Seigniorage

Producing a banknote costs only a small amount, but it can buy goods and services worth far more. The difference is seigniorage. The term comes from the historical right of feudal lords, called seigneurs, to mint coins.

In modern economies, seigniorage arises mainly because central banks issue banknotes and hold reserves on which they pay little or no interest, while holding interest-earning assets, such as government bonds. The income from these assets, after costs, is usually passed to the government.

For example, if people hold 100 billion in banknotes, which pay no interest, and the central bank holds bonds earning 3%, it earns about 3 billion a year from this arrangement.

Seigniorage can be an important source of government revenue, but relying on it too heavily, by printing money to finance spending, can cause high inflation or hyperinflation. Countries that use another country’s currency, through dollarization, give up their seigniorage to the issuing country. As cash use declines, seigniorage from banknotes is shrinking.