This paper studies the relation between policies of financial repression, inflation rates, and long-term growth. We set up a model which shows that governments might want to repress the financial sector because this sector is an 'easy' source of resources for the public budget (the inflation tax). 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 growth rate of the economy. 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 growth rate of the economy. Financial repression will therefore be associated with high tax evasion, low growth, and high inflation.
Price Level; Inflation; Deflation, E310. Financial Markets and the Macroeconomy, E440. Economic Development: Financial Markets; Saving and Capital Investment (financial intermediation), O160. One, Two, and Multisector Growth Models, O410. Inflation Theories; Studies Illustrating Inflation Theories, 1342. Inflation and Deflation-- General, 1340. Macroeconomics--Theory of Aggregate Supply, 0234. Capital Markets--General, 3130. Domestic Monetary Theory; Empirical Studies Illustrating Theory, 3112. Business Investment, 5220. Economic Development Models and Theories, 1120. Multisector Growth Models and Related Topics, 1113. One and Two Sector Growth Models and Related Topics, 1112.