Fiscal Policy Matters A New DSGE Model for Slovakia

The paper sets out a DSGE model designed and calibrated to match key stylized facts about the Slovak economy. The model includes a detailed fiscal policy block that allows a thorough analysis of fiscal policy measures. To evaluate the performance of the model, the response of the economy to a technology shock and to a foreign demand shock is considered under alternative fiscal adjustment scenarios. We find that a well-designed programme involving increases in transfers as well as taxes can stabilize the economy in the short run and improve longer-term growth prospects following a shock with adverse fiscal implications. We study the consequences of fiscal policy shocks in and away from the steady state of the model. The exercise yields implied fiscal multipliers that are relatively large in spite of Slovakia being a small open economy. Raising taxes on employment is particularly bad for the real economy, especially in the long run, whilst cutting government wage bill is the least harmful way of reducing spending.