Elusive Seigniorage
Abstract
The Turkish economy has experienced chronic inflation since the late 1970s and early 1980s. The impact of an
inflationary macroeconomic climate has become more pronounced on the Turkish economy following liberalization
measures in the 1980s. Inability of consecutive governments to rein in inflation has resulted in a greater degree of
currency substitution with the ratio of M2(local currency money supply aggregate) to M2Y (local plus foreign
currency money supply aggregate) falling to 50.7% by May 2001. Higher currency substitution has also whittled
down the ” tax base” for seiginorage gains to the government. Indeed, the significance of any seigniorage gain is
much reduced given the greater cost of external debt service that accompanies a currency depreciation – itself a
result of an excess money supply and lack of market confidence.
This paper estimates a money demand function to derive optimal seigniorage levels for plausible parameter values
for Turkey. A second approach is to present a Laffer curve for Turkey derived from modeling historical data (which
may not, of course, be indicative of the future). It appears that in a chronic inflation economy, optimal seigniorage
gains are well below 10% of GDP. Furthermore, seigniorage gains may be dominated by the increased external debt
service burden, as certainly appears to be the case for Turkey. The paper presents panel regression results which
are broadly supportive of high inflation leading to currency substitution as expected.
JEL Classification: E65
Keywords: Seigniorage, Inflation Tax, Currency Substitution, Turkey.
.
Gıyas Gökkent1
Işık University & Garanti Bank
63 Buyukdere Cad, Maslak 80670, Istanbul, Turkey
e-mail: [email protected]
May 2001
1
I have benefited from discussions with Ece Turgay, Rafael Amiel, and Carlos Moslares.
1
I.
Introduction
Cagan (1956) presents a concise definition of seigniorage by characterizing it as a tax on cash balances. In Cagan’s
words: “ total revenue per period of time is the sum of two parts 2: first, the real value of new money issued per
period of time, and second, the reduction in outstanding monetary liabilities 3, equal to the decline per period of time
in the real value of cash balances ”.
Cukierman, Edwards, Tabellini (1992) tabulate average inflation and seigniorage for the 1971-1982 period for 79
countries. Seigniorage in some of the countries they examine reaches almost 30% of total government revenue. In
this vein, inflation tax comes to be viewed as a substitute for regular taxes. Morales and Sachs (1987) put seigniorage
gains in Bolivia at the height of the hyperinflationary period at more than 5% of GDP in one quarter alone. Fischer
(1981) notes that rates of seigniorage collection are high, typically accounting for more than five percent of
government revenue.
McPherson (1999) disagrees with the portrayal of seigniorage revenue as an important source of finance when, in
fact, seignorage gains may be dominated by exchange rate losses due to external indebtedness. He does not,
however, provide empirical support for this thesis for the Turkish economy. McPherson argues, in essence, that
seigniorage will contribute to the government’s purse only if an economy undergoes significant financial deepening
whereby the currency to deposit ratio would rise, and velocity of circulation would decline.
Anand & van Wijnbergen (1989)4 find base money to be sensitive to inflation in Turkey. In their simulations, real
money holdings fall from 7.8% of GNP at 15% inflation to 5.9% at 60% inflation. They state that the marginal rise in
inflation tax revenue becomes less and less as inflation climbs, and that inflation tax revenue reaches its zenith 5 at
200% inflation per year in Turkey’s case.
Altınkemer (1996) simulates the inflation tax per real GNP consistent with varying degrees of inflation and currency
2
The pertinent expression is easily derived by totally differentiating M/P.
This, of course, represents a capital loss to holders of real balances.
4
Anand & van Wijnbergen (1989) employ quite a different set of variables (such as reserve requirements) to model
the behavior of monetary base because they also focus on the impact of institutional changes on money base. The
coefficient of determination in their regression is higher at 83% than found in this paper (62%), although only two
explanatory variables have been used here.
5
Specifically, they refer to ‘maximum’ revenue from inflation being reached at just above 200% per year. In fact, the
peak of the inflation tax schedule does not strictly speaking represent an upper limit for gains from printing money.
