Government Funding Costs Under Financial Repression -- by Roberto Gómez-Cram, Howard Kung, Hanno Lustig, David Zeke

We study the equilibrium effects of financial repression on government funding costs in an endowment economy with limited asset market participation. We show how a broad set of repression policies operates through a wedge in the Euler equation responsive to government size or by affecting fiscal redistribution between agents. Repression intensity is captured by a policy feedback rule that depends positively on net government spending. When fiscal policy is profligate and monetary policy accommodates, we show that such a repression policy raises bond values, reduces the inflationary cost of unfunded fiscal expansions, and lowers bond risk premia. Repression is not a free lunch for bondholders---they pay a lower inflation tax but also earn lower future real returns. When monetary policy does not accommodate fiscal policy, repression can provide stopgap funding for deficits, allowing the central bank to retain control over inflation while making government debt a hedge for fiscal inflation.