Essays on financial repression

Date of Completion

January 2005


Economics, General|Economics, Finance




The thesis comprises of six independent chapters with the common theme of financial repression and liberalization. Financial repression consists of the following three elements: First, the banking system is forced to hold government bonds and money through the imposition of high reserve and liquidity ratio requirements. Second, the development of private bond and equity markets are discouraged. Lastly, the banking system is characterized by interest rate ceilings. ^ The first chapter develops a neoclassical monetary growth model for a small open economy that encompasses all the features of a financially repressed regime and indicates that in the presence of informal money markets, the relaxation of the interest rate on deposits reduces capital accumulation while a reduction in reserve requirements enhances the same. The second and third chapters develop general equilibrium models to analyze the impact of the relaxation of reserve requirements on inflation, respectively in closed and open economic environments. The results suggest that the relaxation of reserve requirements tend to increase growth and reduce inflation, and hence, corroborate the findings of the empirical literature. The fourth and fifth chapters investigate the two widely held rationales, namely higher tax evasion and higher probability of banking crisis, that are generally used to explain why some countries have higher reserve requirements than others. The general equilibrium models developed indicate that the suggested correlation is not true when the central planner has alternative means of revenue generation besides seigniorage, in our case explicit income taxes. The sixth chapter builds a neoclassical monetary growth model of overlapping generations with endogenous tax evasion, and tries to analyze why some countries with the same degree of tax evasion have widely different reserve requirements. We find that the optimal degree of tax evasion is independent of the reserve requirements. ^ Each of the chapters aims to bridge the gap that exists in the literature between empirical models lacking microfoundation and theoretical models that cannot be extended to real economies. This is performed by providing microfounded models calibrated to Southern European countries. ^