As Cagan (1956) argues, when agents are slow to adjust real money balances to additional monetization, significant
gains could temporarily accrue to the government before the economy is completely disrupted. The peak of an
inflation tax Laffer curve merely depicts the height of sustainable seigniorage. Cagan’s states: ‘ Among all consistent
rates, there is one that yields a maximum ultimate revenue. With a tax rate that increases rapidly enough however,
the revenue exceeds this maximum amount for a constant rate because of delays in adjusting the tax base produced
by the lag in expectations ’ .
3
2
substitution in Turkey as presented below:
Table 1. Currency Substitution & Inflation Tax Collection
Inflation Rate %
80.0
55.0
55.0
38.5
80.0
134.0
Inflation tax/GNP
3.40
3.40
2.45
2.45
2.20
3.40
Currency substitution %
0.50
0.00
0.50
0.00
0.75
0.75
M2 / M2Y
0.50
1.00
0.50
1.00
0.25
0.25
Currency substitutio
0.50
0.00
0.50
0.00
0.75
0.75
Source: Altınkemer (1996).
Here the author ignores new issuance gains. Altınkemer (1996) sums up the impact of higher inflation by pointing to
the increased opportunity cost of holding money, and the subsequent switch to bonds or foreign exchange.
Altınkemer highlights the possibility of a vicious circle of inflation and currency substitution culminating in
hyperinflation.
Claassen (1996) describes the spread of currency substitution 6 as a multi-stage phenomenon. He points out that
typically currency substitution is nascent because, at first, foreign exchange deposits are illegal. Once foreign
exchange deposits become legalized, foreign currency intrudes further into the turf of the local currency. This
process culminates in the gradual domination of foreign currency in most functions that characterize moneyness.
Thus, the first functions to be taken over by the foreign currency are store of value and unit of account aspects. In the
final stretch, foreign exchange also begins to act as a medium of exchange. In the transition to greater currency
substitution, lack of confidence in the local currency itself fuels inflation, creating a vicious cycle.
The thread that binds seignorage and currency substitution is the latter’s impact on the tax base for seigniorage.
Smaller real money balances only yield unchanged seigniorage gains if the rate of money growth, and thus inflation
increases to compensate.
But what of the argument that borrowers gain from inflation ? It is interesting to note that this issue is not addressed
in the seigniorage literature. If one assumes that Turkey’s domestic debt stock will stand at 60.9% of GNP by end20017 as official projections indicate, then in the extreme, limiting case, a one time payment by printing money, or
simply crediting banks’ accounts at the Central Bank would wipe out the domestic debt. Banks would, of course, fail
given that their foreign exchange liabilities at present exceed their foreign exchange assets, but the point would
6
The definition of currency substitution for purposes of measurement in this paper is the ratio of M2 (composed of
currency in circulation, local currency sight deposits, and local currency time deposits) to M2Y (composed of M2
plus foreign exchange deposits). Currency substitution could have different interpretations and measurements as laid
out in detail by Giovannini and Turtelboom (1992).
7
See http://www.imf.org/external/np/loi/2001/tur/02/index.htm.
3
remain that government would gain. Nevermind that the domestic debt stock rose to start with because of the
governmental bail-out of the banking sector. In the limiting case of full repayment of government obligations by
printing money, 61% of GNP should represent the immediate gain to government. This implausible scenario would,
naturally, do away with a Laffer curve type limitation. This gain8 would, of course, be one time unlike seigniorage.
II. Estimation of Seigniorage in Turkey
Real money balances are assumed to be broadly a function of nominal interest rates and real GDP as expressed
below9.
(1)
M/P = L(i, Y)
Where M is monetary base, P is the price level, i is the nominal interest rate, and Y is real GDP.
Ignore GDP growth for tractability, then in steady state, quantity of real balances M/P is constant.
Nominal interest rate i has two components, real interest rate and the expected rate of inflation. The latter is equal to
the growth rate of money supply in the long run.
(2)
M/P = L(r + e, Y)
(3)
M/P = L ( r + gm , Y)
-
.
where gm = m
-
/m
Seignorage is then expressed by,
.
(4)
S=M/P
.
= (M / M) x (M / P)
= gm M / P
_
(5)
S = gm L ( r
_
(6)
_
_
+ gm , Y)
_
_
_
dS / dgm = L ( r + gm , Y) + gm L’( r + gm , Y)
Note that Turkey’s domestic debt stock rose in part because of banking sector bail-out costs. Largest holders of
domestic debt are banks and they would surely be adversely affected by monetization.
