What is... | November 4, 2011

What is financial repression?

You might not have heard of the obscure term “financial repression”. But chances are you’ve felt its effects or know someone who has.

Financial repression describes measures by governments to channel funds their way to reduce national debts. Unlike headline tax hikes, financial repression measures are often less obvious and can include steps such as changing lending and investing rules so that governments benefit.
Part of the attraction of financial repression is that it typically relies on small changes affecting many people over long periods. As a result, it can have large effects, slowly shifting funds to the government. Financial repression plays upon the behavioural trait of individuals failing to consider long-term implications of small changes.

Is history repeating?
The term financial repression dates back to debt crises in emerging economies in the 1960s and 1970s – and it has been revived by some influential economists as governments hike taxes and cut spending in the wake of the most recent global financial crisis.
However, some argue the current developed market moves are more defensible and less distortionary that the early developing market experience.

Secret channels
Financial repression may be achieved in several ways.
At a technical level, financial institutions can be required to hold more of their assets in government bonds. Or the buying and selling foreign currency may be restricted. Special taxes can be imposed on certain types of financial transactions.

Pension puzzler
Changes in pension regulations provide another a possible example.
If pension funds are required to hold a higher percentage of their assets in local government bonds, it may be easier for governments to fund their outstanding debt because they are selling to a “captured market”. Such a move lowers the interest rates the government must pay on its outstanding debt. However, it may also reduce the returns people can expect on their pension funds.
While more subtle than tax hikes, it can still have a large effect on the amount of wealth individuals can accumulate over long periods.

Inflating away
Another possible tool of financial repression is to keep nominal interest rates lower than would otherwise be the case. This may mean that real interest rates – the return rate people get after taking inflation into account – turns negative. This can be good for the government as it “inflates away” the debt. This effect can be large. One estimate suggests that in the post-war period, negative real interest rates in the US and the UK reduced government debt outstanding by to 3 to 4% of GDP on average per year.
However, savers can see their money lose buying power as interest income fails to keep pace with inflation. It is effectively a wealth transfer from savers, to borrowers – including the government.

Relieving repression
Changes to rules governing how people can invest and save for retirement can be difficult to keep track of. However, paying attention to these changes can pay off.
Even in the absence of regulatory change, a regular - perhaps annual - check up of your long term savings plans makes good financial sense.
A financial decision that was good when first made may not meet your needs after regulations change.
Don’t let inertia and procrastination erode your long term security.
If your goals seem unlikely to be met, it may be necessary to revise those plans or save more. It may even be worthwhile seeking professional financial advice.
This should reduce the chances of reaching the time savings are due to be used - only to suddenly find a nasty surprise.


Phil Thornton
Phil Thornton

Lead consultant at Clariti Economics