Modern Financial Repression in the Euro Area Crisis: Making High Public Debt Sustainable?

Abstract

The sharp rise in public debt-to-GDP ratios in the aftermath of the financial crisis of 2008 posed serious challenges for fiscal policy in the euro area countries and culminated for some member states in a sovereign debt crisis. This note examines the public policy responses to the euro area crisis through the lens of financial repression with a particular focus on how they contributed to easing government budget constraints. Financial repression is defined in this context as the government's strategy -supported by monetary and financial policies -to gain privileged access to capital markets at preferential credit conditions and divert resources to the state with the aim to secure and, if necessary, enforce public debt sustainability.Following a narrative approach, this note finds that public debt management and resolution, European financial legislation, EMU crisis support and ECB monetary policy have significantly contributed to relieving sovereign liquidity and solvency stress and generated fiscal space through non-standard means. The respective authorities have in fact applied the tools of financial repression to restore stability after the euro area crisis.

Rules or capacity for the EU’s fiscal future? From Werner and McDougall to the present

“…The NGEU blueprint based on conditional grants and loans offers another lever against misuse of EU budget funds through the conditionality attached to their disbursement.3. A permanent fiscal capacity would provide a steady stream of supranational safe assets (Van Riet, 2021) that could gradually come to dominate the sovereign debt market in the EU (Costa Cabral, 2021). This would have a stabilising effect on the financial system and would fulfil the function of macrofinancial stabilisation.…”

“…A permanent fiscal capacity would provide a steady stream of supranational safe assets (Van Riet, 2021) that could gradually come to dominate the sovereign debt market in the EU JPBAFM 36,2 (Costa Cabral, 2021). This would have a stabilising effect on the financial system and would fulfil the function of macrofinancial stabilisation.…”

Foreign bond investors and market discipline

“…As coined by Ronald McKinnon (1973), the term describes various policies that enable governments to ‘capture’ and ‘under-pay’ investors. ‘Modern financial repression’ in advanced economies (van Riet, 2018) remains a far cry from its cousin of previous centuries (cf. Ironside, 2014).…”

Keynes, inflation and the public debt: How to Pay for the War as a policy prescription for financial repression?

“…Real interest rates turned negative due to inflation in a context of blocked investment alternatives and interest ceilings. Since there seems to have been a conscious decision to expropriate rentiers – as Keynes labelled the holders of government debt (McKibbin 2013, p. 81) – the term ‘financial repression’ was introduced to label and analyse the fiscal and monetary policies of industrialised countries in the decades following World War II, including the case of the UK (Battilossi 2005; Monnet et al 2014; Reinhart and Sbrancia 2015; van Riet 2018; Marinkov 2019). Originating in the early 1970s, the term was first introduced by McKinnon (1973) and Edward S. Shaw (1973) to warn against financial strategies of developing countries that did not follow liberal ideals.…”