9
The treatment here is per Romer (1996).
8
4
Figure 1. Growth Rate of Money Supply Consistent with Optimal Seigniorage
S
S*
gm *
gm
A practical form of the money demand function to be estimated may be described by the expression below:
ln(M/P) = a – bi + lnY
where b >0
-
-
(7)
S = gm ea Y e – b(r + gm )
(8)
S = Cgm e – b gm
(9)
dS / dgm = Ce – b gm + (-Cb gm e – b gm )
= Ce – b gm - C bgm e – b gm
= ( 1 – bgm )Ce – b gm
Seigniorage is at its peak at
( >0 for gm < 1 / b )
gm * where dS / dgm = 0. This holds when gm = 1/b. Cagan estimates b at between
1 / 3 and 1 / 2, implying gm to be between 3 and 2 for the case when seignorage is at its peak. This corresponds to a
200%-300% continously compounded rate of money growth, or a reserve money increase by 7 to 20 times.
Empirical exercises are constrained by a lack of sufficiently long time series data for the Turkish economy. Here the
problem is circumvented by using quarterly data between 1989Q3-2000Q4 that is seasonally adjusted. The
dependent variable is the logarithm of quarterly average reserve money 10, while the explanatory variables comprise
the log of real GDP series and level nominal interest rates. All coefficient signs are as expected, but real GDP is
found to be statistically unimportant as an explanatory variable. This result could be a by-product of rising currency
substitution in the sample period. In fact, similar regressions conducted for broad money aggregate M2Y (sum of
10
Definition of reserve money in Turkey slightly differs from customary practice, and thus the aggregate presented
by the Central Bank has other components (See Keyder (1997) for the origin of this practice) which would impair the
correct calculation of seignorage gains. Reserve requirements and currency in circulation do not receive a return, and
are thus subject to inflation erosion. Certain bank assets held to fulfil liquidity requirements at the Central Bank,
though in a sense representing a loan from banks to CBRT, have a yield which varies depending on the type of
5
Lira and foreign currency deposits plus Lira in circulation) finds real GDP to be a very significant explanatory
variable which is also expected.
Figure 2 – Seigniorage gains as a % of GDP
Seignorage as a % of GDP
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
gm
Source: Author’s calculations
The estimate for b for Turkish data is 0.445, right in the middle of the range estimated by Cagan. This value for b
which results in optimal seigniorage corresponds to a 222% continuously compounded rate of money growth. This
implies a ninefold reserve money increase. The ballpark estimate for C can be derived using an assumed maximum
seignorage level given that S*=C/(eb). If we assume that 0.055 is appropriate for C (corresponding to about 5%
seignorage at peak ), table 10 is the result.
If C is assumed to be 0.09 (per Romer), then sustainable seigniorage
gains of 7.36% of GDP per year is the top limit.
Figure 3 – Seigniorage Gains as a % of GDP
Seignorage as a % of GNP
4.50%
4.00%
3.50%
3.00%
S/Y = -2E-06 2 + 0.0005
2.50%
R2 = 0.568
2.00%
1.50%
1.00%
0.50%
0.00%
-
20.0
40.0
60.0
80.0
100.0
120.0
Inflation Rate %
Source: Author’s calculations
instrument held. The fact that these instruments do present a rate of return leads us to calculate seignorage based
solely on currency in circulation and reserve requirements.
6
Next, with the spirit that the past is a guide to the future, historical annual time series seigniorage estimates for the
brief period between 1990 and 200011 are plotted against average annual inflation as measured by the GNP deflator
as illustrated in figure . Quarterly data was not used because a Laffer curve pattern does not emerge, whilst annual
data –by smoothing out quarterly patterns - immediately reveal an increasing relationship between seigniorage and
inflation.
Figure 4 – Seigniorage gains as a % of GDP
Seignorage as a % of GNP
4.50%
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
0
50
100
150
200
250
300
Annual Inflation Rate %
Source: Author’s calculations
The rainbow shape of a Laffer curve illustrates that, estimated from very short historical time series data for Turkey,
seigniorage gains appear to be upper-bound at about 4% of GNP, with the peak at about 150% annual inflation.
Despite the naïve methodology employed, the figure is roughly in line with that cited by Anand and van Wijnbergen
(1988).
Table 3 presents the two components of the tax on cash balances for Turkish data as a percentage of national income.
