Policy mix for fiscal consolidation in Serbia: Conditional forecast approach

Abstract

The Serbian Parliament has adopted the fiscal consolidation program recognizing an exponentially rising public debt as a real threat to the economy that must be contained in order to avoid sovereign default. Despite the legacy of unfavorable macroeconomic development due to last-year's flood, a challenging expenditure cuts approach was adopted. It will keep domestic demand at depressed levels for some time even if austerity measures are not front-loaded but phased-out over three years. The reverse of the debt trend is projected for 2017, when the debt-to- GDP ratio will reach 80 percent. We use in this paper QUEST_SERBIA DSGE model to assess what would happen to the Serbian economy if the policy maker consistently implemented the policy package. Results are compared with model based estimates of what would happen if the policy maker did nothing at all. The differences between these experiments are considered as net effects of the fiscal consolidation package. Assessment of the spontaneous development is based on an unconditional forecast from the model, while controlled development is based on a conditional forecast. The social costs of fiscal consolidation will be significant if the fiscal policy is not supported by an adequate mix of monetary and foreign exchange policies. Among alternative scenarios we had designed, a delay in monetary easing was the worst case. A timely easing of the monetary policy followed by a relatively stable real exchange rate shows the best simulation results. Fiscal consolidation as proposed is a workable policy, which will keep the rising debt-to-GDP ratio at sustainable level, but it is still not sufficient to reverse debt trend in 2017. Perhaps the other structural measures will do this job, but they are beyond the scope of this paper.