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The basics of financial repression

A subtle type of sovereign debt restructuring is “financial repression.” Financial repression denotes a compound of measures to channel cheap funding to governments, accompanied by a steady dose of inflation. It was practised in the developed world during Bretton Woods era.

The term financial repression was popularized by a working paper of Carmen M. Reinhart and M. Belen Sbrancia (March 2011, http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf).

Also see Camila Campos, Dany Jaimovich, and Ugo Panizza ,”The unexplained part of public debt”, 

Financial repression consists of a range of measures. The most prominent ones are

  • directed lending to government by captive domestic audiences (such as pension funds),
  • explicit or implicit caps on interest rates, regulation of cross-border capital movements, and
  • generally a tighter connection between government and banks.

“In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates helped reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards).”

For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum).”

Campos, Jaimovich, and Panizza support the effectiveness of financial repression. The growth rate of the debt-to-GDP ratio can be divided into five components: inflation, real GDP growth, interest expenditure, primary deficit, and the unexplained part. By applying this decomposition to a large number of countries over the period 1972–2003, the authors find that inflation and GDP growth had been the main drivers of debt reduction. Curiously, the effect of inflation dominates that of real GDP growth in every region of the world. In the developed world growth and inflation reduced debt-to-GDP-ratios by about 3%-points per year, while primary balances on average did not support the process. In the advanced economies and South Asia budget deficits are the main determinants of debt accumulation. In all other regions of the world, the unexplained part of public debt is the key determinant of debt accumulation.”


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