Source: World Bank Staff estimates using Escolano (2018, Eq. 19) and forecasts of public and publicly guaranteed debt at the end of 2018 from the February 2019 World Bank database for the Regular Economic Report for the Western Balkans.

**Of course, these estimates depend crucially on the assumed growth rate** . Nominal growth could well be higher than 5 percent a year, which would reduce the surpluses required to achieve the debt levels shown in Table 5. For example, with annual inflation of 2 percent, the assumed real growth rate underlying Serbia’s deficit rule implies nominal growth of roughly 6 percent a year. On the other hand, in the five years ending in 2018, none of the countries is expected to have achieved nominal growth as high as 5 percent.<sup>12</sup> Estimated by the model, rates range from a low of 2.4 percent in Bosnia and Herzegovina to a high of 4.8 percent in Albania. This period was, of course, affected by the global financial crisis, and future growth may be faster.

**To take account of random shocks and feedback from fiscal policy to the state of the economy, we can turn to macroeconomic modeling** . This modeling, developed by Jooste, Burns, and Song (2019), is based on the World Bank’s macro-econometric models for each of the six countries of the Western Balkans. Added to these models are fiscal-reaction functions that specify how the government responds to fiscal outcomes in the presence of fiscal rules. The models project the fiscal deficit and public debt, as well as other economic variables such as output and inflation. The models can be used to estimate how the economy would respond to changes in fiscal rules or to changes in the strength of the government’s commitment to complying with the rules. The models allow for random shocks, and the generation of some of the results relies on Monte Carlo simulation.

**The additional element of the modeling is a specification of how government spending reacts to differences between fiscal outcomes and what is permitted by fiscal rules.** Specifically, with variables expressed as shares of GDP, the general approach is to determine government spending in the current year as a function of (i) last year’s government spending, (ii) the difference between last year’s public debt and the debt permitted by the debt rule, and (iii) the difference between last year’s fiscal deficit and the deficit permitted by the deficit rule.<sup>13</sup> In some cases, the general approach is modified to take account of the nature of a country’s particular fiscal rules.

# **Crucial assumptions underlying the modeling include the following** :

> 12 Nominal growth is assumed to be the sum of the arithmetic averages of the rates of real growth and consumer price inflation taken from World Bank (2018, p. 75) and depends on forecasts for the year 2018.

> 13 Specifically, government spending as a share of GDP in year _t_ , , is given in the general approach by the following equation: tt gg 1 2 ])] where is the debt, ttis the debt limit, tt−1 is the actual budget balance, tt−1 is the balance required by the deficit rule, tt−1 gg = ββgg + (1 −ββ)[αα+ ωω(θθ [dd −dd<sup>∗</sup> ]) + (1 −ωω)(θθ [bb −bb<sup>∗</sup> and all these variables are expressed as shares of GDP, and , 1, and 2 are policy parameters that reflect the government’s commitment to complying with the rules. dd dd<sup>∗</sup> bb bb<sup>∗</sup> αα ββ, ωω, θθ θθ

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