Public Debt Consolidation and its Distributional Effects. ESRI WP629, July 2019

We build a dynamic general equilibrium model with heterogeneous households, namely Rich and Poor, and capitalskill 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 favours 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

The (intertemporal) equity-efficiency trade-off of fiscal consolidation

We build a dynamic general equilibrium model with heterogeneous households and capital-skill complementarity in the production function to study aggregate and distributional effects of fiscal consolidation policies when government uses a rich set of productivity-enhancing spending instruments along with utility-enhancing spending and tax fiscal instruments. Fiscal policy is conducted through simple fiscal rules. We study both ad-hoc and optimized fiscal rules. Our main results indicate that ad-hoc fiscal consolidation policies, either through spending cuts or tax increases, are recessionary and entail an equity-efficiency trade-off in the short- and medium-run. That is spending-based consolidation policies are less recessionary but come at a higher distributional cost; whereas tax-based consolidation policies result in sharper output losses but have smoother distributional effects. In addition, fiscal consolidation policies through optimized fiscal rules can be expansionary and social welfare enhancing while at the same time balance the equity-efficiency trade-off

The (intertemporal) equity-efficiency trade-off of fiscal consolidation

We build a dynamic general equilibrium model with heterogeneous households and capital-skill complementarity in the production function to study aggregate and distributional effects of fiscal consolidation policies when government uses a rich set of productivity-enhancing spending instruments along with utility-enhancing spending and tax fiscal instruments. Fiscal policy is conducted through simple fiscal rules. We study both ad-hoc and optimized fiscal rules. Our main results indicate that ad-hoc fiscal consolidation policies, either through spending cuts or tax increases, are recessionary and entail an equity-efficiency trade-off in the short- and medium-run. That is spending-based consolidation policies are less recessionary but come at a higher distributional cost; whereas tax-based consolidation policies result in sharper output losses but have smoother distributional effects. In addition, fiscal consolidation policies through optimized fiscal rules can be expansionary and social welfare enhancing while at the same time balance the equity-efficiency trade-off

Public redistributive policies in general equilibrium: an application to Greece

We develop a general equilibrium OLG model of a small open economy to quantify the aggregate and distributional implications of a wide menu of public redistributive policies in a unified context. Inequality is driven by unequal parental conditions in financial and human capital. The model is calibrated and solved using fiscal data from Greece. Our aim is to search for public policies, targeted and non-targeted, that can reduce income inequality without damaging the macroeconomy and without worsening the public finances. Pareto-improving reforms that also reduce inequality include an increase in public education spending provided to all and an increase in the inheritance tax rate on financial wealth. At the other end, we identify reforms that may reduce inequality but make everybody worse o§. Regarding cases in between, a switch to a fully funded public pension system is good for everybody although it is the rich-born that benefit more by moving to a more efficient macroeconomy