Seigniorage

Seigniorage in economics is the difference between the costs of production of currency and what the currency is actually worth. It is the revenue earned by the government while printing or minting the money. The currency is then sold for face value which is generally greater than its cost of production.

The term is also applicable to situations where a central bank lends money and earns interest from the exchange. Seigniorage in economics can be both positive and negative, where a positive seigniorage means that the government earns a profit, and the negative denotes a monetary loss.

• Seigniorage in economics is a government or central bank's revenue from issuing new money.
• It isn’t very costly to produce the new money compared to the worth of actual money. However, some bills or notes are worth higher amounts, such as $20, $50, or $100. The difference between the cost to produce the currency and the money’s actual value is called seigniorage.
• The relationship between seigniorage and inflation can be observed through the Laffer curve. There is a particular point in which seigniorage is most profitable.
• The term is derived from the French term 'seigneur' which was used to describe a lord who minted money and earned a profit from selling it.

Seigniorage is derived from the old French term “seignorage,” which was used to describe a feudal lord (“seigneur”) who had the right to mint money and collect revenue from selling it.

Money production involves two methods –namely, minting and printing.

In the United States, the U.S Mint is in charge of “minting” or making the coins such as pennies, nickels, dimes, and quarters. The U.S Bureau of Engraving and Printing, on the other hand, handles the “printing” or creation of paper currency such as the dollar bill.

This process of minting coins and printing paper currency comes with a cost. According to information from the Federal Reserve’s website, here is the price of printing per each U.S paper currency bill:

As shown in the table, the cost to produce the paper currency is much lower than the bills’ face value. For example, the cost to create a single $1 bill is only 6.2 cents, resulting in a 93.8 cents seigniorage.

This is how a central bank can profit and earn revenue from increasing the money supply. When commercial banks need money, they will borrow from the central bank. The central bank will then loan out the currency to the banks and charge interest on the money lent.

When financial institutions purchase bills from a nation’s central bank, the central bank will use the profits to invest in financial instruments such as bonds or treasury bills. The interest from these investments is also a type of seigniorage. The government uses this profit to fund its various programs and other expenses.

Let’s take the example of the Bank of Canada to see how a government can raise revenue and earn seigniorage from creating and lending banknotes (bills.)

Canada’s central bank, The Bank of Canada, produces the banknotes (bills) for the country, such as the $5, $10, $20, $50, and $100 bills. Just as it is in the U.S, the Canadian bills do not cost nearly as much to produce as their value.

For example, the cost to produce a Canadian bill is around 20 cents per banknote. The interest on investments equals around 2% per year.

Additionally, the cost to produce the $20 Canadian banknote is around 20 cents per bill.

To find the seigniorage earned by the Bank of Canada and the Canadian government, we will use the following formula:

Seigniorage = interest earned – cost to produce

Step 1: Finding the interest earned. 

The interest is 2% per year x $20 bill = .40 or 40 cents per year.

Step 2: Finding the cost to produce the bill.

The cost to produce is around 20 cents per bill, and the $20 bill has an average lifespan of about four years. 

20 cents ÷ 4 years = 5 cents per year.

Step 3: Taking the interest earned and subtracting it from the cost of production

 (40 – 5) cents = 35 cents per year.

This example shows that for every $20 bill the Bank of Canada produces and puts into circulation, the government can collect 35 cents per year in seigniorage.

Inflation is a broad indicator that refers to an increase in buying goods and services. Many things can cause inflation in an economy, such as a spike in aggregate demand.

Many economists agree that the rapid production of currency is another significant contributor to inflation, leading to a considerable increase in the country’s money supply. When a country increases its money supply faster than the supply of goods and services, it can lead to inflation as consumers will be willing to pay more for the goods.

With that being said, to answer the question, many economists consider seigniorage as a form of the inflation tax. Here’s why:

An inflation tax isn’t necessarily a tax in the form that we are used to. Instead, as one holds onto paper currency, such as the dollar bill, when inflation is high, the value of that currency is decreased. So when you go to buy goods or services, the money will be worth less than when you first obtained it.

The relationship between seigniorage and inflation can be observed through the Laffer curve. It shows that at a specific inflation rate, seigniorage revenue will peak.

However, suppose a government is careless with issuing new currency and printing new money. In that case, it can cause inflation as the money supply is increased at a rate that aggregate supply cannot match. Depending on how much new money is issued and the changes in aggregate demand, inflation will affect the price of goods or services.

This has been a guide to Seigniorage in Economics & its Meaning. Here we discuss seigniorage as a revenue, its formula, & why it is called an inflation tax. You may also have a look at the following articles to learn more –

• Dollarization
• Classical Economics
• Voodoo Economics