The Liquidation of Government Debt

47 Pages Posted: 16 Apr 2011 Last revised: 1 Aug 2011

See all articles by Carmen M. Reinhart

Carmen M. Reinhart

Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER)

M. Belen Sbrancia

University of Maryland

Multiple version iconThere are 3 versions of this paper

Date Written: April 14, 2011

Abstract

Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of "financial repression." Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In this paper, the authors describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era.

In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historical standards). For the advanced economies in Reinhart and Sbrancia's sample, real interest rates were negative roughly half of the time during 1945-80. For the United States and the United Kingdom, their estimates of the annual liquidation of debt via negative real interest rates amounted on average to 3 to 4 percent of GDP a year. For Australia and Italy, which recorded higher inflation rates, the liquidation effect was larger (around 5 percent per annum). We describe some of the regulatory measures and policy actions that characterized the heyday of the financial repression era.

Keywords: Public Debt, Financial Repression, Inflation, Interest Rates, Debt Liquidation, Default, Restructuring, Debt Reduction

JEL Classification: E2, E3, E6, F3, F4, H6, N10

Suggested Citation

Reinhart, Carmen M. and Sbrancia, M. Belen, The Liquidation of Government Debt (April 14, 2011). Peterson Institute for International Economics Working Paper No. 11-10. Available at SSRN: https://ssrn.com/abstract=1809777 or http://dx.doi.org/10.2139/ssrn.1809777

Carmen M. Reinhart (Contact Author)

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

M. Belen Sbrancia

University of Maryland ( email )

College Park
College Park, MD 20742
United States

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