This week we examine the topic of financial repression, the term to describe the deliberate action of government to hold down interest rates below inflation. It represents a tax on savers and transfers benefits to government and other borrowers that would otherwise be spent elsewhere.
Financial Repression Back to Stay: Carmen M. Reinhart. “As they have before in the aftermath of financial crises or wars, governments and central banks are increasingly resorting to a form of “taxation” that helps liquidate the huge overhang of public and private debt and eases the burden of servicing that debt…such policies, known as financial repression, usually involve a strong connection between the government, the central bank and the financial sector…this means consistent negative real interest rates (yielding less than the rate of inflation) that are equivalent to a tax on bondholders and, more generally, savers…one of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail…when financial repression produces negative real interest rates and reduces or liquidates existing debts, it is a transfer from creditors (savers) to borrowers and, in some cases governments.” Unlike income, consumption or sales taxes, the “repression” tax is invisible. “Financial repression in its many guises…will likely be with us for a long time.”
Financial Repression: Why It Matters. “Financial repression, in a nutshell, refers to a set of government policies that create an environment of low or negative real interest rates, with the unstated intention of generating cheap funding for government spending…On the surface, these policies are put in place to combat weak economies, spur economic growth, and reduce unemployment …financial repression relies on inflation, but it is a steady, stealthy process and therefore more politically acceptable. By keeping interest rates low, governments receive cheap funding and debt will grow only slowly…the important message is that we need to adjust our expectations to the new economic environment…interest rates will not rise anytime soon, but remain at or below inflation for many years.”
The Fed will opt for the lesser of two evils. America’s central bankers are getting more worried about the collateral damage from financial repression. The Fed faces the uncomfortable choice: “either continue to use imperfect policy tools and risk greater collateral damage on a widening front; or stop and undermine the economy’s momentum….Today’s world of dysfunctional politics is one that pushes central banks further away from their comfort zone and excludes the best possible responses. The resulting inconsistencies can only be resolved through a more comprehensive policy approach that deals directly with the west’s challenges of too little growth, too much debt and too polarized a political discourse. In the meantime, central banks will have no choice but to opt for what they perceive as the lesser of two evils—that of maintaining a visibly imperfect policy stance.”
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