Appendix 11.1 Eight Applications of Real versus Nominal Interest Rates

Curiosity 13.2: What Is Seigniorage?
The government, through its agent the central bank, has the legal right to print money. The new money printed each year is a source of financing for the government. Seigniorage is the amount of financing made available to the government through printing money, currently about 2 percent of total government revenue. The term stems from the right of the lord of the realm (in French the seigneur) to coin money.
Seigniorage is calculated by figuring out how much government spending can be financed by selling bonds to the central bank. The following steps are taken in this calculation:
1. Calculate the annual increase in money demand by multiplying the nominal growth rate times the money supply. This tells us how much the money supply should increase. How many government bonds should the central bank buy in order to increase the money supply by this amount?
2. If the central bank bought an amount of bonds equal to this desired increase in the money supply, far too much money would be created because of the operation of the money multiplier. To increase the money supply by x dollars the central bank should only buy an amount of bonds equal to x divided by the money multiplier. This gives rise to the following formula for calculating seigniorage:
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trading partners is 15 percent. If we fix the exchange rate, each year our goods become 10 percent less expensive to foreigners, and foreign goods become 10 percent more expensive to us. We soon experience a dramatic increase in our exports and a decrease in our imports, producing a surplus of foreign currency in the hands of our citizens. When the central bank exchanges the foreign currency for dollars at the fixed rate, these dollars increase the domestic money supply. By targeting on the exchange rate the central bank loses control over the money supply.
Media Illustrations
Example 1
The Federal Reserve Bank Act of 1978 requires the Fed to pursue full employment as well as low inflation, but Mr. Greenspan has said that he favors legislation to make price stability the Fed's sole objective.
Why might the chairman of the Fed prefer to have price stability as his sole objective?
Using monetary policy to achieve a specific unemployment rate could cause the Fed to lose control over the money supply, with consequent disaster for the inflation goal. The Fed would argue that that monetary policy is capable of achieving only one objective, and since

 



Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

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