Optimal government finance models illustrating trade-offs between different policy instruments, such as seigniorage and income taxes, have focused on the United States and other industrialized countries. This dissertation examines the trade-off between the effective reserve ratio and currency growth in developing countries. Because developing countries have significantly higher reserve requirement rates than industrialized countries, the disaggregation of money into reserves and currency is particularly important for understanding seigniorage revenue. Governments may use the reserve requirement to increase the base on which the inflation tax is levied while minimizing welfare losses and maintaining a given level of seigniorage. In addition, if the government uses reserve money for its own consumption, the reserve requirement constitutes a form of forced lending.; The welfare loss function presented in this dissertation includes the effective reserve ratio and currency growth rate as instruments. A democracy variable, the interaction of democracy and currency growth, and trade as a proportion of gross domestic product are also included in the final regression.; The model is estimated for twenty-nine developing countries via feasible generalized least squares and instrumental variables. The results indicate that the governments in the sample are using the reserve requirement to minimize the welfare losses associated with seigniorage revenue and that they exhibit a preference for currency growth over reserve growth as democracy increases. The effective reserve ratio is also positively associated with the level of democracy. These results are robust to the inclusion of other government revenue in the regression. The results for the effect of openness to trade are mixed.
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