Debt Reduction, Wage Formation and Intergenerational Welfare.

The macroeconomic and cross-generational effects of policies aiming at public debt reduction are shown to depend crucially on how wages respond to the associated tightening of fiscal policy. In order to dampen the adverse transitional effects on the macroeconomy and in order to protect currently living generations against potentially severe drops in consumption possibilities, the paper argues in favour of a long-term strategy for debt reduction, achieved through a temporarily higher excise tax rate rather than raising the tax rate on labour income.