies in Slovenia. We will use the econometric model SLOPOL8, an econometric model of the Slovenian economy built by us to simulate the effects of the global crisis under alternative assumptions about the global development. Among those, we will consider the assumption of no-policy reactions, i.e. assuming that macroeconomic policies are conducted without attempting to deal with the effects of the recession. Moreover, we will investigate whether (and if so, how) fiscal policy can reduce the macroeconomic effects of the recession. We expect to see that there are strong trade-offs between countercyclical fiscal policies and the requirements of fiscal solvency. Acceptable fiscal policies are hypothesized to be mildly countercyclical and can shelter the Slovenian economy from the negative effects of a slump like that occurring during the “Great Recession” only in a limited way. Next, we will determine optimal fiscal policies for the next few years for Slovenia. For this purpose, we will distinguish between scenarios of a further recession (assuming the recent crisis to exhibit a double-dip) and scenarios of a global boom (assuming that the crisis is over by now). We will use the SLOPOL8 model and assume an intertemporal objective function for Slovenian policy maker containing output, unemployment, inflation, the budget deficit, public debt, and the current account as arguments. Using the OPTCON algorithm, approximately optimal policies will be calculated under different scenarios. We expect that the design of fiscal policies will be rather similar in both cases, showing the relatively low effectiveness of the fiscal instruments with respect to their influence on the business cycle in the Slovenian economy.