Financial repression is a policy that channels cheap funding to governments, typically supported by accommodative monetary policy. After the global financial crisis various forms of financial repression have prevailed in most developed and many emerging countries. These policies have been effective in containing public debt but bear risks for future financial stability.
The below are excerpts from various articles and papers. Cursive text and emphasis have been added.
The essence of financial repression
“Financial repression refers to a set of governmental policies that keep real interest rates low or negative and regulate or manipulate a captive audience into investing in government debt. This results in cheap funding and will be a prime tool used by governments in highly indebted developed market economies to improve their balance sheets over the coming decades.” [Shepherd, 2013]
“Financial repression occurs when governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere. Policies include directed lending to the government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy ‘moral suasion.’ Financial repression is also sometimes associated with relatively high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold purchases, or the placement of significant amounts of government debt that is nonmarketable…
Governments do not call these actions financial repression, of course, but characterize them as part of ‘macroprudential regulation’, which is designed to ensure the overall health of the financial system.”
[Reinhart, Kirkegaard, and Sbrancia, 2011]
The history of financial repression
“After World War II the Bretton Woods arrangement of fixed exchange rates and tightly controlled domestic and international capital markets was put in place. The result was a combination of very low nominal interest rates and inflationary spurts of varying degrees across the advanced economies… Real interest rates in both advanced and emerging economies were markedly negative…and remained consistently…negative on average in the ensuing three and a half decades. Binding interest rate ceilings on deposits induced domestic savers to hold government bonds. That this was occurring nearly everywhere at the time helped delay the emergence of leakages from investors seeking higher yields.”
[Reinhart, Kirkegaard, and Sbrancia, 2011]
The attraction of financial repression
“The financial repression tax…[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…the relatively “stealthier” financial repression tax may be a more politically palatable alternative.”
The implementation of financial repression
“Undoubtedly, a critical factor explaining the high incidence of negative real interest rates was the aggressively expansive monetary policy in many advanced and emerging economies during the crisis…A large role for nonmarket forces in interest rate determination is a key feature of financial repression…In the U.S…the combination of Federal Reserve purchases of securities and, more importantly, record purchases of U.S. Treasury securities and GSEs by foreign central banks has left the share of outside marketable treasury securities as of 2010 at nearly 50 percent of the total issued…the lowest share since the expansive U.S. monetary policy stance during the breakdown of the Bretton Woods system in the early 1970s.”
[Reinhart, Kirkegaard, and Sbrancia, 2011]
“Merely setting interest rates below inflation, however, won’t fully achieve the desired result. The second part of financial repression is convincing a captive audience of buyers to hold government debt at exceedingly low yields. This can be done through the regulation of banks and pensions, capital controls, and good old-fashioned arm twisting…It isn’t hard to find examples of these tactics. The Basel III regulations give banks strong incentives to hold sovereign debt to satisfy their capital requirements. Ireland has pressed their National Pension Reserve Fund into service purchasing government securities and recapitalizing their banking system. Japan Post, the world’s largest pension plan, continues to buy JGBs apace.” [Shepherd, 2013]
“Basel III provides for the preferential treatment of government debt in bank balance sheets via substantial differentiation (in favor of government debt) in capital requirements.”
“Financial repression of the banking sector was actively used by European countries during the sovereign debt crisis…By the end of 2013, the share of government debt held by the domestic banking sectors of Eurozone countries was more than twice its 2007 level… Financial repression affects only the domestic sector: it is a forced home bias in banks’ holdings of sovereign debt.” [Becker and Ivashina, 2014]
The monetary policy support for financial repression
“A central bank keeps its interest rate low enough so that the current real interest rate stays considerably lower than the natural real interest rate for a considerable length of time…The measure [of financial repression] simply looks at the spread between the natural real interest rate and the current real interest rate. When…[it] is positive, interest policy has entered the area of financial repression (see chart below)… Since 2011, the line has gone well positive. This is evidence that the US is currently in a monetary policy of financial repression.“ [Lambert, 2014]
The benefits of financial repression
“Why do countries have Financial Repression? Investment increases, productive capacity increases faster…owners of capital are implicitly subsidized by savers, exports increase, [and] governments pay lower debt interest costs.” [Lambert, 2014]
“Financial repression relies on inflation, but it is a steady, stealthy process and therefore much more politically acceptable. By keeping interest rates low, governments receive cheap funding, and debt will grow only slowly. Higher inflation will lead to faster nominal GDP growth. This process will liquidate the size of the government debt burden by an amount equal to the negative real interest rate.” [Shepherd, 2013]
“We quantified the post–World War II wipeout of mountains of public debt in the advanced economies by measuring the so-called liquidation effect, the amount of government debt reduction wrought by financial repression…The liquidation effect occurred in at least a quarter of the years between 1945 and 1980 in the United States and considerably more often in other countries (table below)… For the United States and the United Kingdom, the annual liquidation effect amounted on average to between 3 and 4 percent of GDP a year…For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (about 5 percent a year).” [Reinhart, Kirkegaard, and Sbrancia, 2011]
The dangers of financial repression
“Asset bubbles result from borrowers being implicitly subsidized. Eventually the asset bubble is unsustainable and increasingly fragile…Financial repression is a trick where production can be increased at the expense of domestic demand. So as domestic demand is kept weak, financial repression must race ahead of a tendency for slower growth…If we are finding financial repression as the answer to our problems, we have fallen into the trap that China has set up for us. By trying to compete with China, we are becoming China.” [Lambert, 2014]
“Financial Repression in the European Sovereign Debt Crisis”, Bo Becker and Victoria Ivashina, Swedish House of Finance Research Paper No 14-13, April 2014.
“A Study of Financial Repression”, Edward Lambert, Angry Bear Blog, January 2014
“The Return of Financial Repression”, Carmen M. Reinhart, Banque de France, Financial Stability Review 16, April 2012.
“Governments are once again finding ways to manipulate markets to hold down the cost of financing debt”, Carmen M. Reinhart, Jacob F. Kirkegaard, and M. Belen Sbrancia, IMF Finance and Development, June 2011.
“The Liquidation of Government Debt”, Carmen M. Reinhart and M. Belen Sbrancia, NBER Working Paper, 16893, March 2011
“Financial Repression: Why It Matters”, Shane Shepherd, Research Associates , April 2013