Macroeconomics

F I G U R E

4 - 2

Inflation rate (percent, 

logarithmic scale)

100

10

1

0.1

Money supply growth (percent, logarithmic scale)

1

10

100

Ecuador

United States

Singapore

Argentina

Venezuela

China

Euro Area

Switzerland

Turkey

Belarus

Haiti

Indonesia

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C H A P T E R   4

Money and Inflation

| 93

taxes, such as personal and corporate income taxes. Second, it can borrow from

the public by selling government bonds. Third, it can print money.

The revenue raised by the printing of money is called seigniorage. The term

comes from seigneur, the French word for “feudal lord.” In the Middle Ages, the

lord had the exclusive right on his manor to coin money. Today this right

belongs to the central government, and it is one source of revenue.

When the government prints money to finance expenditure, it increases the

money supply. The increase in the money supply, in turn, causes inflation. Print-

ing money to raise revenue is like imposing an inflation tax.

At first it may not be obvious that inflation can be viewed as a tax. After all,

no one receives a bill for this tax—the government merely prints the money it

needs. Who, then, pays the inflation tax? The answer is the holders of money. As

prices rise, the real value of the money in your wallet falls. Therefore, when the

government prints new money for its use, it makes the old money in the hands

of the public less valuable. Inflation is like a tax on holding money.

The amount of revenue raised by printing money varies from country to

country. In the United States, the amount has been small: seigniorage has usual-

ly accounted for less than 3 percent of government revenue. In Italy and Greece,

seigniorage has often been more than 10 percent of government revenue.

4

In

countries experiencing hyperinflation, seigniorage is often the government’s

chief source of revenue—indeed, the need to print money to finance expendi-

ture is a primary cause of hyperinflation.

4

Stanley Fischer, “Seigniorage and the Case for a National Money,’’ Journal of Political Economy 90

(April 1982): 295–313.

Paying for the American Revolution

Although seigniorage has not been a major source of revenue for the U.S. gov-

ernment in recent history, the situation was very different two centuries ago.

Beginning in 1775, the Continental Congress needed to find a way to finance

the Revolution, but it had limited ability to raise revenue through taxation. It

therefore relied on the printing of fiat money to help pay for the war.

The Continental Congress’s reliance on seigniorage increased over time. In

1775 new issues of continental currency were about $6 million. This amount

increased to $19 million in 1776, $13 million in 1777, $63 million in 1778, and

$125 million in 1779.

Not surprisingly, this rapid growth in the money supply led to massive infla-

tion. At the end of the war, the price of gold measured in continental dollars

was more than 100 times its level of only a few years earlier. The large quan-

tity of the continental currency made the continental dollar nearly worthless.

This experience also gave birth to a once-popular expression: people used to

say something was “not worth a continental’’ to mean that the item had little

real value.

CASE STUDY

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94

|

P A R T   I I

Classical Theory: The Economy in the Long Run

5

Mathematical note: This equation relating the real interest rate, nominal interest rate, and inflation rate

is only an approximation. The exact formula is (1 

+ r) = (1 + i )/(1 +

p

). The approximation in the

text is reasonably accurate as long as r, i, and

p

are relatively small (say, less than 20 percent per year). 

When the new nation won its independence, there was a natural skepticism

about fiat money. Upon the recommendation of the first Secretary of the 

Treasury, Alexander Hamilton, the Congress passed the Mint Act of 1792, which

established gold and silver as the basis for a new system of commodity money. 

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