Such tactics, in which banks are nudged, not coerced, into investing in government debt, constitute “soft” financial repression, but governments can go beyond such methods, demanding that financial institutions maintain or increase their holdings of government debt, as the UK’s Financial Services Authority did in 2009.
Similarly, last year, Spanish banks increased their lending to the government by almost 15 percent, even though private-sector lending contracted and the Spanish government became less creditworthy.
A senior Italian banker once said that Italian banks would be hanged by the Italian Ministry of Finance if they sold any of their government-debt holdings and a Portuguese banker declared that, while banks should reduce their exposure to risky government bonds, government pressure to buy more was overwhelming.
In addition, in many countries, including France, Ireland and Portugal, governments have raided pension funds in order to finance their budget deficits. The UK is poised to take similar action, “allowing” local government pension funds to invest in infrastructure projects.
Direct or indirect monetary financing of budget deficits used to rank among the gravest sins that a central bank could commit. QE and OMT are simply new incarnations of this old transgression.
Such central-bank policies, together with Basel III, mean that financial repression will likely define the economic landscape for at least another decade.
Sylvester Eijffinger is professor of financial economics at Tilburg University in the Netherlands. Edin Mujagic is a monetary economist at Tilburg University.
Copyright: Project Syndicate