A method is provided for operating a power generation system that supplies real and reactive power to a grid, the power generation system including a generator/power converter, and a reactive power compensation device. A total reactive power demand (Qcmd) made on the power generation system is determined , as well as a maximum reactive power capacity for each of a generator stator-side reactive power (Qs), a generator line-side reactive power (Ql), and reactive power from the reactive power compensation device (Qmvb). Allocation of (Qs), (Ql), and (Qmvb) to supply (Qcmd) is coordinated by prioritizing (Qmvb) as a first source of reactive power, and one or both of (Qs) and (Ql) as a second source of reactive power.