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Public debt consolidation and its distributional effects

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  • Varthalitis, Petros
  • Sakkas, Stelios
Abstract
We build a dynamic general equilibrium model with heterogeneous households, namely Rich and Poor, and capital–skill complementarity structure in the production function, to study aggregate and distributional implications of fiscal consolidation policies when the government uses a rich set of spending and tax instruments. Fiscal policy is conducted through constrained optimized fiscal rules. Our results show that, in the long run, fiscal consolidation enhances both aggregate efficiency and equity; however, it may hurt Rich households depending on which fiscal instrument takes advantage of the fiscal space created. Along the transition, wage inequality significantly increases due to the capital–skill complementarity structure of the production function. Specifically, this happens because debt consolidation crowds in capital and this favors Rich (skilled) households. On the other hand, the reduction in interest rates and government bonds lead to a decrease in Rich households’ income coming from capital and government bonds which eventually decrease income inequality. Finally, a rather novel finding is that the combination of asset and skill heterogeneity amplifies the increase in wage inequality in the early phase of fiscal consolidation.
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  • Varthalitis, Petros & Sakkas, Stelios, 2019. "Public debt consolidation and its distributional effects," Papers WP629, Economic and Social Research Institute (ESRI).
    • Handle: RePEc:esr:wpaper:wp629
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    2. Kate Ivory & Eddie Casey & Niall Conroy, 2020. "Ireland’s Fiscal Spending Multipliers," The Economic and Social Review, Economic and Social Studies, vol. 51(1), pages 133-172.
    3. Konstantinos Mavrigiannakis & Andreas Vasilatos & Eugenia Vella, 2023. "Fiscal Tightening and Skills Mismatch," DEOS Working Papers 2313, Athens University of Economics and Business.
    4. Dusan Stojanovic, 2023. "Quantitative Easing in the Euro Area: Implications for Income and Wealth Inequality," CERGE-EI Working Papers wp760, The Center for Economic Research and Graduate Education - Economics Institute, Prague.

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