How could financial repression be achieved?
• Low interest rates: The key precondition to achieving low interest rates is creditor trust. Creditors are more skeptical about the prospects for countries like Spain, Italy, and France, and are asking for higher interest rates to cover the perceived higher risk of not being paid back in full. This risk-based increase in interest rates in itself serves to increase the risk of default because the debtor economies then need to run a bigger primary surplus _ which, in turn, requires austerity measures that lead to lower growth. It seems highly probable that countries like the U.S., the U.K., Germany, and the Netherlands will be able to hold their interest rates low. For the other countries in the euro zone, we see a significant risk that it will not be possible to lower interest rates enough for financial repression to work, unless the ECB(European Central Bank) starts to buy these countries’ bonds—in effect, monetizing government debt. This would increase the probability of significant inflation.
• Higher economic growth: The best solution would be higher real growth of the economy. Unfortunately, the empirical evidence gives little hope. It is axiomatic that economic growth is driven by growth in the size of the workforce combined with increases in productivity. In Europe, the workforce is already shrinking, while in the U.S., the growth rate is forecast to be lower than in the past. Combine this with the fact that productivity growth has been constant for some time in most developed economies (the so-called technological frontier) and the probability of achieving sizable real economic growth in the next ten years is low.
• Higher inflation: Successful financial repression requires tangible inflation. The greater the gap between interest rates and growth, the faster the financial repression.
• Capital controls/government intervention: This requires more than the traditional set of methods to reduce existing debt burdens. This is only imaginable when governments also intervene significantly in financial markets, including banning cross-border capital flows and imposing strict regulation on how savings have to be invested.
Financial repression would have to be significant and requires close political coordination. In addition, it does not address the pressing issues of global imbalances and the adjustments required within the euro zone. The longer this play for time continues, the higher the risk of significant disruptions and social tensions. Given the empty coffers of governments and their recent heavy use of monetary instruments, there is not much left to stimulate the economy once more.