by Don Alexander, MBA Associate, RSD Solutions Inc.
Many advanced countries worldwide are experiencing a problem with surging levels of debt. One of the tactics used to contain the surge of debt is called “financial repression”. Given the recent global and European crises, there is expected to be resurgence in the use of this tactic for debt management. In a recent VOXEU (26th March) communique, “Financial repression: Then and now” authors Jacob Kirkegaard and Carmen Reinhart discuss how it is applied
In the past, policymakers dealt with rising debt levels by a mix of strategies: economic growth, fiscal adjustment and austerity, explicit default or debt restructuring, surprise inflation and financial repression often accompanied by steady inflation. Financial repression is defined as policies that allow governments to capture and under-pay domestic savers and investors. These policies may include forced government lending from pension funds and financial institutions, interest-rate caps, capital controls and other policy options. Countries will now focus on this strategy as one way to reduce the cost of the rising debt burden. Countries will only use outright default or surprise inflation as a desperate measure or as a strategy of last resort.
This is why financial repression is now back as a policy option. Financial repression in conjunction with steady inflation works in debt reduction by two methods: low nominal interest rates reduce debt servicing costs and negative real interest rates erode the debt-to-GDP ratio (tax on savers). The repression tax rate (or rates) can be determined by financial regulations and inflation performance.
Currently, financial repression is represented in the context of macroprudential regulation. The current financial regulatory measures are biased to keeping international capital out of emerging markets and in advanced countries. Emerging market controls are meant to counter loose monetary policy in advanced countries and discourage hot money while regulatory changes create a captive audience for domestic debt. This offers advanced and emerging economies common ground on tighter restrictions on international financial flows as the world is returning to a tightly regulated domestic financial markets.
One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This reduces governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, when this produces negative real rates and helps liquidate existing debt, it serves as a wealth transfer from creditors (savers/investors) to borrowers (governments). The prevalence of a strong regulatory environment during the post WWII Bretton Woods arrangement helped to keep real interest rates negative or lower than levels that would prevail in an environment of greater capital mobility. This allowed many of the advanced countries to use financial repression dramatically reduce accumulated debt burdens from WWII at a lower cost. As countries emerge from the most recent crisis, low real rates are expected to persist as countries struggle for a sustainable recovery.
Currently, many advanced countries have debt (public & private) levels that approach the post WWII levels. Policymakers will be preoccupied with debt reduction, debt management, and generally trying to contain debt servicing costs. The high level of unemployment will be further motivation for keeping rates low. In this environment, financial repression (with dual aim of low rates and captive investor base) will regain renewed favor as many countries struggle with unsustainable levels of debt and a new regulatory environment with a new set of risks.
For more on this follow the link: www.voxeu.org
/index.php?q=node/776
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