Seignorage and ZIRP
part 4 seignorage
Governments through the ages have appropriated real resources through the monopoly of the 'coinage'. In modern fiat money economies, the monopoly of the issue of legal tender is generally assigned to an agency of the state, the Central Bank, which may have varying degrees of operational and target independence from the government of the day. In this paper I analyse four different but related concepts, each of which highlights some aspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) the inflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury. To understand the relationship between these four concepts, an explicitly intertemporal approach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated 'government budget constraint' and consolidated 'government intertemporal budget constraint' into the separate accounts and budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank's ability to pursue and achieve an inflation target, and the importance of cooperation and coordination between the Treasury and the Central Bank when faced with financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimick Milton Friedman's helicopter drop of money in an economy faced with a liquidity trap.
I. Introduction Seigniorage refers historically, in a world with commodity money, to the difference between the face value of a coin and its costs of production and mintage. In fiat money economies, the difference between the face value of a currency note and its marginal printing cost are almost equal to the face value of the note – marginal printing costs are effectively zero. Printing fiat money is therefore a highly profitable activity – one that has been jealously regulated and often monopolized by the state. Although the profitability of printing money is widely recognized, the literature on the subject contains a number of different measures of the revenue appropriated by the state through the use of the printing presses. In this paper, I discuss four of them and consider the relationship between them in an intertemporal setting. There also is the empirical institutional regularity, that the state tends to assign the issuance of fiat money to a specialized agency, the Central Bank, which has some degree of independence from the other organs of the state and from the government administration of the day. This institutional arrangement has implications for the conduct of monetary policy that cannot be analysed in the textbook macroeconomic models, which consolidate the Central Bank with the rest of the government. In the next four Sections, the paper addresses the following four questions. (1) What resources does the state appropriate through the issuance of base money (currency and commercial bank balances with the Central Bank)? (2) What inflation rate would result if the monetary authority were to try to maximise these resources? (3) Who ultimate appropriates and benefits from these resources, the Central Bank or the Treasury/Ministry of Finance? (4) Does the Central Bank have adequate financial resources to pursue its monetary policy mandate (taken to be price stability) and its financial stability mandate. Specifically, for inflation-targeting Central 2 Banks, is the inflation target financeable? The first two questions receive preliminary answers in Section II of the paper, confirming results that can be found e.g. in Walsh (2003) and Romer (2006). The second half of Section II contains an analysis of the relationship between three of base money issuance revenue measures (seigniorage, central bank revenue and the inflation tax) in real time, that is, outside the steady state and without the assumptions that the Fisher hypothesis holds and that the velocity of circulation of base money is constant over time. It derives the ‘intertemporal seigniorage identity’ relating the present discounted value of seigniorage and the present discounted value of Central Bank revenue. The government’s period budget constraint and its intertemporal budget constraint have been familiar components of dynamic macroeconomic models at least since the late 1960s (see e.g. Christ (1968), Blinder and Solow (1973) and Tobin and Buiter (1976)). The ‘government’ in question is invariably the consolidated general government (central, state and local, henceforth the ‘Treasury’) and Central Bank. When the Central Bank has operational independence, it is useful, and at times even essential, to disaggregate the general government accounts into separate Treasury and Central Bank accounts. Section III of the paper presents an example of such a decomposition, extending the analysis of Walsh (2003). In Section IV, a simple dynamic general equilibrium model with money is presented, which incorporates the Treasury and Central Bank whose accounts were constructed in Section III. It permits all four questions to be addressed. Section V raises two further issues prompted by the decomposition of the government’s accounts into separate Central Bank and Treasury accounts: the need for fiscal resources to recapitalise an financially stretched or even insolvent Central Bank and the institutional modalities of ‘helicopter drops of money’.