Reduction in outstanding monetary liabilities is by far the dominant source of finance amongst the two components
of seigniorage. This capital loss to holders of real money balances peaks at 4.71% of national income in 1994. But is
actually counterbalanced to a small degree by a decline in the real value of new issues. The new issue component of
seigniorage has clearly been insignificant in Turkey’s case over the past decade. It is noteworthy that seigniorage
was the lowest in a decade in 2000. This was a year during which an ultimately unsuccessful exchange rate based
stabilization policy had brought down the rate of inflation to its lowest level in 14 years.
Reserve money data since 1989 are readily available at CBRT’s internet database at www.tcmb.gov.tr. Meticulous
national income data have been available for Turkey since 1987.
11
7
Rough estimates for the magnitude of the impact of real currency depreciation in terms of higher external debt
service as a proportion of GDP shows that in a crisis year such as 1994 (and 2001) any seigniorage gain is dwarfed
by the capital loss from additional external debt service.
Table 2. Seigniorage & Annual Inflation Rate
Table 3. Seigniorage Components
Actual Data Sorted by Seigniorage Levels
GNP Deflator
Seigniorage
2000
51.6
1.44%
1990
57.6
2.66%
1999
55.8
2.77%
1996
78.0
2.81%
1991
59.2
2.83%
1993
67.4
3.15%
1997
81.2
3.15%
1998
75.3
3.17%
1995
87.2
3.27%
1992
63.5
3.54%
1994
107.3
4.12%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Components of Seigniorage
New Issue
Capital Loss*
-0.35%
3.01%
-0.15%
2.99%
0.32%
3.22%
-0.01%
3.15%
-0.59%
4.71%
-0.15%
3.42%
-0.03%
2.83%
0.23%
2.91%
0.32%
2.85%
0.34%
2.43%
-0.45%
1.89%
*To holders of real balances
Source: Author’s calculations
Source: Author’s calculations
Table 4. Exchange Rate Loss
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Real Exchange Rate Movement Impact on Primary Balance as a % of GDP
Public External Debt % of GDP
RER Impact on Primary Bal as a % of
GDP
gross
net
gross
25.6%
3.77%
20.2%
23%
2.21%
21.6%
27%
-2.97%
21.1%
25%
-0.94%
20.2%
26%
-0.25%
30.5%
31%
-9.58%
23.3%
29%
-0.49%
29.0%
26%
1.73%
27.0%
23%
2.34%
26.6%
20%
-1.29%
28.9%
20%
-3.00%
31.0%
20%
1.93%
Source: Author’s calculations based on
net
2.53%
-3.64%
-1.13%
-0.32%
-9.66%
-0.61%
1.55%
1.95%
-0.98%
-2.09%
1.23%
a financeable budget deficit approach which permits the calculation of rough orders of magnitude of a
devaluation’s impact on fiscal balances. Net external debt series are from the IMF staff country report for Turkey dated February 2000. Net
external debt is defined as gross debt less net foreign assets of CBRT.
III. Currency Substitution
8
Inflation and currency substitution appear to be self-reinforcing once confidence in the local currency is damaged.
As agents reduce their real money balances as a proportion of national income, the velocity of money rises, just as it
has persistently risen in Turkey over the years. The one exception is 1999 which was a recession year, but
unaccompanied by financial meltdown, accounting for the drop in money velocity 12 that year).
Greater local currency holdings in a stable macroeconomic climate with financial deepening causes the effect of
slowing the velocity of money. Turkish data point as expected, to the link between a higher velocity of money and
greater currency substitution. In the limiting case of a hyperinflation, velocity of money converges to infinity.
Ultimately, of course, both currency substitution and a higher velocity of money are symptoms of a malaise rather
than being the underlying problem themselves.
A common characteristic of countries experiencing inflation is poor public finances and indebtedness, culminating
in excess money creation by governments. Under a high domestic – local currency denominated - debt burden, it is
not obvious, however, that debt redemptions will automatically be channeled towards foreign exchange. However,
under a high foreign exchange denominated debt burden, the mere hint of forthcoming foreign exchange redemptions
could put downward pressure on the local currency. The same could, admittedly, occur if debt holders begin
questioning the ability of the Sovereign to service its local currency denominated debt. The more domestic currency
denominated assets lose their lustre, the more danger of downward pressure on the currency.
