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A Growth Model of Inflation, Tax Evasion, and Financial Repression

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Nouriel Roubini
Xavier Sala-i-Martin

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Abstract

In this paper we study the effects of policies of financial repression on long term growth and try to explain why optimizing governments might want to repress the financial sector. We also explain why inflation may be negatively related to growth, even though it does not affect growth directly. We argue that the main reason why governments repress the financial sector is that this sector is the source of "easy" resources for the public budget The source of revenue stemming from this intervention is modeled through the inflation tax. Our model has the implication that financial development reduces money demand. Hence, if the government allows for financial development the inflation tax base, and the chance to collect seigniorage, is reduced. To the extent that the financial sector increases the efficiency of the allocation of savings to productive investment, the choice of the degree of financial development will have real effects on the saving and investment rate and on the growth rate of the economy. We show that in countries where tax evasion is large the government will optimally choose to repress the financial sector 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 steady state rate of growth of the economy. Financial repression will therefore be associated with high tax evasion, low growth and high inflation.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4062.

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Date of creation: May 1992
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Handle: RePEc:nbr:nberwo:4062

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  1. Robert J. Barro & Xavier Sala-i-Martin, 1990. "Public Finance in Models of Economic Growth," NBER Working Papers 3362, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October. [Downloadable!] (restricted)
  3. Dornbusch, Rudiger & Fischer, Stanley, 1991. "Moderate inflation," Policy Research Working Paper Series 807, The World Bank. [Downloadable!]
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  4. Levine, Ross, 1990. "Stock markets, growth, and policy," Policy Research Working Paper Series 484, The World Bank. [Downloadable!]
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  5. Roubini, N. & Sala-I-Martin, X., 1991. "Financial development , the Trade Regime and Economic Growth," Papers 646, Yale - Economic Growth Center.
  6. Greenwood, Jeremy & Jovanovic, Boyan, 1990. "Financial Development, Growth, and the Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 1076-1107, October. [Downloadable!] (restricted)
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  7. Stanley Fischer, 1991. "Growth, Macroeconomics, and Development," NBER Working Papers 3702, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Robert J. Barro, 1991. "Economic Growth in a Cross Section of Countries," NBER Working Papers 3120, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October. [Downloadable!] (restricted)
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  10. Stigler, George J, 1970. "The Optimum Enforcement of Laws," Journal of Political Economy, University of Chicago Press, vol. 78(3), pages 526-36, May-June. [Downloadable!] (restricted)
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  11. Fry, Maxwell J., 1982. "Models of financially repressed developing economies," World Development, Elsevier, vol. 10(9), pages 731-750, September. [Downloadable!] (restricted)
  12. Feenstra, Robert C., 1986. "Functional equivalence between liquidity costs and the utility of money," Journal of Monetary Economics, Elsevier, vol. 17(2), pages 271-291, March. [Downloadable!] (restricted)
  13. Bencivenga, Valerie R & Smith, Bruce D, 1991. "Financial Intermediation and Endogenous Growth," Review of Economic Studies, Blackwell Publishing, vol. 58(2), pages 195-209, April. [Downloadable!] (restricted)
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  14. Roubini, Nouriel & Sala-i-Martin, Xavier, 1992. "Financial repression and economic growth," Journal of Development Economics, Elsevier, vol. 39(1), pages 5-30, July. [Downloadable!] (restricted)
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  15. Fischer, S., 1991. "Growth, Macroeconomics, and Development," Working papers 580, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. Kimbrough, Kent P., 1986. "The optimum quantity of money rule in the theory of public finance," Journal of Monetary Economics, Elsevier, vol. 18(3), pages 277-284, November. [Downloadable!] (restricted)
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