Zero lower bound speech
The Zero Lower Bound Problem Has Been, And Will Continue to Be, A Big Deal I’ll begin by motivating why I see the zero lower bound problem as likely to be central to future macroeconomic policy-making. If we go back a decade in time, the zero lower bound problem was still viewed as largely a curiosum in macroeconomics. Yes, the Bank of Japan had kept short-term nominal interest rates at the zero lower bound for many years. But this experience, and the associated macroeconomic outcomes, was viewed by many experts in the policy and academic community outside of Japan as largely reflecting factors peculiar to that country. Of course, if we fast forward to 2017, the situation has changed tremendously. Central banks in the West have spent much of the past decade at their own effective lower bounds. For example, in the US, the Fed kept the interest rate on excess reserves at a quarter percent for seven years between December 2008 and December 2015. Indeed, I’ve been a macroeconomist for thirty years, and the Fed has been at or near its effective lower bound for about a quarter of that time. The recent stays at the effective lower bound have been associated with truly horrific macroeconomic outcomes throughout the West. But even in the US, where the recovery was relatively stronger, the civilian unemployment rate was over 7% for nearly five years, and did not return to its pre-crisis low for 3 over a decade. Yearly core PCE inflation has been below the Fed’s target of 2% for most of the past nine years. These outcomes are certainly suggestive that Fed was significantly constrained in the past decade in its pursuit of its dual mandate. Are central banks and their economies likely to endure similar experiences going forward? Forecasting is hard, especially about the future. But I believe that there are two good reasons why, in the absence of large changes in the policy regimes, we should anticipate even longer stays at the zero longer bound than we’ve seen in the recent past. My first reason is empirical, and will come as no surprise to followers of the research produced at this institution. Roughly speaking, central banks hit the zero lower bound when the neutral real rate of interest – so-called r* - falls to -2% or lower. Of course, r* isn’t observable. But Thomas Laubach and John Williams have provided a simple but compelling approach to impute long-run measures of r* from observables like real GDP growth, inflation, and nominal interest rates. Their approach suggests that long-run r* has fallen by over 200 basis points in the US over the past ten years and, as of the end of the second quarter of 2017, remains close to zero.3 This estimate suggests it will take significantly smaller adverse shocks to the neutral real rate of interest than in the past to push the Fed into the zero lower bound.4 My second reason is related to the “fear of fear” about which Franklin Roosevelt warned in his first inaugural address. Suppose that the economy were to experience a sharp decline in the neutral real rate of interest – possibly due to a new financial crisis
over a one to two year period. Given how low r* is, the central bank would be unable to insulate the macroeconomy against the shock. As a result, aggregate economic activity could fall by a lot in response to this kind of shock. In my hypothetical, I’ve posited that the decline in the neutral real rate of interest was only transitory. It might seem that the economy should recover rapidly after this shock. The problem is that after a short, but sharp, decrease in economic activity, people are likely to believe that they face a significant near-term risk of another big recession. That belief increases their precautionary demand for savings and lowers their demand for current consumption. The central bank can and should offset this decline in consumption demand by lowering its target interest rate. However, if this fear-generated decline in demand is sufficiently large, then the central bank could be constrained by the effective lower bound. In this way, even a short decline in the neutral real rate of interest can lead to protracted stays at the effective lower bound. To summarize: in the past decade, many central banks have spent extremely long periods of time at their effective lower bounds. The decline in long-run r*, combined with plausible feedback effects of deep recessions on household uncertainty and fear, is likely to make future stays even longer. In the absence of a significant change in the US macroeconomic policy regime, we face a considerable risk that the economy could endure damaging decade-long spells at the Fed’s effective lower bound.
Governments through the ages have appropriated real resources through the monopoly of the 'coinage'. In modern fiat money economies, the monopoly of the issue of legal tender is generally assigned to an agency of the state, the Central Bank, which may have varying degrees of operational and target independence from the government of the day. In this paper I analyse four different but related concepts, each of which highlights some aspect of the way in which the state acquires command over real resources through its ability to issue fiat money. They are (1) seigniorage (the change in the monetary base), (2) Central Bank revenue (the interest bill saved by the authorities on the outstanding stock of base money liabilities), (3) the inflation tax (the reduction in the real value of the stock of base money due to inflation and (4) the operating profits of the central bank, or the taxes paid by the Central Bank to the Treasury. To understand the relationship between these four concepts, an explicitly intertemporal approach is required, which focuses on the present discounted value of the current and future resource transfers between the private sector and the state. Furthermore, when the Central Bank is operationally independent, it is essential to decompose the familiar consolidated 'government budget constraint' and consolidated 'government intertemporal budget constraint' into the separate accounts and budget constraints of the Central Bank and the Treasury. Only by doing this can we appreciate the financial constraints on the Central Bank's ability to pursue and achieve an inflation target, and the importance of cooperation and coordination between the Treasury and the Central Bank when faced with financial sector crises involving the need for long-term recapitalisation or when confronted with the need to mimick Milton Friedman's helicopter drop of money in an economy faced with a liquidity trap.