An interesting point
is that the existence of alternatives to local debased currencies is likely to help accelerate the inflationary process.
Local currency holders’ switch to ‘hard’ currencies – currency substitution – itself causes a decline in the value of
the local currency vis-à-vis foreign exchange. Local currency prices then rise due to higher imported input costs and
foreign exchange indexation for the prices of domestic goods and services – the real estate sector in Turkey, for
instance, widely employs the practice of quoting prices in foreign exchange.
Figure 5. Currency Substitution and Velocity of Money
30
100%
25
80%
20
60%
15
40%
10
RM velocity (LHS)
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
0%
1991
0
1990
20%
1989
5
M2/M2Y
Source: CBRT
Table 5. Velocity of Money in Turkey
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
V3Y
3.3
3.1
3.3
3.6
4
3.6
3.6
4
3.1
3.1
2.6
2.6
2.5
1.9
2.2
V2Y
3.5
3.2
3.5
3.7
4.2
3.7
3.7
4.2
3.2
3.2
2.7
2.7
2.6
1.9
2.2
V2
4.2
4.2
4.8
4.8
5.5
5.4
5.7
7
6.1
6.2
5.1
5.1
4.6
3.5
4
Source: CBRT
12
Cagan (1956) provides empirical evidence on the pro-cyclicality of the velocity of money.
9
VRM M2/RM M2Y/RM
13.3
16.5
16.9
17.9
19.5
20.8
22.6
23.8
24.3
24.3
19.7
21.0
2.77
3.00
3.14
3.12
2.78
3.39
3.66
4.71
4.77
5.32
5.59
5.23
3.60
3.91
4.51
4.80
4.65
6.44
7.03
8.65
8.99
9.42
10.21
9.42
The ratio of M2 to M2Y is the common way of looking at (one aspect of) currency substitution 13 in Turkey. Table 7
presents comparable annual data, when and where available, for five other countries with the choice of countries
largely being dictated by data availability. All except Finland are developing economies, and may be broadly
separated into two groups: countries which experienced high inflation (Bulgaria, Peru, Poland, Turkey) and those
that did not (Finland, Thailand). Only one country in the above table experienced hyperinflation as described by
Cagan, registering monthly inflation of 50% - corresponding to 12,875% year-on year inflation, or roughly 5,217%
average inflation -, or more. Peru’s rate of inflation, as measured by the GDP deflator, reached 6,134% in 1990.
Bulgarian inflation peaked at 949% in 1997, Poland’s at 417% in 1990, and Turkey’s at 107% in 1994. Both
Thailand and Finland had single digit inflation rates, although Baht price growth accelerated in 1998 following the
currency’s devaluation during the Asian crisis. In all cases, an acceleration of inflation has led to greater currency
substitution as holders of local currencies attempted to stem wealth erosion from their perspective and wealth
transfer from the society’s point of view.
Establishment of relative price stability does not appear to result
rate. It is noteworthy, thus, that various policies in countries
Table 6. Monthly M2/M2Y for Turkey
1999
2000
2001
%
Jan
57.77
54.70
56.81
Feb
56.82
52.73
56.14
Mar
56.59
52.29
50.43
Apr
56.62
51.70
50.66
May
56.24
50.95
50.09
Jun
56.90
52.02
Jul
57.36
52.30
Aug
57.37
51.61
Sep
57.27
51.03
Oct
56.14
51.20
Nov
54.27
53.10
Dec
56.32
55.34
such as Bulgaria and Argentina may
Source: CBRT
in a quick change in preferences, thus does not automatically
lower currency substitution. Indeed, the phenomenon of
hysteresis
whereby temporary dislocations
may become
permanent is applicable to countries which have experienced
high inflation in their recent past. Countries which adopted
currency boards thus sought to borrow the credibility of the
selected currency (or basket) to which the local curency was
pegged. Turkey had a quasi-currency board in 2000. Currency
substitution rose in this period despite a 14 year low inflation
have themselves
institutionalized currency substitution. The logic of currency
boards harks back to the gold standard except that gold has no return barring capital gain. The near perfect
substitubility of currencies may cause the populace to err on the side of caution by opting to hold foreign exchange.
