Quiz 22: Developing Countries: Growth, Crisis, and Reform

Business

Seigniorage is profit from money creation (that is printing money), a way for governments to generate revenue without levying conventional taxes. Under fiat money system, the product of the inflation rate and the inflation tax base gives seigniorage revenue. Mathematically expressed as: img The inflation tax base is the level of real money balances that reflects the purchasing power of the public's money holdings. img Remember, rapid monetary expansion causes the inflation rate to rise, but the revenue effects are offset, as individuals attempt to spend the extra money, quickly before it depreciates further. If people spend more money than being printed, the rate of price increase exceeds the rate of money issued. Therefore, an attempt to raise seigniorage revenue not only leads to inflation, but also eventually is self-defeating.

Seigniorage is profit from money creation (that is printing money), a way for governments to generate revenue without levying conventional taxes. Under fiat money system, the product of the inflation rate and the inflation tax base gives seigniorage revenue. Mathematically expressed as: img The inflation tax base is the level of real money balances that reflects the purchasing power of the public's money holdings. img Therefore, a higher inflation rate leads to lower levels of real money balances and vice-versa.Given that: • Inflation rate in the year 1990 and 2000 is 100% • It was falling in the 1 st year and rising in the 2 nd year. Since the asset holders, have correctly anticipated the path of inflation, the real money balances of the people will be more. As a result, seigniorage revenues will be less. Similarly, in the year 2000, though the inflation rate is rising, the real balances of the people will fall. As a result, the seigniorage revenue will be greater.

________________________________________________________________________ Seignior-age revenue refers to the product of inflation rate and the real money balances held by the people. Higher is the inflation rate, lower is the real money balances level; therefore lower is the seigniorage revenues. ________________________________________________________________________ Since Brazil's inflation rate is at 147 percent, its real money balance holdings will be reduces so as to reduce its seigniorage revenue. While Sierra Leone's inflation rate is less than one-third of that of Brazil, that is 49 percent, its real money balance holdings will be increased so as to increase its seigniorage revenue. Relatively Brazil's seignior-age revenue as a percentage of output (1.0%)is lesser than that of Sierra Leone (2.4%). Now the difference in seigniorage revenue for both the countries reflects a difference in the financial structure in both the countries. The contrasting fact is that nominal money holdings in Sierra Leone (7.7%)is much more than that of Brazil (1.4%)along with the given inflation rates implies that the Brazil has less real money holdings.