ABSTRACT
While the literature on financial repression and its effects on the growth of developing countries is quite voluminous by now, much less attention has been paid to its public finance aspects. In particular, it is beginning to be argued that financial repression can be and is being used by governments to extract more resources from the economy. Two recent interesting attempts in this direction are by Sussman (1991) and by Giovannini and De Melo (1993). Sussman defines financial repression as a tax on interest income from bonds. Using an overlapping intergenerations model, he shows that in the short-run, this form of financial repression always leads to a reduction in capital accumulation and in the rate of inflation. However, in the long-run, while the effect on capital accumulation is unambiguously negative, the outcome for inflation is uncertain, meaning that the certain short-run trade-off is not always guaranteed in the long-run. Giovannini and De Melo, on the other hand, provide empirical evidence on the effect of financial repression on government revenues. They argue that since financial repression enables the government to borrow from domestic sources at a rate lower than what it would be if borrowed at the international rate, the policy in effect amounts to raising additional revenue from this source. Their evidence shows that in many cases the revenue from this source amounts to almost as much as from seigniorage. The aim of this chapter is to add to this small body of literature.