Those on the buying side of a transaction would not mind transacting in foreign exchange (so long as they believe in
the credibility of the peg), while sellers would have extra security. Currency substitution would only be limited in a
relatively uncertain macroeconomic environment if to buy local assets one is still compelled to acquire local
currency, and if local currency savings yield more than foreign exchange savings. In Turkey’s case, currency
13
These data show the degree of deposit substitution which is not necessarily the mirror image of credit substitution.
10
substitution as measured by deposit ratios shows that in the short term it is interest rates which to some degree dictate
the currency composition of deposits14.
Table 7 – Currency Substitution (local currency broad money as a percentage of local currency plus FX broad
money)15
M2/M2Y
2001
2000
Bulgaria
30.8%
Finland
98.1%
97.9%
Peru
40.6%
40.7%
Poland
82.8%
83.5%
Thailand
98.5%
98.6%
Turkey
50.7%
55.5%
1999
1998
1997
1996
1995
1994
1993
1992
1991
32.5%
31.0%
29.6%
40.6%
67.6%
-
97.7%
96.6%
96.0%
95.8%
95.2%
-
39.9%
37.8%
-
82.2%
82.5%
79.3%
79.1%
74.9%
66.1%
65.0%
-
98.7%
98.6%
98.7%
99.6%
99.7%
99.8%
99.7%
99.8%
99.8%
54.8%
56.5%
53.1%
54.4%
52.0%
52.7%
59.7%
64.9%
69.7%
1990
-
-
-
-
99.9%
76.7%
1989
1988
1987
1986
-
-
-
-
99.7%
99.7%
99.6%
99.7%
76.9%
74.1%
76.7%
83.3%
Source: BNB, Bank Suomi, CBP, NBP, BoT, CBRT
Figure 6. Currency Substitution and Annual Inflation Rate
1.20
M2/M2Y = -1.5681 + 1.5905
GDP Deflator %
1.00
2
R = 0.7943
0.80
0.60
0.40
0.20
0.00
0.00
0.20
0.40
0.60
0.80
1.00
M2/M2Y
Source: Author’s estimates
14
Note the five point swing in M2/M2Y between October 2000 and February 2001.
Tomás J., T. Baliño, A. Bennett (1999) present currency substitution intercountry data for the period between 1990
and 1995.
15
11
Panel data – for Turkey, Thailand, Finland, Bulgaria, and Poland - regression results confirm, as expected, the strong
link between inflation and currency substitution. When the ratio of local currency deposits to foreign exchange
deposits plus local currency deposits (M2/M2Y) equals unity, currency substitution is nil. A ratio value of less than
one indicates a greater degree of currency substitution. Agents simply seek to maintain the purchasing power of their
savings under an inflationary climate. At the start of this phenomenon the causality should thus run from inflation to
currency substitution. Later on, however, a vicious cycle of currency substitution and inflation may result as the tax
base for seignorage is eroded, and only a higher level of inflation compensates for the decline in local currency use.
Budget Balance % of GDP
Figure 7. Currency Substitution and Fiscal Balance
0.06
0.04
0.02
0.00
-0.02
-0.04
-0.06
-0.08
-0.10
-0.12
-0.14
M2/M2Y = 0.1624BB - 0.1593
R2 = 0.4837
0.00
0.20
0.40
0.60
0.80
1.00
M2/M2Y
Source: Author’s estimates
Whilst there is a consensus that persistent fiscal deficits may fuel an inflationary climate, the link between currency
substitution and fiscal imbalance does not appear strong. The answer must lie in the ability of governments to
arrange non-inflationary finance of their deficits. So long as debt remains sustainable, then there will be no need to
resort to monetization, and consequently no impact on agents’ currency preferences.
12
Real Interest Rate % pa
Figure 8. Currency Substitution and Real Interest Rate
0.30
0.25
0.20
0.15
0.10
M2/M2Y = -0.09r + 0.1578
R2 = 0.0803
0.05
0.00
-0.05
-0.10
-0.15
0.00
0.20
0.40
0.60
0.80
1.00
M2/M2Y
Source: Author’s estimates
Debt sustainability, and the ability to shy away from monetization as a source of finance, is, in part, reflected by real
interest rates. The noteworthy point here is that countries with low currency substitution have unfluctuating real
interest rates (which is not surprising given their low inflation rates) that are clustered around the 5% to 10% level.
