The key ingredient in the mix, according to a recent working paper* by Carmen Reinhart of the Peterson Institute for International Economics and Belen Sbrancia of the University of Maryland, was “financial repression”. The term was first coined in the 1970s to disparage growth-inhibiting policies in emerging markets but the two economists apply it to rules that were common across the post-war rich world and that created captive domestic markets for government debt.
The exchange-rate and capital controls of the Bretton Woods financial system kept savers from seeking high returns abroad. High reserve requirements forced banks to lock up much of the economy’s savings in safe asset classes like government debt. Caps on banks’ lending rates ensured that trapped savings were lent to the sovereign at below-market rates. Such rules were not necessarily adopted to facilitate debt reduction, though that side-effect surely didn’t go unnoticed. The system was ubiquitous, reducing pressure on governments to abandon it.
Repression delivered impressive returns. In the average “liquidation year” in which real rates were negative, Britain and America reduced their debt by between 3% and 4% of GDP. Other countries, like Italy and Australia, enjoyed annual liquidation rates above 5%. The effect over a decade was large. From 1945 to 1955, the authors estimate that repression reduced America’s debt load by 50 percentage points, from 116% to 66% of GDP. Negative real interest rates were worth tax revenues equivalent to 6.3% of GDP per year. That would be enough to move America’s budget to surplus by 2013 without any new austerity programme.
The Link
The exchange-rate and capital controls of the Bretton Woods financial system kept savers from seeking high returns abroad. High reserve requirements forced banks to lock up much of the economy’s savings in safe asset classes like government debt. Caps on banks’ lending rates ensured that trapped savings were lent to the sovereign at below-market rates. Such rules were not necessarily adopted to facilitate debt reduction, though that side-effect surely didn’t go unnoticed. The system was ubiquitous, reducing pressure on governments to abandon it.
Repression delivered impressive returns. In the average “liquidation year” in which real rates were negative, Britain and America reduced their debt by between 3% and 4% of GDP. Other countries, like Italy and Australia, enjoyed annual liquidation rates above 5%. The effect over a decade was large. From 1945 to 1955, the authors estimate that repression reduced America’s debt load by 50 percentage points, from 116% to 66% of GDP. Negative real interest rates were worth tax revenues equivalent to 6.3% of GDP per year. That would be enough to move America’s budget to surplus by 2013 without any new austerity programme.
The Link
