Maxwell J. Fry1
This chapter reviews the fiscal activities that governments have imposed on their central banks in a sample of 26 developing countries. In the main, these activities fall under five categories: (1) seigniorage; (2) financial restriction; (3) selective credit policies; (4) foreign exchange operations at nonmarket-clearing prices; and (5) implicit or explicit deposit insurance at subsidized rates and recapitalization of insolvent financial institutions. Not all central banks engage in all these activities, but some central banks perform additional fiscal activities such as collecting taxes and running food procurement programs.
Much of the literature on government revenue from inflation displays technique rather than realism. In response to a flurry of increasingly unworldly articles on the inflation tax, Vito Tanzi (1977) pointed out that, in practice, inflation erodes the real value of traditional tax revenues; he elaborated on the negative impact of inflation on the real value of traditional tax revenue sources in 1989 (Tanzi, 1989). The Tanzi effect is now part of the vocabulary of economists. While one of the inferences to be drawn from the Tanzi effect is that maximizing revenue from inflation does not maximize combined traditional and inflation tax revenue, another is that inflation is even more deleterious than had generally been recognized.
Here I attempt to extend Tanzi’s fiscal approach to inflation by taking a fiscal approach to a broader range of central banking activities. Not only can the central bank collect revenue for the government through the inflation tax, it can also engage in a number of other activities of a fiscal nature on both the revenue and the expenditure side of the fiscal equation. As with the inflation tax, these other fiscal activities have drawbacks that may not have been fully recognized.
Traditional texts on central banking generally list the following functions of the central bank: