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Optimal Public Debt Consolidation with Distributional Conflicts

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  • Roberta, Cardani
  • Lorenzo, Menna
  • Patrizio, Tirelli

Abstract

In this paper, we adopt a Ramsey-optimal approach to the identification of debt reduction strategies, that is, the optimal policy mix for labor and capital income taxes, public expenditures and inflation designed to achieve an exogenous debt reduction path. Our model accounts for monopoly profits, limited asset market participation and asset holders' infrequent optimization of their portfolio composition between money holdings and other financial assets. The optimal policy envisages persistent reductions in public consumption and increases in taxes and inflation. Distributional conflicts arise between asset owners and the rest of the population. When asset holders interests are relatively less important in the planner's objective function, labor income taxes are drastically reduced whereas capital income taxes and inflation are increased. Just in this case the consolidation has short term expansionary effects.

Suggested Citation

  • Roberta, Cardani & Lorenzo, Menna & Patrizio, Tirelli, 2016. "Optimal Public Debt Consolidation with Distributional Conflicts," Working Papers 350, University of Milano-Bicocca, Department of Economics, revised 05 Oct 2016.
  • Handle: RePEc:mib:wpaper:350
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    Keywords

    Fiscal Consolidation; Limited Asset Market Participation; Ramsey Fiscal Policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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