HANK-Based Fiscal Consolidation for a High-Debt Advanced Euro Area Economy

Gee Hee Hong, Naowar Mohiuddin, Rasmané Ouedraogo, Danila Smirnov and Maryam Vaziri

No 2026/121, IMF Working Papers from International Monetary Fund

Abstract: High-debt euro area economies face fiscal consolidation in a low-growth environment. We use a Heterogeneous Agent New Keynesian model to assess how consolidation composition shapes aggregate and distributional outcomes in a representative high-debt economy. The status quo is not neutral: delay generates its own costs through lower investment, higher debt service, and damage to constrained households. For a given fiscal effort, expenditure-based consolidation achieves faster debt reduction with lower growth and distributional costs than revenue-based consolidation. As a complementary exercise, pairing the expenditurebased path with growth-enhancing structural reforms further improves outcomes by lifting real wages, a channel that disproportionately benefits hand-to-mouth households. Across both strategies, modest well targeted transfers to low-income households can substantially mitigate distributional costs at minimal fiscal expense while supporting aggregate demand.

Keywords: HANK model; fiscal policy; public debt; distributional effects; MPC; transfers (search for similar items in EconPapers)
Pages: 53
Date: 2026-06-12
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