Economy & Business, Volume 8, 2014

Abstract: The objective of this paper is to investigate the effect of fiscal policy in small open transition economy. This paper employs, Granger- Causality test, Impulse Response Function and Forecast Error Decomposition, in order to assess the impact of fiscal policy on real GDP and prices. In this finding, all econometrics result do not show a conventional Keynesian effect of fiscal policy on real economic activity due to the counteracting effect of the monetary policy reaction. This causes a crowding out effect. Therefore, the results suggest that there is no coordination between fiscal and monetary policy. Moreover, the results from the Granger Causality test and Impulse Response Function show that the best fiscal policy for stimulating the economy appears to be one of tax-cuts. However, a change in taxation may produce a short-lived effect on real GDP; but, such action is likely to generate higher burdens in the future. In addition, the higher burdens are likely to have long-term consequences that far outweigh any short-term benefits in terms of real GDP.