Year of Graduation
Financial Repression in a Model of Strategic Fiscal and Monetary Policy Interaction
Modern financial repression refers to the non-market public debt placement with the below-market rate of return. It provides the government with extra revenues to finance government purchases and at the same time guarantees the sustainability of public debt. We aim to explain financial repression as an outcome of strategic fiscal and monetary policy interaction. To do this, we modify the framework introduced by Isakov and Pekarski (2018) by explicitly attributing two financial repression instruments to independent policymakers. The government has the regulatory power to enlarge the demand for public debt. The central bank controls the rate of return on debt. It is reluctant to set the interest rate below the neutral level, but benefits from closer-to-target public debt. Our analysis shows that in different strategic regimes (Cournot equilibrium, leadership and coordination) financial repression instruments can either substitute or complement each other in terms of providing the revenue. Moreover, institutional framework that gives strategic advantage in policy making to central bank helps to soften financial repression in terms of both fiscal and monetary instruments and delivers maximum possible level of social welfare.