Financial repression is any of the measures that governments employ to channel funds to themselves, that, in a deregulated market, would go elsewhere. Financial repression can be particularly effective at liquidating debt. The term was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon.
In a 2011 NBER working paper, Carmen Reinhart and 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 economic crisis. Reinhart and Sbrancia characterise financial repression as consisting of the following key elements:
- 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 seeking to enter 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. Thus, financial repression is most successful in liquidating debts when accompanied by inflation and can be considered a form of taxation, or alternatively a form of debasement.
- "Unlike income, consumption, or sales taxes, the "repression" tax rate (or rates) are determined by financial regulations and inflation performance that are opaque to the highly politicized realm of fiscal measures. Given that deficit reduction usually involves highly unpopular expenditure reductions and (or) tax increases...the relatively 'stealthier' financial repression tax may be a more politically palatable alternative to authorities faced with the need to reduce outstanding debts."
Giovannini and de Melo calculated the size of the financial repression tax for a 24 emerging market country sample from 1974-1987. Their results showed 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 6% of GDP, or 40% of tax revenue.
As noted by Reinhart and others in a June 2011 IMF publication, "financial repression issues come under the broad umbrella of 'macroprudential regulation' (or macroprudential policy), which refers to government efforts to ensure the health of an entire financial system".
Critics argue that if this view was true, investors (i.e. capital seeking parties) would be inclined to demand capital in large quantities and would be buying capital goods from this capital. This high demand for capital goods would certainly lead to inflation and thus the central banks would be forced to raise interest-rates again. As a boom pepped by low interest rates fails to appear these days in industrialized countries, this is a sign that the low interest rates seem to be necessary to ensure an equilibrium on the capital market, thus to balance capital-supply (savers) on one side and capital-demand (investors and government) on the other side. This view argues rather, that interest rates would be even lower, if it wasn't for the high governmental debt ratio (=capital demand from the governmental side).
- Protecting Against Financial Repression
- The Caine Mutiny Part 2, Bill Gross
- Policymakers learn a new and alarming catchphrase Financial Times, By Gillian Tett Published: May 9 2011
- The great repression The Economist Published: June 16 2011
- Financial Repression Redux (Reinhart, Kirkegaard, Sbrancia June 2011)
- The 2nd Edge Of Modern Financial Repression
- Shaw, Edward S. Financial Deepening in Economic Development. New York: Oxford University Press, 1973
- McKinnon, Ronald I. Money and Capital in Economic Development. Washington D.C.: Brookings Institute, 1973
- The Liquidation of Government Debt, Reinhart, Carmen M. & Sbrancia, M. Belen
- Reinhart, Carmen M. and Rogoff, Kenneth S., This Time is Different. Princeton and Oxford: Princeton University Press, 2008, p. 143
- Bill Gross, "The Caine Mutiny (Part 2)"
- Government Revenue from Financial Repression Giovannini, Alberto and de Melo, Martha, The American Economic Review, Vol. 83, No. 4 Sep. 1993 (pp. 953-963)
- Financial Repression Redux (Reinhart, Kirkegaard, Sbrancia June 2011) IMF Finance and Development, June 2011, p. 22-26