Financial repression
Encyclopedia
Financial repression is a term used to describe several measures which governments employ to channel funds to themselves which in a deregulated market would go elsewhere. Financial repression can be particularly effective at liquidating debt
.
The term financial repression was first introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon. The term was used to describe emerging market financial systems in the 1960s-80s. However, the same techniques were also used extensively in developed economies, particularly after World War II
and up through the 1980s, when such direct government intervention in markets fell out of favour.
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 their high levels of debt following the 2008 economic crisis. Reinhart and Sbrancia characterise financial repression as consisting of the following key elements:
These measures allow governments to issue debt at lower interest rates than would otherwise be possible. A low nominal interest rate
can help governments 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, and it can be considered a form of taxation.
Giovannini and de Melo (1993) 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".
Government debt
Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...
.
The term financial repression was first introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon. The term was used to describe emerging market financial systems in the 1960s-80s. However, the same techniques were also used extensively in developed economies, particularly after World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
and up through the 1980s, when such direct government intervention in markets fell out of favour.
In a 2011 NBER working paper, Carmen Reinhart
Carmen Reinhart
-External links:*...
and Belen Sbrancia speculate on a possible return by governments to this form of debt reduction in order to deal with their high levels of debt following the 2008 economic crisis. Reinhart and Sbrancia characterise financial repression as consisting of the following key elements:
- Explicit or indirect capping or control over interest rates, such as on government debt and deposit rates (e.g., Regulation QRegulation QRegulation Q is Title 12, part 217 of the United States Code of Federal Regulations. It prohibits banks from paying interest on demand deposits in accordance with Section 11 of the Glass–Steagall Act ....
). - Government ownership or control of domestic banks and financial institutions while placing barriers to entry before other institutions seeking to enter the market.
- Creation or maintenance of a captive domestic market for government debt achieved by requiring domestic banks to hold government debt via reserve requirements, or by prohibiting or disincentivising alternative options that institutions might otherwise prefer.
- 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 than would otherwise be possible. A low nominal interest rate
Nominal interest rate
In finance and economics nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation ; or, for interest rates "as stated" without adjustment for the full effect of compounding...
can help governments 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, and it can be considered a form of taxation.
- "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 (1993) 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
Mexico
The United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...
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
Macroprudential policy
Macroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.-Origin:...
), which refers to government efforts to ensure the health of an entire financial system".
See also
- Capital controls
- Sovereign debt
- Banking regulation
- Bank reservesBank reservesBank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...
- Inflation taxInflation taxInflation tax is a term which refers to the financial loss of value suffered by holders of cash and fixed-rate bonds, as well those on fixed income , due to the effects of inflation...
- Indirect taxIndirect taxThe term indirect tax has more than one meaning.In the colloquial sense, an indirect tax is a tax collected by an intermediary from the person who bears the ultimate economic burden of the tax...
- Hidden taxHidden taxA hidden tax is a tax that is not visible to the taxpayer. These taxes can raise prices of goods and lower salaries for workers. Hidden taxes, although hidden, can decrease the purchasing power of individuals significantly....
- Financial regulationFinancial regulationFinancial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system...
- Macroprudential policyMacroprudential policyMacroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.-Origin:...
External links
- Protecting Against Financial Repression
- The Caine Mutiny Part 2
- 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