Financial repression
From Wikipedia, the free encyclopedia
Financial repression refers to government implementation of policies to channel domestic funds to the public sector that in a deregulated market environment would go elsewhere. These policies are used to reduce the government's debt-to-GDP ratio.[1][2] In the case of Japan, research suggests that financial repression can last for decades.[3][4]
The term was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon[5][6] to refer to well-intentioned but counterproductive policies that might impair a country’s economic development.[7]
Financial repression may consist of any of the following, alone or in combination.:[8]
- Explicit or indirect capping of interest rates, such as on government debt and deposit rates (e.g., Regulation Q).
- Government ownership or control of domestic banks and financial institutions with barriers that limit other institutions from entering the market.
- High reserve requirements.
- Creation or maintenance of a captive domestic market for government debt, achieved by requiring banks to hold government debt via capital requirements, or by prohibiting or disincentivising alternatives.
- Government restrictions on the transfer of assets abroad through the imposition of capital controls.
These measures allow governments to issue debt at lower interest rates. A low nominal interest rate can reduce debt servicing costs, while negative real interest rates erodes the real value of government debt.[8] Thus, financial repression is most successful in liquidating debts when accompanied by inflation and can be considered a form of taxation,[9] or alternatively a form of debasement.[10]
A 1993 study estimated the size of the financial repression tax for 24 emerging markets from 1974 to 1987. The results found that financial repression exceeded 2% of GDP for seven countries, and greater than 3% for five countries. For five countries (India, Mexico, Pakistan, Sri Lanka, and Zimbabwe) it represented approximately 20% of tax revenue. In the case of Mexico financial repression was estimated at 6% of GDP, or 40% of tax revenue.[11]
Financial repression is categorized as "macroprudential regulation"—i.e., government efforts to "ensure the health of an entire financial system.[1]
Examples
After World War II
Financial repression "played an important role in reducing debt-to-GDP ratios after World War II." By keeping real interest rates for government debt below 1% for two-thirds of the time between 1945 and 1980, the United States was able to "inflate away" the large debt (122% of GDP) left over from the Great Depression and World War II.[1] In the UK, government debt declined from 216% of GDP in 1945 to 138% ten years later in 1955.[12]
China
China's economic growth has been attributed to financial repression thanks to "low returns on savings and the cheap loans that it makes possible". This has allowed China to rely on savings-financed investments for economic growth. However, because low returns also dampens consumer spending, household expenditures account for "a smaller share of GDP in China than in any other major economy".[13] However, as of December 2014, the People’s Bank of China "started to undo decades of financial repression" and the government now allows Chinese savers to collect up to a 3.3% return on one-year deposits. At China's 1.6% inflation rate, this is a "high real-interest rate compared to other major economies".[13]
After the 2008 economic recession
In a 2011 NBER working paper, Carmen Reinhart and Maria Belen Sbrancia speculate on a possible return by governments to this form of debt reduction in order to deal with high debt levels following the 2008 financial crisis.[8]
"To get access to capital, Austria has restricted capital flows to foreign subsidiaries in central and eastern Europe. Select pension funds have also been transferred to governments in France, Portugal, Ireland and Hungary, enabling them to re-allocate toward sovereign bonds."[14]