Financial Repression

Financial Repression

June 2, 2011
I’ve been getting questions about Carmen Reinhart’s new paper on financial repression (pdf) in the aftermath of large debt buildups, which asserts that said repression was a large part of the way the US and UK, in particular, dealt with their war debts.
On a first read, I have some problems with the methodology, which is based on lopping off any years in which the real interest rate on government debt was negative. It’s easy to think of ways this could go wrong, when you have fluctuating annual inflation and debt of relatively long maturity. But leave this aside, and look at broader economic performance during the period in which financial repression was supposedly a big factor: why are we supposed to think of what happened as a bad thing?

Here’s the log of real median family income (I use a log so that equal proportional changes are equal in height) since 1947:

 

Census

The first half of this figure is, according to Reinhart, the era of financial repression. It’s also, as you can see, the era of the great postwar boom. Surely one’s response to this history should be “Yay financial repression!”
What’s happening here is that Reinhart is using a term originally developed to describe an extremely distortionary policy in developing countries, and applying it to much more defensible policies pursued in advanced countries. It used to be common for third world governments to impose sharply negative real interest rates on savers year after year, driving saving down or pushing saving into unproductive channels. Maybe Regulation Q had something in common with those policies qualitatively; but the America of Regulation Q was an enormously successful economy with a much higher savings rate than we have had since financial repression, if that’s what it was, came to an end.
In that sense the new discussion of financial repression is like the old discussion of top tax rates. If you believe modern rhetoric, tax rates like those that prevailed under Eisenhower and Kennedy must have destroyed all initiative; the whole economic elite must have gone Galt. But that didn’t actually happen — on the contrary, the economy did fine.
I have seen the past, and it worked.