The Liquidation of Government Debt

High public debt often produces the drama of default and restructuring. But debt is alsoreduced through financial repression, a tax on bondholders and savers via negative or belowmarketreal interest rates. After WWII, capital controls and regulatory restrictions created acaptive audience for government debt, limiting tax-base erosion. Financial repression is mostsuccessful in liquidating debt when accompanied by inflation. For the advanced economies,real interest rates were negative ½ of the time during 1945–1980. Average annual interestexpense savings for a 12—country sample range from about 1 to 5 percent of GDP for the full1945–1980 period. We suggest that, once again, financial repression may be part of thetoolkit deployed to cope with the most recent surge in public debt in advanced economies.