2017, №4

On the Efficiency of Fiscal Stimulus under Financial Repression


Financial repression in the form of regulated expansion of demand for public bonds with a below-market rate of return stabilizes public debt and decreases its service cost. This helps to finance the fiscal stimulus programs in times of economic recession and of high public sector indebtedness. But being implicit and distortionary taxation of households, financial repression interferes with market mechanisms and can decrease the effectiveness of fiscal stimulus. In this paper, the authors augment the New Keynesian dynamic stochastic general equilibrium model with the elements of financial repression to evaluate the impact of financial repression on fiscal multipliers. We compare different regimes of finance of fiscal expansion and confirm that lump-sum taxation delivers the highest multiplier, while proportional labor income taxation leads to substantial distortions and decreases the effectiveness of fiscal stimulus. Most importantly, we show that tighter financial repression in the form of higher requirement for households to hold public debt only marginally decreases the fiscal multiplier. At the same time, tightening repression by decreasing the rate of return on public bonds leads to the higher fiscal multiplier. We also estimate the short- and the long-run impact of financial repression on public debt. Under substantial inflation inertia, positive monetary policy shock provides long-lasting effect of the liquidation of the public debt.

Kanat S. Isakov — Intern Researcher,  HSE University (Moscow, Russian Federation; e-mail: kisakov@hse.ru).

Sergey E. Pekarski PhD in Economics, Professor, HSE University (Moscow, Russian Federation;  e-mail: spekarski@hse.ru).