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(I'm not a student specializing in Economics or Politics, just an undergraduate in Computer Science, so my understanding of basic economic concepts is limited. I'd appreciate it if the answer could minimize the use of technical jargon.)

For simplicity, let's use "apples" to represent produced goods and "coins" to represent currency.
Imagine a (very small) country with the following situation:

  • It currently has a reserve of 200 apples.
  • Its annual GDP is 10 apples.
  • There are 1000 coins in circulation: 50 held by the government and 950 in the market.

From this, we know that the current value of 1 apple equals 5 coins.
This year, the citizens produced another 10 apples, bringing the total to 210 apples.
Let's consider two scenarios:

Balancing Prices

To maintain the value ratio of

\begin{equation} 1 \, \text{apple} = 5 \, \text{coins} , \end{equation}

the government mints 50 new coins.

These 50 new coins eventually enter the market in various ways.

Question: Does this mean the government effectively gains the equivalent of 10 apples' worth of products from the market without any effort?

Currency Devaluation

The government creates even more coins, say 100.
Now, there are 1050 coins in the country, with 100 held by the government and 950 in circulation.
There are 2 factors here that increase the government's wealth:

  • The proportion of coins held by the government increases from 50/1000 to 100/1050.
  • The number of apples increases from 200 to 210.

Again: Does this mean the government gains wealth effortlessly?

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1 Answer 1

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Is Printing Money a Form of Hidden Taxation?

In modern economy most new money is created electronically. Also due to elasticity of money supply not all money is high powered money (i.e. money created by the government), but some money is endogenously created through supply and demand interactions on money market and government does not get to directly control this new money.

When central bank creates more money by buying government bonds against fresh reserves, or in some countries prints more money etc, and gives them to the government, then government can gain a so called seigniorage revenue. Since this new money, ceteris paribus, leads to higher price level it can be considered a 'tax' on everyone's money holding's, including the government's own money (see Mankiw Macroeconomics 7th ed pp 89-94). But since the inflation occurs due to supply demand interactions when the money are initially spent, and if this spending is not anticipated in advance, government does benefit.

However, even though it is possible to see some economists referring to inflation as 'hidden tax' it is worth noting this is not kept as a secret. Even central banks like Fed openly talk about the inflation 'tax' (see St. Louis Fed, 2022) even in its educational pages that are meant to be consumed by general public. Virtually every developed country does it and every country publishes inflation statistics. So it is only 'hidden' in a sense you are not being proactively notified about it by the government. In the past the moniker 'hidden tax' was more justified because before internet and mass media you would only learn about it in college if you majored in economics, and inflation statistics was hard to come by, but now everyone with internet can easily get informed about it.

Does this mean the government effectively gains the equivalent of 10 apples' worth of products from the market without any effort?

No.

  1. Even though the administrative costs of getting seignorage revenue are trivially low compared to administrative costs of regular taxation, it is not literally effortless.

  2. The government can only benefit in real terms when the increase in amount of money is unexpected. When people expect that that there will be inflation of 2% they will continuously adjust prices upward by 2% even before government can spend them. Hence as explained by St. Louis Fed (2022)), in order for the government to actually have some real gains from the inflation it has to be unexpected.

    Moreover, while small level of inflation can be beneficial for an economy, high inflation is causes all sort of distortions (e.g. menu costs - costs to firms of continuously adjusting prices, shoe-leather cost - costs to households that are created when inflation incentivizes suboptimal money holdings, distortions due to redistribution between borrowers and lenders etc. Mankiw Macroeconomics 7th ed pp 102-105).

    Hence we are not talking about some sort of free lunch. Every economy has some optimal level of inflation (many economists think it is around 2% per year). If we assume that we start in equilibrium where government sets and follows 2% inflation target and people trust this (so the inflation is anticipated), government does not really benefit in real terms from this inflation since it will be automatically translated into higher prices and interest rates. If government surprisingly deviates from this 2% equilibrium by for example creating so much money that inflation will become 4%, the government will be better off in real terms for a time before people's expectation adjusts, however, this also comes at a cost to wider economy. These costs are only getting higher the higher inflation is, and at some point high inflation might damage productive capacity of whole economy to such extent that government is not really getting any more real resources out of doing this on net balance.

  3. Since not all money are high powered (government created) money and money supply is not necessarily completely vertical, when the amount of high powered money is increased it could be either offset or supplemented by further money creation or destruction depending on parameters of an economy. Hence the amount of real revenue government gets out of it is much more uncertain. Economy also responds to regular taxation, so regular tax revenue is uncertain as well, but certainly not to such a high degree as revenue government can collect through inflation tax.

PS:

Currency devaluation is when central bank sets different value of money directly (e.g on forex with fixed exchange rate or changing the convertibility rate under commodity standards such as gold standard), not when value of money decreases naturally on the market. That is called currency depreciation not currency devaluation.

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