Central Bank Responsibility, Seigniorage, and Welfare

Abstract

The money stock, in almost every country in the world, does not contract. This paper attempts a welfare-based explanation for this observation. We study an overlapping generations model with return dominated money. A reserve requirement forces agents to hold money. There is a government that has to raise a fixed amount of revenue solely for the purposes of making transfers to the old. It has two revenue generating options: lump-sum taxes (money creation) under the control of the treasury (central bank). We restrict the amount of seigniorage collected to be non-negative, and also require that the government's budget constraint be satisfied on a per-period basis. The question we then pose is: if the government is benevolent, should the central bank be asked to bear at least some responsibility for revenue generation? Alternatively, can we find stationary monetary competitive equilibria which are also welfare maxima, in a world where the money stock cannot contract. Computational experiments reveal, somewhat surprisingly, that the answer is yes. Indeed, in our setup, benevolent governments may require that at least part, if not all of the revenue, be raised via money creation.

JEL Classification: E4, E5, E6