Double-Dip Recession And Policy Options

It is reasonable to expect the Serbian economy to decline up to -1% in 2012. A double-dip recession is inevitable. Lessons from the previous recession in 2009 suggest that an expansionary fiscal policy has clear limits, and that any misalignment of economic policies might be highly costly.This time, in addition to a recession and lack of policy coordination, the Serbian economy is exposed to the political risk associated with new elections. All of these risks deserve proper attention. In this paper, we provide a growth forecast for 2012 and discuss three potential policy response options. Coordination between fiscal consolidation and monetary expansion is the preferred solution. However, no one should take this for granted, and even if it is adopted by the Serbian policy makers, the problem of unsustainable long-term growth will remain. The model developed in this paper is a New-Keynesian model, modified to tackle the issue of fiscal consolidation. We expect that the inflation targeting policy framework will prevail in 2012, despite its poor record, and that this provides a good reason for using DSGE models to simulate policy options.