From fiscal consolidation to fiscal optimization

Abstract

The fiscal consolidation program in 2015 was a success. Despite this success, it is time to consider a switch away from the fiscal consolidation policy towards a fiscal optimization policy. By 'fiscal optimization policy' we mean a proper design of fiscal instruments that might lead towards the maximum potential rate of GDP growth. Relying on a panel regression model for 76 countries, the IMF recommended some guidelines for such an optimal fiscal policy in its latest regional report on Central, Eastern, and Southeastern European (CESEE) countries. In this paper we test the IMF's recommendations in a different analytical framework based on the QUEST_Serbia Dynamic Stochastic General Equilibrium (DSGE) model. We endogenize all fiscal revenue instruments, update macroeconomic data, and estimate the model's coefficients using Bayesian technique. We also develop a new analytical tool for the decomposition of Impulse Response Functions (IRF), which helps us to reduce complex dynamic non-linear general equilibrium relations to simpler linearized relations between endogenous variables and key state variables. Our findings support a general IMF suggestion in the particular case of the Serbian economy for reducing fiscal duties on labor and capital inputs, as well as public consumption and transfer payments. We, however, do not support increasing VAT rates or expanding public investments unless some additional conditions are met.