The Agenda

Carmen Reinhart on the Return of Financial Repression

Carmen Reinhart, co-author of This Time is Different, explains why heavy debt burdens in the advanced market economies will mean tighter state control of capital flows:

One of the main goals of financial repression is to keep nominal interest rates lower than would otherwise prevail. This effect, other things being equal, reduces governments’ interest expenses for a given stock of debt and contributes to deficit reduction. However, 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.

This amounts to a tax that has interesting political- economy properties. Unlike income, consumption or sales taxes, the “repression” tax rate is determined by factors such as financial regulations and inflation performance, which are opaque — if not invisible — to the highly politicized realm of fiscal policy. Given that deficit reduction usually involves highly unpopular spending cuts and/or tax increases, the “stealthier” financial-repression tax may be a more politically palatable alternative.

The concern is that heavy reliance on financial repression will undermine allocative efficiency:

This raises the broad question of whether current interest rates are more likely to reflect market conditions or whether they are determined by the actions of official large players in financial markets. A large role for non-market forces in interest-rate determination is a central feature of financial repression.

Reinhart offers a fair-minded portrait of why states are embracing financial repression — they have very few attractive options given the size of the debt overhang — but one gets the strong impression that we’re all going to collectively pay for poor policy decisions made in recent decades for many decades to come, and it’s hard not to be a little resentful.  

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.
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