Optimal monetary and fiscal policies for Slovenia under flexible and fixed exchange rate

This paper analyzes the consequences of the exchange rate regime on optimal monetary and fiscal policies for Slovenia. Applying the optimum control algorithm OPTCON, quantitative optimal fiscal and monetary policies for Slovenia under different exchange rate regimes are calculated. The algorithm OPTCON minimizes an intertemporal objective function of a hypothetical policy-maker subject to the constraints given by an econometric model. Here, the constraints are given by a macroeconometric model of the Slovenian economy, called SLOPOL1. Fixing the exchange rate results in monetary policies which are significantly more restrictive, thus pushing the interest rate up. The higher interest rate leads to lower GDP growth rates, but inflation is reduced faster. Hence, fixing the exchange rate puts a strong pressure on national economic policies.