Table 8. Annual Inflation Rates in Various Countries
Inflation, GDP deflator (annual %)
Bulgaria Finland
Peru
Poland
Thailand
Turkey
1998
1997
1996
1995
1994
1993
1992
1991
22.2
949.1
121
62.8
72.7
51.1
59.6
226.6
1.4
2.2
0.8
2.4
1.3
2.4
0.7
2.5
5.5
8.8
9.7
12.2
19.2
46.3
63.3
350.6
12
14
18.7
27.9
28.4
30.6
38.5
55.3
8.7
3
4
6
5.1
3.3
4.5
5.7
74.2
81.2
78.3
87
107.1
67.3
64
58.8
1990
26.2
5.8
6,134.40
416.7
5.8
58.2
1989
1988
1987
1986
6.7
-5.4
0.1
1.3
6.1
7
4.7
4.6
2,926.60
555
83.9
74.7
298.6
68
28.3
19
6.1
5.9
4.7
1.7
75.7
69.3
33.6
35.4
Source: World Bank
13
IV. Conclusion
Seigniorage is simply a wealth transfer mechanism from holders of real balances to the government. This paper
provides empirical evidence that the Turkish government should have no stake in attempting to raise seigniorage
gain by an increase in the growth rate of money because this will also engender a currency depreciation. This latter
effect will cause exchange rate related losses to the government that may – and does as exhibited in financial crisis
years – eclipse any hoped for gain from monetization. In other words, the wealth transfer mechanism ceases to be a
merely internal flow distribution from one portion of society to another, but becomes an external transfer
mechanism. The only manner in which sustainable net gains in seigniorage appear possible to the Turkish
government is through greater financial intermediation and deepening in local currency terms. The lesson is a
straightforward one: If you want to raise more tax revenue on a sustainable basis, don’t raise the tax rate, but
implement reforms to enlarge the tax base.
In Turkey’s instance, economists have interpreted possible issuance of foreign exchange denominated debt instead of
existing domestic currency debt as an incentive for the government to maintain the value of the currency. As a matter
of fact, the analysis in this paper show that the government already has an incentive to maintain the strength of the
Lira because real currency depreciation causes seigniorage to be dominated by capital losses to the government due
to higher external debt service.
Crucially, then, it is not the mere matter of seigniorage which dictates government’s policy decisions 16 but also the
size of the domestic currency debt in relation to external debt. This issue becomes important especially if the
government has external loans forthcoming and acts to lower the foreign exchange value of domestic debt which is
then serviced with longer tenor, cheaper outside loans.
14
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1996.
Anand, R. & S. van Wijnbergen. “Inflation, External Debt and Financial Sector Reform: A Quantitative Approach to
Consistent Fiscal Policy with an Application to Turkey”, Working Paper # 2731, National Bureau of Economic
Research, October 1988.
Cagan, P., “The Monetary Dynamics of Hyperinflation”, in Studies in the Quantity Theory of Money, ed. Friedman,
M., :25-117, University of Chicago Press, 1956.
Catão, L. and M. Terrones, “Determinants of Dollarization: The Banking Side”, IMF Working Paper # WP/99/146,
August 2000.
Claassen, E-M., “Global Monetary Economics”, Oxford University Press, 1996.
Copelman, M., “Financial Innovation and the Speed of Adjustment of Money Demand: Evidence from Bolivia,
Israel, and Venezuela”, International Finance Discussion Papers # 567, Board of Governors of the Federal Reserve
System, October 1996.
Cukierman, A. , S. Edwards and G. Tabellini, “Seigniorage and Political Instability”, American Economic Review,
Volume 82 (3): 537-555, June 1992.
Dornbusch, R., “Stopping Hyperinflation: Lessons from the German Inflation Experience of the 1920s”, Working
Paper # 1675, National Bureau of Economic Research, August 1985.
Giovannini, A. & B. Turtelboom, “Currency Substitution”, Working Paper # 4232, National Bureau of Economic
Research, December 1992.
IMF, “Turkey: Letter of Intent”, May 2001.
Keyder, N. “Money Theory – Policy Application”, Fourth Edition, Middle East Technical University, 1997.
Selçuk (2001) states that “it is important for a policymaker to obtain some information on the ‘critical level’ of
inflation, or the shape of the seigniorage Laffer curve”.