I. Introduction Seigniorage refers historically, in a world with commodity money, to the difference between the face value of a coin and its costs of production and mintage. In fiat money economies, the difference between the face value of a currency note and its marginal printing cost are almost equal to the face value of the note – marginal printing costs are effectively zero. Printing fiat money is therefore a highly profitable activity – one that has been jealously regulated and often monopolized by the state. Although the profitability of printing money is widely recognized, the literature on the subject contains a number of different measures of the revenue appropriated by the state through the use of the printing presses. In this paper, I discuss four of them and consider the relationship between them in an intertemporal setting. There also is the empirical institutional regularity, that the state tends to assign the issuance of fiat money to a specialized agency, the Central Bank, which has some degree of independence from the other organs of the state and from the government administration of the day. This institutional arrangement has implications for the conduct of monetary policy that cannot be analysed in the textbook macroeconomic models, which consolidate the Central Bank with the rest of the government. In the next four Sections, the paper addresses the following four questions. (1) What resources does the state appropriate through the issuance of base money (currency and commercial bank balances with the Central Bank)? (2) What inflation rate would result if the monetary authority were to try to maximise these resources? (3) Who ultimate appropriates and benefits from these resources, the Central Bank or the Treasury/Ministry of Finance? (4) Does the Central Bank have adequate financial resources to pursue its monetary policy mandate (taken to be price stability) and its financial stability mandate. Specifically, for inflation-targeting Central 2 Banks, is the inflation target financeable? The first two questions receive preliminary answers in Section II of the paper, confirming results that can be found e.g. in Walsh (2003) and Romer (2006). The second half of Section II contains an analysis of the relationship between three of base money issuance revenue measures (seigniorage, central bank revenue and the inflation tax) in real time, that is, outside the steady state and without the assumptions that the Fisher hypothesis holds and that the velocity of circulation of base money is constant over time. It derives the ‘intertemporal seigniorage identity’ relating the present discounted value of seigniorage and the present discounted value of Central Bank revenue. The government’s period budget constraint and its intertemporal budget constraint have been familiar components of dynamic macroeconomic models at least since the late 1960s (see e.g. Christ (1968), Blinder and Solow (1973) and Tobin and Buiter (1976)). The ‘government’ in question is invariably the consolidated general government (central, state and local, henceforth the ‘Treasury’) and Central Bank. When the Central Bank has operational independence, it is useful, and at times even essential, to disaggregate the general government accounts into separate Treasury and Central Bank accounts. Section III of the paper presents an example of such a decomposition, extending the analysis of Walsh (2003). In Section IV, a simple dynamic general equilibrium model with money is presented, which incorporates the Treasury and Central Bank whose accounts were constructed in Section III. It permits all four questions to be addressed. Section V raises two further issues prompted by the decomposition of the government’s accounts into separate Central Bank and Treasury accounts: the need for fiscal resources to recapitalise an financially stretched or even insolvent Central Bank and the institutional modalities of ‘helicopter drops of money’.
Zero lower bound speech
The Zero Lower Bound Problem Has Been, And Will Continue to Be, A Big Deal I’ll begin by motivating why I see the zero lower bound problem as likely to be central to future macroeconomic policy-making. If we go back a decade in time, the zero lower bound problem was still viewed as largely a curiosum in macroeconomics. Yes, the Bank of Japan had kept short-term nominal interest rates at the zero lower bound for many years. But this experience, and the associated macroeconomic outcomes, was viewed by many experts in the policy and academic community outside of Japan as largely reflecting factors peculiar to that country. Of course, if we fast forward to 2017, the situation has changed tremendously. Central banks in the West have spent much of the past decade at their own effective lower bounds. For example, in the US, the Fed kept the interest rate on excess reserves at a quarter percent for seven years between December 2008 and December 2015. Indeed, I’ve been a macroeconomist for thirty years, and the Fed has been at or near its effective lower bound for about a quarter of that time. The recent stays at the effective lower bound have been associated with truly horrific macroeconomic outcomes throughout the West. But even in the US, where the recovery was relatively stronger, the civilian unemployment rate was over 7% for nearly five years, and did not return to its pre-crisis low for 3 over a decade. Yearly core PCE inflation has been below the Fed’s target of 2% for most of the past nine years. These outcomes are certainly suggestive that Fed was significantly constrained in the past decade in its pursuit of its dual mandate. Are central banks and their economies likely to endure similar experiences going forward? Forecasting is hard, especially about the future. But I believe that there are two good reasons why, in the absence of large changes in the policy regimes, we should anticipate even longer stays at the zero longer bound than we’ve seen in the recent past. My first reason is empirical, and will come as no surprise to followers of the research produced at this institution. Roughly speaking, central banks hit the zero lower bound when the neutral real rate of interest – so-called r* - falls to -2% or lower. Of course, r* isn’t observable. But Thomas Laubach and John Williams have provided a simple but compelling approach to impute long-run measures of r* from observables like real GDP growth, inflation, and nominal interest rates. Their approach suggests that long-run r* has fallen by over 200 basis points in the US over the past ten years and, as of the end of the second quarter of 2017, remains close to zero.3 This estimate suggests it will take significantly smaller adverse shocks to the neutral real rate of interest than in the past to push the Fed into the zero lower bound.4 My second reason is related to the “fear of fear” about which Franklin Roosevelt warned in his first inaugural address. Suppose that the economy were to experience a sharp decline in the neutral real rate of interest – possibly due to a new financial crisis
over a one to two year period. Given how low r* is, the central bank would be unable to insulate the macroeconomy against the shock. As a result, aggregate economic activity could fall by a lot in response to this kind of shock. In my hypothetical, I’ve posited that the decline in the neutral real rate of interest was only transitory. It might seem that the economy should recover rapidly after this shock. The problem is that after a short, but sharp, decrease in economic activity, people are likely to believe that they face a significant near-term risk of another big recession. That belief increases their precautionary demand for savings and lowers their demand for current consumption. The central bank can and should offset this decline in consumption demand by lowering its target interest rate. However, if this fear-generated decline in demand is sufficiently large, then the central bank could be constrained by the effective lower bound. In this way, even a short decline in the neutral real rate of interest can lead to protracted stays at the effective lower bound. To summarize: in the past decade, many central banks have spent extremely long periods of time at their effective lower bounds. The decline in long-run r*, combined with plausible feedback effects of deep recessions on household uncertainty and fear, is likely to make future stays even longer. In the absence of a significant change in the US macroeconomic policy regime, we face a considerable risk that the economy could endure damaging decade-long spells at the Fed’s effective lower bound.
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