The Green and Equitable Challenge of Fiscal Consolidation

Nicoletta D'Alterio, Maria Ferrara and Alessia Paccagnini

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: Fiscal consolidation and decarbonization are two of the European Union's most pressing - and typically separately analyzed - policy challenges. This paper asks whether they can be pursued jointly, and at what distributional cost. We develop a Two-Agent New Keynesian model augmented with an environmental sector and compare a standard expenditure-based consolidation with an environmental-fiscal policy mix in which the carbon tax responds systematically to the debt gap, becoming an active consolidation instrument. The policy mix reaches the debt target faster under a pure announcement of future tax cuts (22 rather than 35 quarters), delivers a substantially larger reduction in emissions at a comparable output cost, generates a smaller transitional rise in consumption inequality, and lowers inequality in the long run. Automatic stabilizers cushion financially constrained households, roughly halving the transitional rise in inequality, while countercyclical monetary policy contains welfare costs for both household types. Debt reduction and decarbonization thus emerge as complementary, rather than competing, objectives under a coordinated policy design.

Keywords: fiscal consolidation; environmental policies; inequality; DSGE (search for similar items in EconPapers)
JEL-codes: E62 E63 Q58 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2026-07
New Economics Papers: this item is included in nep-dge
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2026-63

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