Working Paper: NBER ID: w0783
Authors: Stanley Fischer
Abstract: A country that decides to fix its exchange rate thereby gives up control over its own inflation rate and the determination of the revenue received from seigniorage. If the country goes further and uses a foreign money, it loses all seigniorage. This paper uses an optimal inflation tax approach to analyze the consequences for optimal rates of income taxation and welfare of the alternative exchange rate and monetary arrangements. From the viewpoint of seigniorage, a system in which the country is free to determine its own rates of inflation is optimal; fixed exchange rates are second best, and the use of a foreign money is worse. The paper notes that seigniorage is only one of the factors determining the choice of optimal exchange rate regime, but also points out that rates of seigniorage collection are high, typically accounting for five or more percent of government revenue.
Keywords: seigniorage; fixed exchange rates; inflation tax; optimal taxation
JEL Codes: E31; E52; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fixed exchange rates (F31) | inability to set optimal inflation rates (E31) |
| Fixed exchange rates (F31) | loss of seigniorage revenue (H69) |
| Using foreign money (F31) | complete loss of seigniorage (H69) |
| Loss of seigniorage (H69) | decreased government revenue (H27) |
| Flexible exchange rate system (F33) | optimal inflation rates (E31) |
| Fixed exchange rates (F31) | second-best solution (H21) |