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The resource costs to the U.S. Treasury [to print a $100 bill] are more than offset by the value of the goods that could be purchased with the $100 bill.
Money creation is one potential source of revenue for a government. Seigniorage-government revenue received through creating money-is a relatively inexpensive means of raising funds. Take the United States as an example. It costs just a few pennies to print a $100 bill. The resource costs to the U.S. Treasury are more than offset by the value of the goods that could be purchased with the $100 bill. It is even less expensive for the Federal Reserve to electronically purchase large quantities of Treasury bonds, notes, and bills from traders in New York. It is important to note that the Federal Reserve returns the interest payments on its security holdings (less its expenses) to the U.S. Treasury. Consequently, when the Federal Reserve increases its bond holdings, for example, the U.S. Treasury realizes an effective reduction to its debt expenses.' The present value of the reduction in Treasury expenses is equal to the amount of money injected by the Federal Reserve's open market purchase.
The problem is that although money may be cheap to produce, the social costs of money creation are almost certainly greater than what the Federal Reserve pays to create it. Indeed, a large body of empirical evidence suggests that the rate of money creation is closely correlated with inflation. Thus, faster money creation costs society by eroding the purchasing power of money already in circulation, which is the inflation tax. Though tempted by low production costs, governments must balance the benefits with social costs when deciding how much to rely on seigniorage.
The article addresses two questions. First, how much do countries rely on money creation as a source of revenue? The answer to this question gives some idea of the size of the seigniorage revenue "problem." For most of the countries, money creation accounts for less than 2 percent of real GDP. The evidence indicates that seigniorage revenue is not the primary source of revenue for a government, but neither is it quantitatively insignificant.
Second, are monetary policy settings systematically related to a government's reliance on real seigniorage revenue, and,...