The Liquidation of Government Debt

IMF Working Papers, January 21, 2015

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High public debt can be reduced not only through default and restructuring but also through financial repression, described as a tax on bondholders and savers via negative or belowmarket real interest rates.
After WWII, capital controls and regulatory restrictions created a captive audience for government debt, limiting tax-base erosion.
Financial repression is most successful in liquidating debt when accompanied by inflation.
The authors suggest that financial repression may again be part of the toolkit to cope with the recent surge in public debt in advanced economies.

After WWII, capital controls and regulatory restrictions were used to create a captive domestic audience for government debt.
Financial repression operates through negative or below-market real interest rates, effectively transferring wealth from savers and bondholders to governments.
The effectiveness of financial repression increases when combined with inflation, which reduces the real value of outstanding nominal debt.

For the advanced economies, real interest rates were negative ½ of the time during 1945–1980.
Average annual interest expense savings for a 12—country sample range from about 1 to 5 percent of GDP for the full 1945–1980 period.

Financial repression (including policies that produce negative or below-market real interest rates and capital controls/regulatory measures) may be considered as part of the policy toolkit to manage and reduce elevated public debt in advanced economies.
Policymakers should be aware that financial repression acts as an implicit tax on savers and bondholders and is most effective when combined with inflation.

The Liquidation of Government Debt, By Carmen Reinhart, M. Belen Sbrancia, January 21, 2015.