Financial Repression Definition, Features, Consequences

What Is Financial Repression?

Financial repression is a term that describes measures by which governments channel funds from the private sector to themselves as a form of debt reduction. The overall policy actions result in the government being able to borrow at extremely low interest rates, obtaining low-cost funding for government expenditures.

This action also results in savers earning rates less than the rate of inflation and is therefore repressive. The concept was first introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon to disparage government policies that suppressed economic growth in emerging markets.

Understanding Financial Repression

Financial repression is an indirect way for governments to have private industry dollars pay down public debts. A government steals growth from the economy with subtle tools like zero interest rates and inflationary policies to knock down its own debts. Some of the methods may actually be direct, such as outlawing the ownership of gold and limiting how much currency can be converted into foreign currency.

In 2011, economists Carmen M. Reinhart and M. Belen Sbrancia hypothesized in a National Bureau of Economic Research (NBER) paper, entitled "The Liquidation of Government Debt," that governments could return to financial repression to deal with debt following the 2008 economic crisis.

Financial repression can include such measures as direct lending to the government, caps on interest rates, regulation of capital movement between countries, reserve requirements, and a tighter association between government and banks. The term was initially used to point out bad economic policies that held back the economies in less developed nations. However, financial repression has since been applied to many developed economies through stimulus and tightened capital rules following the 2007–09 Financial Crisis.

Features of Financial Repression

Reinhart and Sbrancia indicate that financial repression features:

• Caps or ceilings on interest rates
• Government ownership or control of domestic banks and financial institutions
• Creation or maintenance of a captive domestic market for government debt
• Restrictions on entry to the financial industry
• Directing credit to certain industries

The same paper found that financial repression was a key element in explaining periods of time where advanced economies were able to reduce their public debt at a relatively quick pace. These periods tended to follow an explosion of public debt. In some cases, this was a result of wars and their costs. More recently, public debts have grown as a result of stimulus programs designed to help lift economies out of the Great Recession.

The stress tests and updated regulations for insurers essentially force these institutions to buy more safe assets. Chief among what regulators consider a safe asset is, of course, government bonds. This buying of bonds helps, in turn, to keep interest rates low and potentially encourages overall inflation—all of which culminates in a quicker reduction in public debt than would have otherwise been possible.