We build a new Keynesian DSGE model consisting of two heterogeneous countries participating in a monetary union. We study how public debt consolidation in a country with high debt (like Italy) affects welfare in a country with solid public finances (like Germany). Our results show that debt consolidation in the high-debt country benefits the country with solid public finances over all time horizons. By constrast, in Italy, namely the country that takes the consolidation measures, such a policy is productive only in the medium and long term. Thus, although there is a conflict of national interests in shorter horizons, there is a common interest in the medium and long term. All this is with optimized feedback policy rules. By contrast, debt consolidation is welfare inferior to non-consolidation for both countries and all the time, if it is implemented in an ad hoc way, like an increase in income taxes. Therefore, the policy mix is important.
debt consolidation Country spillovers feedback policy rules new Keynesian