Tuesday, 7 October 2014

Kenneth Rogoff’s “financial repression”.

Kenneth Rogoff and Carmen Reinhart (R&R) in a recent IMF paper entitled “Financial and Sovereign Debt Crises..” are back to their old trick of using emotional phraseology to try and scare us on the subject of national debts. They’ve been using the phrase “debt overhang” instead of the word “debt” for several years so as to persuade us we’re beneath some sort of overhanging cliff which is about to collapse on our heads.
And their latest bit of emotional propaganda is the phrase “financial repression”: that’s the idea that some countries in the past have employed various draconian or dishonest measures to reduce debts like defaults or engineering excess inflation so as to cut the real value of the debt, therefore the same is likely happen again in the case of countries which currently have larger than normal debts.
In the above paper they use the phrase “debt overhang” twelve times and the word “repression” twenty six times! Plus they allude vaguely to the “austerity” which is allegedly needed to pay down debts: they say, “Although austerity in varying degrees is necessary, in many cases it is not sufficient to cope with the sheer magnitude of public and private debt overhangs.”
Well, just in case you’re worried about all this, I’ll attempt a more calm, collected and precise analysis of this near non-existent problem than R&R managed. 

Why reduce the debt?
The first flaw in R&R’s argument is that they don’t tell us why, just because the debt is larger than normal, it needs to be reduced. After all, if the rate of interest paid on it is equal to or less than inflation, then the REAL RATE OF INTEREST (i.e. the inflation adjusted rate) is respectively zero or negative. And in the case of a negative real rate, the debtor profits at the expense of the creditor. In that case there is no problem for the debtor!
In fact, assuming interest on the debt is zero or near zero (which is about where it’s been for several large countries for a few years now) it would actually be COUNTER PRODUCTIVE to dispose of the debt, and for a reason pointed out time and again by advocates of Modern Monetary Theory. That is that the debt and monetary base are ASSETS as viewed by the private sector. And if the private sector is not supplied with the quantity of assets that it wants, it will attempt to save so as to acquire those assets. But that leads to paradox of thrift unemployment!

The solution: quantitative easing.
But let’s assume that interest on the debt is too high, and that the debt needs to be reduced.
At the start of their section IV, R&R give a list of five possible ways of reducing the debt. They are (to quote):
1. Economic growth. 2. Fiscal adjustment-austerity. 3. Explicit (de jure) default or restructuring.4. Inflation surprise. 5. A steady dose of financial repression accompanied by a steady dose of inflation.

They say that economic growth is unlikely to contribute much (despite the fact that growth in the two decades after WWII contributed a lot to reducing the big debt / GDP ratio that WWII caused). So that leaves four “nasty” solutions.
But they’ve missed out a near painless way of reducing the debt which about 99% of the population, the mentally retarded included, are by now all aware of: QUANTITATIVE EASING!!!!

QE involves having the central bank create new money out of thin air and buy up sundry private sector held assets (almost exclusively government debt in the case of the UK). 

Of course that debt is still theoretically in existence: it’s the property of the central bank. So the Treasury owes the central bank megabucks. But the central bank’s profits are remitted to the Treasury at the end of every year. So if that debt is simply torn up, there’s no effect on the real economy.

Of course printing new money and buying up government debt might be inflationary, though QE has not in practice proved all that inflationary. But to the extent that IT IS INFLATIONARY, that’s easily countered by raising taxes and “unprinting” the money collected (and/or cutting public spending).

Note that as long as the latter inflationary effect equals the DEFLATONARY effect of the “unprinting”, there is no effect on GDP, numbers employed, etc. Where’s the “repression” there?

You could of course count the latter raised taxes as “repression”. But if you do, then we’ve endured tens of billions of dollars / pounds  worth of “repression” (aka taxes) every year for the last two centuries or so. Somehow we’ve survived to tell the tale. Moreover, 99% of the population are perfectly comfortable with the fact that taxes have to be collected, first to pay for public spending, and second to adjust demand. 

Money owed to foreigners.
Having just said that the QE method of cutting the debt has no effect on GDP, numbers employed, etc, there is an exception to that rule: where a significant portion of the debt is held by foreigners. R&R do refer to the distinction between debt owed to natives of a country and debt owed to foreigners, but they do not explain the exact relevance of that distinction. Perhaps I can help.
If foreigners are given zero interest yielding base money in exchange for their government debt as part of QE, obviously some of them will take their money elsewhere in the world in search of better yield. And that will depress the value of the currency of the country doing the QE on foreign exchange markets. And that means a cut in living standards for citizens of the country concerned (though there is no good reason for unemployment to rise). 
However, it is inevitable that when a country borrows from abroad it enjoys a temporary standard of living boost, and when it repays the money, it endures a temporary standard of living cut. That’s no different to a household which enjoys a temporary standard of living boost when it borrows and spends the money on consumer goodies, and then endures a standard of living cut when it works extra hours and abstains from consumption so as to repay what it has borrowed.

