Financial repression

Financial repression comprises 'policies that result in savers earning returns below the rate of inflation' in order to allow banks to 'provide cheap loans to companies and governments, reducing the burden of repayments'. It can be particularly effective at liquidating government debt denominated in domestic currency. It can also lead to a large expansions in debt 'to levels evoking comparisons with the excesses that generated Japan’s lost decade and the Asian financial crisis' in 1997.Reform:General: Financial repression comprises 'policies that result in savers earning returns below the rate of inflation' in order to allow banks to 'provide cheap loans to companies and governments, reducing the burden of repayments'. It can be particularly effective at liquidating government debt denominated in domestic currency. It can also lead to a large expansions in debt 'to levels evoking comparisons with the excesses that generated Japan’s lost decade and the Asian financial crisis' in 1997. The term was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon in order to 'disparage growth-inhibiting policies in emerging markets'. Financial repression consists of the following: 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. The size of the financial repression tax was computed for 24 emerging markets from 1974 to 1987. The 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. Financial repression is categorized as 'macroprudential regulation'—i.e., government efforts to 'ensure the health of an entire financial system. 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. In the UK, government debt declined from 216% of GDP in 1945 to 138% ten years later in 1955. 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'. 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”. 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 economic crisis.