The opinions expressed in this publication are solely the author’s; they do not necessarily reflect the views of CASE E-Brief Editor: Ewa Błaszczynski CASE - Center for Social and Economic Research, nor any of its partner organizations in the CASE Network.    No. 11/2010 September 2010 www.case-research.eu Bulgaria’s Fiscal Expansion: Navigating Through Stormy Waters By Georgy Ganev When the global economic crisis wreaked havoc across the world, most governments responded with a dramatic increase in spending. Their reactions had two main goals in mind: first, to bailout failing financial systems and second, to substitute the decline in private demand with a boost in aggregate public spending. For Bulgaria, fiscal stimulus programs proved to present their own unique set of challenges. The Merits of Fiscal Stimulus Many people, subscribing to the standard logic of Keynesian economic policy, will argue that it is precisely this swift action on the part of several governments that is the sole reason for why the world avoided slipping into a depression at least as deep and long as the Great Depression. Some prominent economists, including Nobel laureates Paul Krugman 1 and Joseph Stiglitz 2 continue to defend the proposition that now that the trough of the crisis seems to be behind us, any attempt to curb deficits and consolidate public finances will inevitably cause a double dip recession. This proposition rests on two related, but not equivalent, claims. The first is that fiscal stimuli help to avoid depressions and shorten recessions. The second is that fiscal consolidation, or austerity, causes recessions. In economic parlance, the claim is that the fiscal multiplier is large in both directions. One can easily imagine the theory behind this claim, but the infinitely more important question is the one surrounding its empirical validity, especially its validity under various contexts and idiosyncratic circumstances. 1 See comments in his blog http://krugman.blogs.nytimes.com 2 See http://www.bloomberg.com/news/2010-08-24/stiglitz-says- government-cuts-set-to-push-europe-into-double-dip-recession.html Bulgarian Response The case of Bulgaria during the last business cycle offers a very peculiar set of circumstances. Specifically, they can help shed light on the first part of the claim: that fiscal stimuli can help avoid depressions and shorten recessions. Bulgaria’s economic circumstances at the beginning of the 21 st century are indeed peculiar. First and foremost, it operates under a currency board regime, which means that there is a highly institutionalized fixed exchange rate to the Euro as well as an almost complete lack of autonomous domestic monetary policy. Today, the central bank has no control over the monetary base and is not allowed to hold any form of Bulgarian debt, including government paper and loans to Bulgarian banks. For this reason the stability of the monetary regime requires fiscal prudence. In fact, the country has actually recorded a decade of fiscal surpluses, which have been piled up into the government’s fiscal reserves. At the same time Bulgaria is a small, open, and converging member of the European Union (EU). These characteristics are quite relevant. For example, as a small economy, Bulgaria’s size is negligible relative to world capital flows. Its openness implies that exchanges with the rest of the world are large relative to its domestic size. Finally, as its economy seeks to converge with wealthier EU member states, its domestic rates of return are relatively high, so that in normal economic times it is highly attractive to capital. As an EU member Bulgaria’s current and financial accounts are completely open. This means that when the global crisis knocked on Bulgaria’s door in late 2008, the country had ample reserves, as large as 20% of annual GDP, stacked in a highly liquid form and ready for spending. Bulgaria did