Academic journal article Federal Reserve Bank of St. Louis Review

Seigniorage in the United States: How Much Does the U.S. Government Make from Money Production?

Academic journal article Federal Reserve Bank of St. Louis Review

Seigniorage in the United States: How Much Does the U.S. Government Make from Money Production?

Article excerpt

Money is certainly one of the greatest inventions of mankind. As Brunner and Meltzer (1971) have noted, its vast social productivity arises from the enormous reduction in transactions and information costs that it provides by serving as a standardized medium of exchange.(1) Of course, these benefits like those of any other good or service, are not provided at zero cost. The revenue received from producing and maintaining a nation's money stock covers its production costs and, perhaps, some profit as well for its producers.

In monetary economics, the revenue from money creation is called "seigniorage." Unfortunately, this term has been subject to a variety of interpretations in the literature. After reviewing several traditional definitions, this article develops a new seigniorage measure, extended monetary seigniorage, and shows how it is distributed between the Federal Reserve, member banks and the U.S. Treasury during the 1951-90 period. Then, it examines the relationship between inflation and seigniorage during this period and shows that this relationship is analogous to the well-known "Laffer curve" that relates tax rates and tax revenues: seigniorage increases as inflation rises until the inflation rate reaches about 7 percent; thereafter, inflation and seigniorage are inversely related. Indeed, for each percentage point rise in inflation above 7 percent, the U.S. Treasury's share of seigniorage fell, on average, by $1.4 billion (measured at 1982/84 consumer prices).




The term "seigniorage" dates back to the early Middle Ages, when it was common for sovereigns of many countries to finance some of their expenditures from the profits they earned from the coinage of money. In the money literature, seigniorage has often been used interchangeably for either the total revenue or the profit derived from money production and maintenance. Of course, revenues and profits are identical only if costs are zero. Although theoretical analysis can be simplified by assuming that costs are zero, this assumption cannot be maintained in empirical applications. Since this article focuses on the empirical issues associated with seigniorage, the total revenue, cost and profits associated with money production must be carefully distinguished and the relevant notion of seigniorage must be clearly defined.

In the analysis that follows, seigniorage is defined as the revenue associated with money production and maintenance, rather than the resulting profit. Also, the focus is on the revenue accruing to the government and, therefore, on the creation of monetary base rather than the creation of deposits by private depository institutions.

Monetary theorists have used two main concepts of seigniorage in analyzing its relationship to inflation. These concepts are termed "opportunity cost seigniorage" and "monetary seigniorage."

Opportunity Cost Seigniorage

As its name indicates, opportunity cost seigniorage defines seigniorage as the total "opportunity costs" of money holders. It asks the question, What additional real income would individuals have earned if they had held interest-earning assets instead of non-interest-earning money.? The real interest earnings foregone by holding money are called its opportunity cost.

Real opportunity cost seigniorage ([S.sub.O]) is:

(1) [S.sub.O] = rB/P,

where B denotes total base money holdings, r is the representative nominal rate of return on assets other than base money and P is the consumer price level.

This concept of seigniorage has been used as an elegant tool of theoretical analysis.(2) Its analytical attraction is that it derives the value of seigniorage from the individuals' valuation of the services of money. It does this by identifying seigniorage with the interest income that individuals voluntarily forego by holding some of their wealth as money instead of as earning assets. …

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