Financial repression: Then and now
In light of the record or near-record levels of public and private debt, debt-reduction strategies are likely to remain at the forefront of policy discussions in most of the advanced economies for the foreseeable future (Reinhart and Sbrancia 2011). Throughout history, debt-to-GDP ratios have been reduced by:
Economic growth. Fiscal adjustment and austerity plans. Explicit default or restructuring of private and public debt. Surprise inflation. Steady financial repression accompanied by steady inflation.
As coined by Ronald McKinnon (1973), the term financial repression describes various policies that allow governments to capture and under-pay domestic savers. Such policies include forced lending to governments by pension funds and other domestic financial institutions, interest-rate caps, capital controls, and many more. Governments have typically used a mixture of these to bring down debt levels, but inflation and financial repression typically only work for domestically held debt (the Eurozone is a special hybrid case). In the current policy discussion, financial repression comes under the macroprudential regulation rubric. Most governments would only contemplate default or surprise inflation in truly desperate economic conditions. In Europe, austerity is being pursued but in the countries that need it most, falling growth tends to offset much of the progress. Little wonder, then, that financial repression is back on the policy menu. Financial repression, teamed with a steady dose of inflation, cuts debt burdens from two directions:
Low nominal interest rates reduce debt servicing costs. Negative real interest rates erode the debt-to-GDP ratio (it is a tax on savers).
Here, inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). Financial repression also has some interesting political-economy properties. Unlike other taxes, the repression tax rate (or rates) is determined by financial regulations and inflation performance that are opaque to the highly politicised realm of fiscal measures. Given that deficit reduction usually involves highly unpopular expenditure reductions and/or tax increases of one form or another, the relatively stealthier financial repression tax may be a more politically palatable alternative for authorities faced with the need to reduce outstanding debts.
http://www.voxeu.org/index.php?q=node/7767
1. So : For the next 35 years or so, real interest rates in both advanced and emerging economies would remain consistently lower than during the eras of freer capital mobility before and after the financial repression era. In effect, real interest rates were, on average, negative. 2. But : Our discussion has focused primarily on Western Europe but similar trends are emerging in Eastern Europe. Pension reform adopted by the Polish parliament in March of this year has met with criticism from employers' federations and business circles. 3. And : As noted, financial repression contributed to rapid debt reduction following World War II. At present, the levels of public debt in many advanced economies are at their highest levels since that time; some of these governments face the prospect of debt restructuring. Furthermore, public and private external debts (which are a relatively volatile source of funding) are at historic highs. It seems probable that policymakers for some time to come will be preoccupied with debt reduction, debt management, and, in general, efforts to keep debt servicing costs manageable. 4. When : However, when financial repression produces negative real interest rates and reduces or liquidates existing debts, it is a transfer from creditors (savers) to borrowers (government and private). A recent study by Reinhart and Sbrancia (2011) documents such historical episodes.
