Public spending and fiscal multipliers under various policy mixes

In the research project, growth effects of different public spending categories in Slovenia will be analysed. Furthermore, against the backdrop of the current need for fiscal consolidation in Slovenia, it will be analysed whether expenditure reductions or tax increases are less harmful to long-term economic growth or even in some instances may enhance growth. Applying an optimization algorithm, optimal strategies of consolidating the public budget will be determined. The main hypotheses to be explored are: - The size of fiscal multipliers is different among expenditure categories. - Public investment proper and government expenditures enhancing human capital have larger multipliers than transfers and government consumption. - Budget consolidation measures should concentrate on decreasing transfers and public consumption and on increasing taxes with low effects on labour supply, disposable income and investment. - Optimal fiscal policies involve trade-offs between macroeconomic stimulation and public debt sustainability. - The design of future budgetary policies for Slovenia (and similar countries) requires shifts of public expenditures from transfers to investment in infrastructure and human capital. The methodology used are simulations and optimizations with a medium-sized macroeconometric model of the Slovenian economy. To obtain information about the robustness of conclusions, a large number of sensitivity analyses will be performed. Apart from methodological innovations, the main novelty is a thorough model based analysis of the possibilities and the optimal choices (under various objective functions) of fiscal policy for a small open economy within the Euro Area which has managed the transition to a market economy after the breakdown of a command economy.

The aim of this research project funded by the Austrian Science Foundation FWF was calculating optimal consolidation strategies for public finances in Slovenia. Very often, when economic activity is weak, the public sector is called for to compensate this. Usually, this implies increasing public expenditures or decreasing tax revenues which however has negative implications on government deficits and debt. Reinhard Neck, Klaus Weyerstrass, Dmitri and Viktoria Blüschke (Department of Economics, Alpen-Adria-Universität Klagenfurt) together with colleagues from Slovenia analysed macroeconomic effects of different kinds of expenditures and revenues of the public sector in Slovenia. In particular, they asked whether reducing government expenditures or increasing government revenues exhibit less disadvantages for medium and long run growth. The research team was mainly interested in the so-called fiscal multipliers, i.e. economic parameters indicating the effects of higher or lower government expenditures and revenues on other macroeconomic variables. Using an algorithm for the optimization of dynamic systems, they calculated optimal strategies for consolidating public finances. The first hypothesis was: public expenditures which enhance research and development or human capital and, more generally, public investment have larger multipliers than transfers and public consumption. Another hypothesis stated that budget consolidations should concentrate on reducing transfers and public consumption and on increasing those taxes that do not affect labour supply, disposable income and private investment. At the same time, optimal fiscal policy has to confront a trade-off between macroeconomic stabilization and sustainable development of government expenditures. The project used the methods of econometric modelling and simulation and optimization of these models. Slovenia is of interest as a small open economy within the Euro Area which has successfully managed the transition from a command economy to market economy. As such it can be seen as a prototype for similar countries, e.g. of the Balkans; the results are therefore also of interest for other countries. Some of the most important results of the project are as follows: Effects of fiscal policy measures confirm the predictions of Keynesian theory (reducing public expenditures and increasing taxes have restrictive effects on production and employment) but their quantitative extent is very small. Reducing income taxes and social security contributions increases economic growth while their negative effects on public debt can be compensated by increasing the value-added tax rate without relevant unwanted side-effects. Shifting government expenditures from transfers and public consumption to public investment can be recommended; in particular, expenditures on research and development and on increasing human capital are highly effective.