A GROWTH-MODEL OF INFLATION, TAX EVASION, AND FINANCIAL REPRESSION

This paper studies the relation between policies of financial repressi on, inflation rates, and long-term growth. We set up a model which sho ws that governments might want to repress the financial sector because this sector is an 'easy' source of resources for the public budget (t he inflation tax). To the extent that the financial sector increases t he efficiency of the allocation of savings to productive investment, t he choice of the degree of financial development will have real effect s on the growth rate of the economy. In countries where tax evasion is large the government will optimally choose to repress the financial s ector in order to increase seigniorage taxation. This policy will then reduce the efficiency of the financial sector, increase the costs of intermediation, reduce the amount of investment, and reduce the growth rate of the economy. Financial repression will therefore be associate d with high tax evasion, low growth, and high inflation.