But the pound sterling was devalued by 25% in 2008 and no one in the UK noticed far as I remember (apart from those taking foreign holidays, buying foreign cars, etc). No disastrous levels of “repression” there.


  1. When we wonder how to analyse money owed to foreigners, we might first wonder how they got that money.

    I think of them as first having joined our economy. Yes, they live in a foreign land BUT, for a while, they spent their working life doing work that benefited our economy. If we think of the results of their efforts, they are no different from the results of workers living right here in our economy.

    If the results of efforts are no different, then the payment for those results should be the same. Both local and foreign workers are paid in the coin of the local economy.

    Now foreign workers have a problem in this model. After they perform their work, they are paid in a currency that is not accepted in their home economy. This is a problem that MUST be solved if this practice of living in one economy and selling in another economy is to become durable. And it MUST be durable if products like oil are to be traded across borders year after year.

    I have no solution for this problem.

    I do see that foreign interest have a large ownership in our debt. I also see that this debt can be converted to money if our central bank buys debt owned by foreigners.

    One of my goals is to extend this model (foreign workers as local economy actors) to include the effect of debt buy back. A project for my future!

    1. Hi Roger,

      It strikes me the foreigner / native distinction is no different to the distinction one can draw between any two groups of people you like: e.g. “people in Yorkshire” and “others in the UK” or “people with red hair” and “others”.

      To illustrate, if Yorkshire County Council borrows and issues bonds to anyone interested, and spends that money in Yorkshire, then the people of Yorkshire will initially gain and everyone else (especially those who lend to Yorkshire) suffer a standard of living hit. Then when it’s payback time, the roles are reversed.

      If Yorkshire had its own currency and assuming that currency maintained a more or less constant value relative to the pound, that wouldn’t make any difference. Alternatively, if Yorkshire borrowed in pounds (not a wise move) and Yorkshire’s currency lost value, then Yorkshire would be in an “Argentina” situation, i.e. up shit creek!

  2. You are making this more complicated than it is.

    QE cant be inflationary because the money has already been spent. Dollars in checking accounts are the same as dollars in savings accounts.

    The initial spending is how the people got those dollars, switching them between accounts (QE) doesnt matter.

    1. QE involves the creation of ENTIRELY NEW money by the central bank, and using that to buy up assets (mainly government debt).

      You could count government debt (Treasuries in the US) as a form of saving account and cash / base money as a form of current or checking account. I'm pretty sure Warren Mosler has portrayed it that way. And it's true that switching between the two is not a hugely significant move, hence the muted effect of QE.

    2. Ralph-

      QE does not involve the creation of any new money.

      Its no wonder you analysis is confused.

      In one short comment you say that QE is both creating new money and that QE is simply shifting already existing money between checking and savings accounts.

      It cant be both Ralph.

      Either QE is money printing and you have to explain how increasing the money supply by $4 trillion has led to zero additional growth.


      QE shifts already existing money between account types and thus is not creating new money. Which would answer the question of why QE hasn't done anything to help the economy.

      Pick 1 and only 1

    3. Why would you consider Govt liabilities in reserve accounts at the Govt Bank to be 'money' and govt liabilities in securities accounts at the Govt Bank as not 'money'?

    4. Auburn,

      Re your claim that “QE does not involve the creation of any new money, the Financial Times Lexicon site (link below) says “the most important step in QE is that the central bank creates new money…”

      And according to Investopedia (link below), “Quantitative easing increases the money supply…”. So QE does involve money creation – at least initially.


      However, the government debt or securities that are surrendered in exchange for that new money can themselves be regarded as money, as pointed out by Warren Mosler. So QE involves net money creation, or not, depending on whether you count those securities as money or not.

      A security which is due to mature in say a month is the equivalent of money in a term account at a bank where the account holder can get access to the money within a month. And most countries count that as money. On the other hand if the term is more than a year, the contents of the account are not normally counted as money. But there are no clear dividing lines here.

  3. Yes if you use the mainstream definitions which are inaccurate, you get inaccurate analysis like QE is printing money.

    "printing money" as misguided a term as it is, is associated with adding money to the economy, or at a minimum, wealth.
    QE does neither.

    Either way, my main point still stands un-addressed.

    Reserves are Govt liabilities in Fed bank accounts.
    Securities are Govt liabilities in Fed bank accounts.

    If you dont consider both types of bank accounts as "money" for the purposes of your analysis (like everyone does for private banks and M2), then you are bound to get things confused.

    At a minimum, people should use the same definitions for Govt bank accounts as we all do for private bank accounts.


Post a comment.