Open AccessOptimal Inflationary and Reserve Requirement Policies: A Study of an Economy with an Informal Sector
Author(s) -
Hamid E. Ali
Publication year - 2011
Publication title -
s and p : sound and pictures
Language(s) - English
Resource type - Journals
ISSN - 1675-722X
DOI - 10.32890/ijbf2011.8.1.8419
Subject(s) - seigniorage , economics , reserve requirement , inflation (cosmology) , context (archaeology) , informal sector , money creation , monetary policy , government (linguistics) , finance , developing country , monetary economics , economy , macroeconomics , central bank , market economy , economic growth , biology , paleontology , linguistics , philosophy , physics , theoretical physics
Governments in developing economies often resort to taxing bank money balances through imposition of high reserve requirements and also by relying on seigniorage to finance their deficits. In the context of those practices, this research attempts to answer the following questions. First, why do developing economies with an informal sector resort to inflationary measures to finance their activities? Second, how does a government induce an agent to choose the formal economy? As to the first question on the trade-off between inflation and reserve requirements, it is shown that of maximum inflation and minimum reserve requirements will increase the steady-state utility of an optimizing agent. Regarding the second question, the agents prefer the informal economy if policy relies on a maximum reserve requirement.