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This phrase has suddenly started
appearing in economic research, and will probably do so more frequently in
the coming months. Its origin is a Bank for International Settlements working
paper co-authored by Carmen Reinhart and Belen Sbrancia, economists well enough known to
merit attention. So what is it all about?
Financial repression includes
directed lending to governments by captive funds such as pension and insurance
funds, artificial caps on interest rates, restrictions on capital flows and a
generally tighter connection between government and banks. Some or all of
these devices have been used in the past to reduce the level of government
debt to GDP, particularly in the two decades after the Second World War. Many
countries reduced the level of their outstanding debt by a significant amount
over a 10 to 20 year timeframe through these techniques, assisted by moderate
levels of inflation.
Two of the alternatives to
financial repression listed in the paper are clearly unpalatable: default,
and “a burst of high inflation”. Two further alternatives are
either impractical or politically unattractive: economic growth, which is
slipping away further into the future, and austerity plans involving years of
unpopular policies with the risk of a deflationary depression. For these
reasons, financial repression seems the default option to Reinhart and Sbrancia.
Some of its elements are already
being implemented. eurozone
bail-outs involve contributions from government-controlled pension funds.
Bank and financial regulation allocates lower risk weightings to government
debt, giving it a systemic subsidy despite current events. Interest rates are
being held below the rate of inflation by central banks, lowering the cost of
borrowing for most governments to artificially cheap levels.
But will it work this time? To
do so will require private individuals to continue with an unquestioning
belief in the soundness of their paper currencies. In the wake of Bretton
Woods, when there was a gold exchange standard underpinning the dollar,
together with higher levels of national patriotism, the might of the dollar
was never questioned. Instead, we now have a US dollar-standard with
substantial levels of foreign ownership of government debt and an
increasingly sceptical public. This suggests that
financial repression would probably bring on a currency crisis.
Reinhart and Sbrancia
are not recommending financial repression, but they are right to point out
its attractions to governments in financial difficulties. It is, in the
cliché often used today, a description of the various means of kicking
the can down the road. This is something governments have been doing for a
long time: it has generally worked in the past, so they are almost certain to
assume it will work again now.
However, economic and financial
problems are rapidly mounting. Today’s situation is very different from
the end of WW2 with all that destructive spending replaced by people rebuilding
for the future, as they did in the 1950s and 1960s. Instead, our systemic and
economic problems are leading to yet more deterioration in government
finances. No amount of financial repression can fix that.
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