Seigniorage

In my June 10 post on the penny, I wrote:

The U.S. government makes a pretty penny (pun intended) on seigniorage. It’s not as much as it used to be because more and more people use credit cards and even cryptocurrency to buy goods and services. Still, it’s a good amount.

The biggest gain from seigniorage is on the $100 bill. Printing one costs the federal government just 9.4 cents. So, when the feds spend this $100, they make a nice profit of $99.90. Not bad. Printing a $1 bill costs the feds 3.2 cents. So even on a $1 bill, the feds make 97 cents.

In the comments, Rob Rawlings wrote:

I’m a bit confused by the idea of the government earning seigniorage by printing new notes. Happy to be corrected if I’m wrong but don’t they earn seigniorage when they buy back their own bonds with newly created electronic money rather than when they print new paper notes? When they print these new notes (to match an increased demand to hold them rather than electronic money) then the costs of printing seems like it would be a real cost.

I agreed that the cost of printing would be a real cost but that that cost was small relative to the face value of a $100 bill and even of a $1 bill.

Rob responded:

If the newly printed note is provided to a bank in exchange for an equivalent amount of base money, then where is the “net seigniorage”? It seems the seigniorage occurred previously when the government created new base money by buying back bonds.

Somehow, in responding, I missed Rob’s second sentence above. I think that’s true. The bottom line is that there is seigniorage and that he identified where it happens.

I think I erred in even going in the direction of talking about “net seigniorage,” as you’ll see when I quote Jeff Hummel below.

I brought in my monetary theory and policy guru, Jeff Hummel, who sent me the following paragraph:

I think we just have a definitional difference here. If you want to look at net seigniorage as you define it, that is fine and sometimes informative. But what I think is the standard way to think about seigniorage is as a tax (a tax on real cash balances), analogous to explicit taxes and government borrowing, the other two main ways governments generate revenue. Both of those have their associated costs of collection that you could at least in theory net out. But no matter how a government creates a new dollar and puts it into circulation, whether with a coin, bill, or electronically as with non-interest-bearing bank reserves, the burden imposed on the government’s subjects (through an eventual reduction of real cash balances) is still ultimately a dollar.

I agree with Jeff. Well, almost. I’m going to be a little picky here and point out that the burden of a tax is never (except in the case of a lump-sum tax) the amount of revenue collected. It’s that amount plus the deadweight loss, in this case, from people economizing on their holdings of real cash balances.

It occurs me now in retrospect that some readers might think I’m advocating that the federal government print more $100 bills. I’m not.

Instead, I’m making a more modest point, and it’s this. Let’s say that the Federal Reserve has chosen an optimal monetary policy, defined however. Scott Sumner will have one definition, John Taylor another, and so on. But let’s hypothesize that in choosing this optimal monetary policy, the Fed assumed that there would be no additional demand in other countries for U.S. currency. In other words, it assumed that whatever U.S. currency was currently being held abroad, there would be no additional demand.

But, it turns out, there is additional demand. Then the optimal monetary policy would not be the one the Fed chose. The optimal policy would be to print more $100 bills.

Note 1: Thanks to Rob Rawlings for raising good points and to Jeff Hummel for helping me think through it.

Note 2: I gave directions to ChatGPT to draw a picture of a $100 bill with, due to whimsy on my part, the size of Ben Franklin’s head exaggerated. At whatever size, I think Franklin’s expression makes him look a little like Jack Benny.