OPTIMAL SEIGNIORAGE AND FINANCIAL LIBERALIZATION

This paper analyzes the effect of financial integration for countries relying on the taxation of their domestic financial system. A two-country model with overlapping generations and explicit financial intermediation is used. Governments derive revenues from seigniorage and set optimally, but non-cooperatively, the rate of inflation and the level of required reserves on bank deposits. A financial liberalization leads to lower reserve ratios, higher inflation rates, and larger stocks of government debt. When the liberalization is anticipated, governments may temporarily increase the reserve ratios before the liberalization occurs. (JEL F30, E60)