Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Seigniorage: Financing the government by printing money

When governments generally behave themselves, they fund their economies from the tax revenue they collect. If they’re feeling slightly naughty, they fund themselves by borrowing money from whomever will lend it to them.

If they’re feeling very naughty (or perhaps no one is willing to lend to them, because they’re seen as a bad risk), governments fund themselves by printing money – known as seigniorage (and you thought it was the name of a French actress!). For more on the three potential sources of funds, turn to Chapter 11.


The bottom line is that a government usually turns to printing money when the following two situations apply:


It’s running a budget deficit: Government spending is greater than tax revenue.


No one is willing to lend it money on reasonable terms: Potential lenders don’t believe that they’re likely to be paid back.

In other words, if the government wasn’t running a budget deficit, it wouldn’t have to borrow money, and if someone was willing to lend to it at reasonable rates it wouldn’t have to print money to cover its budget deficit. As you can guess, governments tend not to use seigniorage unless it’s the only remaining option, for the simple reason that seigniorage never ends well…

Seeing how seigniorage can lead to hyperinflation

As we describe in the earlier section ‘Trying out the quantity equation’, the quantity equation (MV = PY) means that the rate of inflation is equal to the

rate of growth of the money supply minus the rate of growth of output:


Seigniorage on any meaningful scale means a massive increase in the amount of money in the economy: that is, a massive increase in g_M. In turn, this causes a massive increase in inflation. The intuition is clear: if the government prints large amounts of money, it devalues the money already in existence by making it worth less.

Things might be okay if this was the end of the story. Unfortunately, it’s not. High inflation makes collecting tax revenue very difficult, owing to a time lag in the collection of taxes. For example, you may work all year but only pay your income tax at the end of the year. Or a business may pay its VAT bill after a few months. In normal times these short delays have little impact, but in an economy with high levels of inflation, even short delays destroy the real value of tax receipts.

Now the government’s initial problem is ten times worse: it has a worse budget deficit than it started with, financial markets still won’t lend to it and inflation has taken off. In the short term, the government can do very little except to engage in even more seigniorage.

The vicious cycle is now in full motion, with large amounts of seigniorage leading to large amounts of inflation, which further reduces real tax revenue and requires even more seigniorage. Unchecked, hyperinflations can easily become explosive – where the price level doubles every couple of hours. Money stops functioning as a store of value, medium of exchange and unit of account, and people switch to bartering or using another country’s currency – usually the US dollar.