Dynamic Inefficiency of Financial Repression Policy

An optimal fiscal policy in theory and practice can be dynamically inconsistent, so the optimal policy of financial repression as a part of fiscal policy can be dynamically inconsistent too. The term "dynamic inconsistency" refers to the situation in which the initial optimal plan chosen at a certain period of time will not remain optimal in the future. The problem of dynamic inconsistency exists when discretion policy leads to the worser outcome compared to the commitment policy. We find out theoretically if there is a problem of dynamic inconsistency of optimal financial repression policy in the form of pension wealth confiscation. We introduce the fully-funded pension scheme and financial repression in the form of pension wealth confiscation in the overlapping generations model. It is shown, that the problem of dynamic inconsistency of optimal financial repression policy in the form of pension savings confiscations exists only if the government does not give a binding commitment but has to liquidate all the debt it has accumulated before. Otherwise, optimal financial repression policy is dynamically inconsistent but does not lead to the deterioration of the policy outcome.