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This paper builds and solves numerically, by using Eurozone data, a
closed-economy new Keynesian DSGE model in which the fiscal authorities
are engaged in public debt reduction over time. The emphasis is
on the aggregate and distributional implications of debt consolidation,
where agent heterogeneity,and hence distribution, has to do with the
distinction between ”capitalists” and ”workers”. The paper studies how
these implications depend on the specific fiscal policy instrument used
for debt consolidation. There are two key results. First, if the criterion
is total, or per capita, output (GDP), then the best policy mix found
is to use the long term fiscal gain created by debt reduction so as to
reduce the capital tax rate, and, during the early period of fiscal pain,
to use spending cuts in order to bring public debt down. Second, if the
criterion is equity in net incomes, the best recipe is to use the long term
fiscal gain created by debt reduction so as to reduce the labor tax rate,
and, during the early period of fiscal pain, to use capital taxes in order
to bring public debt down.