16
15
McPherson, M., “Seigniorage in Highly Indebted Developing Countries”, Development Discussion Paper # 696,
HIID, April 1999.
Moalla-Fetini, R., “Inflation as a Fiscal Problem”, in IMF Staff Country Report #00/14: 7-27, IMF, February 2000.
Morales, J. & J. Sachs, “Bolivia’s Economic Crisis”, in Developing Country Debt and Economic Performance, ed.
Sachs, J., Volume 2: 159-267, National Bureau of Economic Research, 1987.
OECD, “ Country Survey: Turkey”, 1997.
Romer, D., “Advanced Macroeconomics”, McGraw-Hill, 1996.
Schmitt-Grohe, S. & M. Uribe, “Stabilization Policy and the Costs of Dollarization”, mimeo, University of
Pennsylvania, May 2000.
“Dollarization and Seignorage: How Much is at Stake ?”, University of
Pennsylvania, July 1999.
Selçuk, F. “Seigniorage, Currency Substitution and Inflation in Turkey”, mimeo, Bilkent University, February 2001.
16
APPENDIX
Table 9. Regression Estimate
Variable
Dependent Variable: LOG(RAVERMSA)
Method: Least Squares
Date: 05/21/01 Time: 14:30
Sample(adjusted): 1989:3 2000:4
Included observations: 46 after adjusting endpoints
Coefficient
Std. Error
t-Statistic
Prob.
NOMINT
LOG(RGDPSA)
C
-0.45
0.02
8.51
0.05
0.08
0.77
-8.41
0.30
11.05
0.00
0.77
0.00
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.62
0.61
0.07
0.20
59.93
0.51
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
F-statistic
Prob(F-statistic)
Source: Author’s estimates
17
8.39
0.11
-2.48
-2.36
35.80
0.00
Table 10 - Model Calibration For Turkey
C
b
gm
S/Y
0.055
0.445
0.10
0.53%
0.055
0.445
0.20
1.01%
0.055
0.445
0.30
1.44%
0.055
0.445
0.40
1.84%
0.055
0.445
0.50
2.20%
0.055
0.445
0.60
2.53%
0.055
0.445
0.70
2.82%
0.055
0.445
0.80
3.08%
0.055
0.445
0.90
3.32%
0.055
0.445
1.00
3.52%
0.055
0.445
1.10
3.71%
0.055
0.445
1.20
3.87%
0.055
0.445
1.30
4.01%
0.055
0.445
1.40
4.13%
0.055
0.445
1.50
4.23%
0.055
0.445
1.60
4.32%
0.055
0.445
1.70
4.39%
0.055
0.445
1.80
4.44%
0.055
0.445
1.90
4.49%
0.055
0.445
2.00
4.52%
0.055
0.445
2.10
4.54%
0.055
0.445
2.20
4.55%
0.055
0.445
2.30
4.55%
0.055
0.445
2.40
4.54%
0.055
0.445
2.50
4.52%
0.055
0.445
2.60
4.50%
0.055
0.445
2.70
4.47%
Source: Author’s calculations
18
Table 11. GDP at Current Prices and Nominal Monetary Aggregates (end-period)
TL bn
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Nominal GDP
51,079
74,722
129,225
227,324
393,060
630,117
1,093,368
1,981,867
3,868,429
7,762,456
14,772,110
28,835,883
52,224,945
77,415,272
124,982,454
M3Y
15,591
24,460
39,128
63,940
97,921
174,084
306,493
490,217
1,233,539
2,495,183
5,608,503
11,144,687
20,826,990
41,065,980
57,780,498
M2Y
M2
RM
14,609
12,173
23,004
17,648
36,707
27,194
61,274
47,139
17,035
93,363
71,570
23,871
168,054
117,118
37,244
293,970
190,736
61,195
473,059
282,442
101,721
1,195,353
630,348
185,738
2,414,597 1,256,632
343,484
5,373,709 2,924,893
621,487
10,664,059 5,658,800 1,186,386
20,212,650 11,423,198 2,145,691
40,153,556 21,992,654 3,932,210
56,046,300 31,109,334 5,948,675
RM: Reserve Money = currency in circulation plus deposits at the Central Bank
M2= currency in circulation plus Lira sight and time deposits
M2Y= M2 plus foreign exchange deposits
M3Y= M2Y plus other official deposits
Source: CBRT
19