Home > Uncategorized > “Seigniorage” is not the same thing as the “inflation tax”

“Seigniorage” is not the same thing as the “inflation tax”

Update: a follow up to this post which calculates seigniorage income of European private banks can be found here

The most dramatic example of “seigniorage” I know about is the period after the German hyperinflation of the 1920’s. During the hyperinflation people shunned money and wanted to get rid of it: the “hot potato effect”. After the hyperinflation, people wanted to restore their cash balances and the stock of money (the new ‘Rentenmark’, not legal tender by the way) quadrupled without any inflationary consequences. Let’s call this the “seed potato effect”. Which, of course, led to a seigniorage profit for the institution wich emitted this money. Just like the selling of stamps to stamp collectors leads to a seigniorage profit for countries like Lichtenstein (aside: the new-age idea of Thomas Sargent that the non-inflationary expansion of money was possible because of enhanced ‘credibility’ of the German government is of course wrong. It was due to new institutions. The Central Bank was even side-lined. Hjalmar Schacht, the main bureaucrat of the new German system, was of course extremely credible – as he knew that it was not gold, rye (yes, even a rye standard was devised) or credibility but rationing of credit in the new, non-Central Bank currency which was the solution).

I state this because recently two Dutch economists again equated ‘seigniorage’ with the ‘inflation tax’– which is wrong and confuses the already confused discussion about the Euro even more. You can call an inflation tax ‘seigniorage’ – but that does not mean that seigniorage is the same thing as an inflation tax. A cow is an animal but not every animal is a cow. Seigniorage can even exist when the price level goes down. These economists are to be excused: the same mistake can be found even in enlightened textbooks (for instance Colander and Gamber, 2002, p. 188). According to these textbooks, an increase in the supply of money by definition leads to an increase in the price level – and the value of existing money diminishes as much as the total value of the newly emitted money. Quod non (see the examples above). TAM (to avoid misunderstandings): we’re at this moment of course not in the same situation as the Weimar Republic in 1923.

I think that it’s better to call ‘seigniorage’ seigniorage and to restrict the phrase to the profits made by emitting money (including for instance interest on mortgages enabled by creating ‘bankmoney’) and to call an ‘inflation tax’ an inflation tax and to restrict this phrase to the decline of the value of existing money caused by an increase of the price level caused by emitting money. It’s however quite possible to estimate ‘seigniorage’, while it’s, in cases of low inflation, quite hard to estimate any kind of inflation tax. How, for instance, to treat the 1990 – 2008 house price inflation triggered by  the run away increase of mortgage lending?

Is this just another esoteric economic discussion? No. At this moment the institution emitting Euro notes is making quite a seigniorage-profit, as people in Spain and Greece seem to change deposit-money (created by the banks) for Euro notes (emitted by the ECB) at a billion-a-day rate. They are using deposit money to buy notes, to state this otherwise. As far as I know (but I might be wrong on this) this profit (officially, production costs of the notes has to be subtracted) is split among the Euro states according to the number of ECB-shares the Euro countries own.

  1. cidiel
    May 18, 2012 at 2:37 pm

    i’m almost following you on this but i’m a little fuzzy on the mechanics of it. I’m under the impression that germany under the guise or solidarity of the union is effectively letting the ECB print the deposit flight, which is how i see it. If that is the case then by definition wouldn’t the increase in euro’s be leading to potential diminishing effects to the currency as a whole? As you stated above,
    “According to these textbooks, an increase in the supply of money by definition leads to an increase in the price level – and the value of existing money diminishes as much as the total value of the newly emitted money.”
    this increase in price level of money being referred to is = to inflation? I’m not saying the ECB is creating a weimar situation, but they are increasing actual Euros in circulation, which should ultimately be detrimental to the currency in the end. still fuzzy, but 100% agree, that ECB is printing the deposit flight.

    • merijnknibbe
      May 18, 2012 at 6:41 pm

      At this moment Mario Draghi tries to increase the amount of money in the Eurozone – but he’s not succesfull: mney growth is way below target (+4,5%). He did manage to prop up the banks – but that did work as well as putting more money into an ATP machine and hoping that people will take more money out of this machine, because you put more money into it. But if people do not want to spend and do not want the money… so, the ECB is trying to increase the amount of money but does not succeed.

      And just changing deposit money for cash does not increase the amount of money, as the deposit money ‘paid’ to the banks to obtain cash ‘vanishes’ from the stock of money owned by households and companies.

  2. May 21, 2012 at 9:20 am

    Instead of making yet another unpayable “loan” to Greece, the ECB should just make a grant, interest AND principal free. Ironically, because Greece would then be able to stimulate job creation, and would have wage-inflation instead of asset inflation for a change, they would actually be a in a better position to pay off the remaining debt. Of course, that would expose the fiction that fiat money is something one can “run out of.” It would make the banks look like the leeches they are. We can’t have that. Better to condemn millions of Greeks to poverty and ruin their country.

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