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Edin Mujagic and Sylvester Eijffinger
Published: Sunday 25 November 2012
When the economy is growing, automatic stabilizers work their magic. As more people work and earn more money, tax liabilities rise and eligibility for government benefits like unemployment insurance falls.

The Age of Financial Repression

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Following his re-election, US President Barack Obama almost immediately turned his attention to reining in America’s rising national debt. In fact, almost all Western countries are implementing policies aimed at reducing – or at least arresting the growth of – the volume of public debt.

In their widely cited paper “Growth in a Time of Debt,” Kenneth Rogoff and Carmen Reinhart argue that, when government debt exceeds 90% of GDP, countries suffer slower economic growth. Many Western countries’ national debt is now dangerously near, and in some cases above, this critical threshold.

Indeed, according to the OECD, by the end of this year, America’s national debt/GDP ratio will climb to 108.6%. Public debt in the eurozone stands at 99.1% of GDP, led by France, where the ratio is expected to reach 105.5%, and the United Kingdom, where it will reach 104.2%. Even well disciplined Germany is expected to close in on the 90% threshold, at 88.5%.

Countries can reduce their national debt by narrowing the budget deficit or achieving a primary surplus (the fiscal balance minus interest payments on outstanding debt). This can be accomplished through tax increases, government-spending cuts, faster economic growth, or some combination of these components.

When the economy is growing, automatic stabilizers work their magic. As more people work and earn more money, tax liabilities rise and eligibility for government benefits like unemployment insurance falls. With higher revenues and lower payouts, the budget deficit diminishes.

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But in times of slow economic growth, policymakers’ options are grim. Increasing taxes is not only unpopular; it can be counter-productive, given already-high taxation in many countries. Public support for spending cuts is also difficult to win. As a result, many Western policymakers are seeking alternative solutions – many of which can be classified as financial repression.

Financial repression occurs when governments take measures to channel to themselves funds that, in a deregulated market, would go elsewhere. For example, many governments have implemented regulations for banks and insurance companies that increase the amount of government debt that they own.

Consider the Basel III international banking standards. Among other things, Basel III stipulates that banks do not have to set aside cash against their investments in government bonds with ratings of AA- or higher. Moreover, investments in bonds issued by their home governments require no buffer, regardless of the rating.

Meanwhile, Western central banks are using another kind of financial repression by maintaining negative real interest rates (yielding less than the rate of inflation), which enables them to service their debt for free. The European Central Bank’s policy rate stands at 0.75%, while the eurozone’s annual inflation rate is 2.5%. Likewise, the Bank of England keeps its policy rate at only 0.5%, despite an inflation rate that hovers above 2%. And, in the United States, where inflation exceeds 2%, the Federal Reserve’s benchmark federal funds rate remains at an historic low of 0-0.25%.

Moreover, given that the ECB, the Bank of England, and the Fed are venturing into capital markets – via quantitative easing (QE) in the US and the UK, and the ECB’s “outright monetary transactions” (OMT) program in the eurozone – long-term real interest rates are also negative (the real 30-year interest rate in the US is positive, but barely).

Such tactics, in which banks are nudged, not coerced, into investing in government debt, constitute “soft” financial repression. But governments can go beyond such methods, demanding that financial institutions maintain or increase their holdings of government debt, as the UK’s Financial Service Authority did in 2009.

Similarly, in 2011, Spanish banks increased their lending to the government by almost 15%, even though private-sector lending contracted and the Spanish government became less creditworthy. A senior Italian banker once said that Italian banks would be hanged by the Ministry of Finance if they sold any of their government-debt holdings. And a Portuguese banker declared that, while banks should reduce their exposure to risky government bonds, government pressure to buy more was overwhelming.

In addition, in many countries, including France, Ireland, and Portugal, governments have raided pension funds in order to finance their budget deficits. The UK is poised to take similar action, “allowing” local government pension funds to invest in infrastructure projects.

Direct or indirect monetary financing of budget deficits used to rank among the gravest sins that a central bank could commit. QE and OMT are simply new incarnations of this old transgression. Such central-bank policies, together with Basel III, mean that financial repression will likely define the economic landscape for at least another decade.

ABOUT Edin Mujagic


Edin Mujagic is a monetary economist at Tilburg University.


Let's cut to the chase.

Let's cut to the chase. Differentiating between a nation's central bank and a nation's budgeting are but two parts of a whole intertwined system. Each central bank as managers of their respective host's national economy try to get as much profit as possible from the nation's population without crippling the value of the debt (bonds and money) owed to the banker. The bankers have just got too greedy and pushed debt levels too high by extending too much credit for far too long. It's the banker's system and they are the ones who have screwed it up with their greed while expecting the taxpayers to pay up under austerity conditions, which are really depressionary as the bankers suspend credit and contract the money supply.
Their system, fractional reserve banking, where all money is created as debt is bankrupt almost literally and definitely morally.

Two PHD economists working for the IMF recently ran a powerful simulation of an alternate monetary system where the government creates non debt bearing money in appropriate supply and commercial banks are at 100% reserves and concluded that this type of system (Chicago Plan) not only works exceptionally well but is in fact far superior to the current banker's system. Just don't hold your breath waiting for it's implementation as the financial elites would loose most of their power, returning it to the people, under such a monetary system. Check it out on a link at the American Monetary Institute....

this is what people voted for

this is what people voted for

In the US this means that if

In the US this means that if you have a little "nest egg", some money that you have been able to put aside, you are FORCED into the Ponzi-Scheme stock market to have a chance at beating inflation. If you keep your money in savings or money market accounts or CDs -- the banksters chip away at your principle.

I asked my Credit Union that since they're only paying me .05% on my savings and then "lending" 10 times as much thanks to fractional reserve at an average of 4%, where's my damn share of the difference?

I was blown off by the CFO...

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ABOUT Sylvester Eijffinger


Sylvester Eijffinger is Professor of Financial Economics at Tilburg University in the Netherlands.


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