In a recent interview, Argentina’s President Javier Milei proposed jail time for central bankers, lawmakers, and even the president himself if any of them participates in the funding of deficits in the government budget by means of newly printed cash.
This drastic idea is meant to help break a trend of rapidly rising inflation—the most recent annual rate is 254%—and to also prevent a return to runaway inflation, once this episode has been brought to an end.
Europe and America should pay attention to Milei’s war on inflation. We have just been through a tough inflation episode, and although our inflation rates did not even come close to what Argentina is experiencing, the economic mechanisms that cause runaway inflation are present here as well. With just a little bit more fiscal and monetary mismanagement than we saw in the years 2020-2022, we could easily end up with Argentinian inflation rates.
In my previous article on Milei’s inflation-battling policies, I explained the multi-pronged nature of his strategy. In addition to forcing the national congress to operate with a strictly balanced budget, President Milei also wants to—as mentioned—make so-called seigniorage illegal.
My only problem with the Argentinian president’s reference to ‘seigniorage’ is that he does not use the term correctly. To sort out what exactly Milei is out to accomplish, let us take a closer look at what this term really means.
It is often thrown around in the debate over monetary policy, and it is used prolifically in the academic literature on monetary economics. However, that same literature is noticeably thin on definitions and measurement methods for the term. This is surprising given the prominence of some of the economists who have made their contributions to the debate; sometimes I get the impression that some of those who use it in a scholarly setting are themselves unsure of what the term means.
The most concise and analytically efficient definition to date is found in an article titled “Fiscal Effects of Monetary Seigniorage: A Case Study of Pakistan” by economists Kalbe Abbas and Tariq Mahmood (The Pakistan Development Review, Winter 1994):
By printing money the government gets command over goods and services produced by the private sector to the extent of the money printed … This is just like imposing an implicit tax on the private sector.
This tax is seigniorage. Plain and simple.
Abbas and Mahmood also point out that economists have been unable to produce a universally accepted method for measuring seigniorage. My own experience corroborates their observation: in a survey of the literature on monetary economics from the past 40 years I find such a great variation in the use of the term that it cannot be explained by anything else except ignorance among some of the economists who talk about ‘seigniorage’.
Since economists are not entirely sure what they mean by the term, it is almost inevitable that someone in Javier Milei’s position would misunderstand the term.
The president of Argentina refers to the following as ‘seigniorage’:
- Government runs a budget deficit;
- The central bank prints money and hands it over to the treasury to cover the deficit.
Based on the definition provided by Abbas and Mahmood, it looks like President Milei is right on the money (pun intended). Unfortunately, he is not. Milei implies that the value of seigniorage is identical to the value of the newly printed money that pays for the deficit. This is correct if and only if the central bank hands over the cash as a gift to the treasury
If the central bank uses the money to buy debt securities from the treasury, no seigniorage is created.
In short: seigniorage is the net value of the goods and services that government pays for with newly printed money. If
- The treasury sells a debt security to the central bank in exchange for the newly printed cash, then
- The treasury creates an amount of debt that is equal to the value of the goods and services it bought with the newly printed money.
In this case, no seigniorage has been created. Therefore, when President Milei wants to outlaw seigniorage, he has to be careful not to accidentally allow the central bank to print money as a means to buy government debt.
Interestingly, America’s central bank, the Federal Reserve, is not allowed to directly interact with the U.S. Treasury. When the Fed buys Treasury-issued debt, it does so using an intermediary—formally the secondary market for U.S. debt—and therefore avoids the creation of seigniorage.
Some economists speak of seigniorage as an ‘inflation tax’ on the economy. They do so under the implicit assumption that the money that is printed to fund a budget deficit leads to a proportionate inflation rate. It does not: although there is indisputable evidence that printing money for deficit funding causes inflation, the timing and proportions of the inflationary consequences are neither immediate nor exactly proportionate.
With that said, the link from money printing to inflation is what matters here. In this regard, President Milei has started working on an economic policy agenda that is nothing short of existential to the Argentinian economy—and, frankly, to the country as a whole. Latin America has had many encounters with runaway inflation, including Venezuela where, at one point, prices were rising by 350,000% per year. Argentina is far from that point, but with its current inflation rate just above 250%, the country is absolutely on the wrong track.
To avoid the complications that come with the use of the term ‘seigniorage’, it is better to refer to the money-for-deficit practice as deficit monetization. This renders precision to the analysis by unifying the purpose and the method of a certain episode of monetary expansion—as well as its inflationary consequences.
The last part is important. It is easy to read stories about Javier Milei and his crusade against inflation in Argentina, and dismiss it as a ‘local’ problem; after all, Europe and America do not have problems with extreme inflation rates, so how are Milei’s anti-inflation policies relevant to us?
Some countries in Europe have experienced problematically high inflation recently, with prices rising faster than 20% per year. However, they have all gotten their inflation problem under control, and they did so without resorting to anything even remotely as drastic as President Milei’s proposal to make deficit monetization illegal. The same is true for the American economy, where inflation topped out at 9.1% in the summer of 2022; during the stagflation episode in the late 1970s and early 1980s, the record inflation rate was 14.8%.
Despite the relatively modest rates of price hikes in the U.S. and EU economies, the mechanisms that can cause extreme inflation are still in place. In terms of timing, monetary inflation does not rise in close proximity to the money printing; it builds up in the economy, gradually mounting an inflationary pressure that, at some point, has to erupt. After having spilled over into equity markets, driving up prices in the stock and real estate markets beyond what can reasonably be motivated by real economic activity, the inflation-triggering expansion of the money supply eventually works its way into the market for consumer products.
The Federal Reserve and the European Central Bank were quick to react to rapidly rising inflation rates. Their measured but pointed responses returned inflation to levels that are still elevated but manageable for the respective economies. This was important, especially in the case of the U.S. economy: due to the federal government’s chronic budget deficits, it was essential for the Federal Reserve to end its monetization of those deficits. Had that not happened, inflation would have taken a very different turn than it did when it started falling in the second half of 2022.
It is recommendable that European and American legislators consider legal obstacles against deficit monetization. That does not include a copy of President Milei’s call for jail time for any official who participates in deficit monetization, but it should include measures that make it significantly less desirable for the treasuries of the EU and the U.S. to borrow money—under any circumstances.
