As if on cue, Federal Reserve Chairman Ben Bernanke signaled he would take further action to keep interest rates low the day a new study on “financial repression” predicted the tactic. Financial repression, by which governments channel money to themselves, is not going away any time soon.
In a speech on Tuesday, Bernanke buoyed markets with his call for “continued accommodative policies,” which is Fed-speak for another round of monetary easing.
The same day, Jacob Funk Kirkegaard and Carmen Reinhart published a paper looking at what they called financial repression in historical context. The term, coined by the Stanford economist Ronald McKinnon in 1973, has gained new popularity in the current economic crisis through research by Carmen Reinhart, cited often by the Pimco bond manager Bill Gross. Reinhart is co-author with Ken Rogoff of the 2009 bestseller This Time is Different: Eight Centuries of Financial Folly.
The paper by Kirkegaard and Reinhart, both fellows at the Peterson Institute for International Economics, says there are five ways nations have adopted to deal with debt. These include economic growth, austerity, default, “surprise” inflation and financial repression combined with inflation. The authors say that default and surprise inflation are undertaken in “truly desparate economic conditions” and that with austerity, as shown in Europe right now, “falling growth tends to offset much of the progress.”
Consequently, financial repression, which “allows governments to ‘capture’ and ‘under-pay’ domestic savers” is back in favor. The tactic, combined with steady inflation, works to cut debt through low nominal rates that reduces debt-servicing costs, negative real interest rates that erode the nation’s debt-to-GDP ratio and effectively act as a tax on savers.