From time to time, there are suggestions that the future seigniorage income of a central bank is an asset that is available for current lending. Buiter (2008) argues that the discounted present value of future seigniorage should be included as an asset on the balance sheet of the central bank, implying a large capacity to sustain losses. Soros (2012) sees it as a source of funds (via a Special Purpose Vehicle) for buying the debts of stressed eurozone sovereigns.
This note argues that it is wrong to consider the future seigniorage income of central banks as a source of funds for current lending.
The value of seigniorage
Currency (i.e. banknotes) issued by a central bank constitutes an interest-free loan to the central bank: seigniorage is the interest that the central bank earns on the assets that it holds against its currency issue. In a country which has its own currency, this seigniorage income is passed to the government: for instance, the UK government receives the seigniorage earned by the Bank of England from its issue of £-sterling currency.
In the eurozone, the seigniorage from the total issue of euro currency is divided amongst the 17 national central banks in proportion to their shares in the European Central Bank (as described by Whittaker, 2011), and the national central banks pass it to their respective governments.
How much is euro-seigniorage worth? The total issued value of euro banknotes is currently €880bn (July 2012), but this only provides a small seigniorage income in today’s environment of low interest rates. Using the ECB’s current main official (refinancing) rate of 0.75% as the relevant interest rate for the assets that are held against the euro banknote liability, total euro seigniorage is currently €6.6bn per year. In more ‘normal’ times of higher interest rates, the relevant rate would be closer to, say, 4% (the approximate average 10-year yield on German government bonds over the 8 years before the crisis), which would make annual seigniorage income equal to €35.2bn.
The discounted present value S of all future seigniorage is given by (see appendix)
where the current value of the banknote issue is C0, the risk-free rate of interest is r and the rate of growth of the currency issue is g.
This may also be written as
where the two components are the present value of the seigniorage arising from the current banknote issue (equal to the banknote issue itself, C0) and the present value C1 of the seigniorage on future increases in the banknote issue.
With C0 = €880bn and supposing, for illustration, that the nominal interest rate is r = 4% and that the banknote issue will grow at g = 3%, the present value of the future seigniorage that will accrue to eurozone governments is S = €3,520bn.
This number is very sensitive to parameter values, however. Keeping the interest rate at r = 4%, if the growth rate of the banknote issue were g = 3.5% instead of 3%, this would double the present value of future seigniorage to S = €7,040bn. If g > r, which is not implausible given that the average rate of increase of the euro banknote issue over the past 5 years has been 7% per year, S becomes unbounded.
All that can be said is that the present value of future euro seigniorage is a big number but we have no idea how big.
Seigniorage as a source of funds for current lending
The magnitude of this future central bank income has no bearing, however, on the amount of lending that a central bank may undertake. The central bank can lend without restriction.
In attempting to encourage commercial banks in their retail lending, the central bank can lend to them (as in the LTROs undertaken by the eurosystem) or it can purchase government securities (quantitative easing). There is no limit to the size of either of these support measures, since they can always be funded by increases in the monetary base in the form of commercial bank reserve deposits. They do not affect the central bank’s solvency because they involve equal increases in the central bank’s liabilities and assets, leaving its capital unchanged.
However, the national central banks of the eurozone or the ECB itself could become insolvent (in the accounting sense) if the assets obtained in these operations lose value; indeed, De Grauwe (2012) argues that this is a major reason for the ECB’s reluctance to lend. The total capital and reserves of all the national central banks of the eurosystem is only €86bn (July 2012). It is not hard to envisage this being overwhelmed by writedowns either on their holdings of peripheral government debt or on their lending to commercial banks (although a further €410bn of revaluation reserves, mainly due to gold holdings, could presumably be liquidated if necessary).
The solution, according to Buiter (2008), is to include the present value of future seigniorage as an asset in the ‘comprehensive’ balance sheet of the central bank (C1 of equation (2); C0 is already taken care of by the assets that back the existing currency issue). This would add directly to the book value of its equity capital, implying that it could sustain very much larger writedowns while its accounts indicate that it remains solvent. This accounting change might be compared with the common practice of recognising ‘goodwill’ as an intangible asset on a company balance sheet when the company is sold, as a reflection of its potential future earnings.
But besides being dependent on accounting practices, the book value of a central bank’s capital also depends on the amount subscribed by its government. If the losses of a central bank were to exceed the book value of its capital, while this would not help the central bank’s credibility, its government would subscribe new capital to restore solvency (regardless of any precommitment by the government or indemnity for the central bank against loss). Whatever the accounting practice, losses incurred by the central bank are losses for its government and the question of central bank solvency is therefore irrelevant.
Recognising future euro seigniorage as an asset of the ECB or the national central banks of the eurosystem would not alter the current or future cash flows of the ECB or eurozone governments. Hence it would alter neither the ability to lend to weak banks or sovereigns nor the wisdom of doing so. Future euro seigniorage cannot be used as an excuse for increasing the exposure of Germany or the other eurozone creditor countries.
Appendix: the present value of future seigniorage
If the yield on the assets that the central bank holds against its currency issue is r for all maturities, the seigniorage from currency C(t) received during a future interval dt is rC(t)dt. Assuming that r is also the appropriate risk-free discount rate, the present value of all future seigniorage is
Alternatively, the value of seigniorage may be considered as the value of the central bank’s monopoly right to issue currency, equal to assets of value C0 plus future currency increments dC.
Buiter, Willem (2008). “Can Central Banks Go Broke?”, Centre for Economic Policy Research Policy Insight No.24, May.
De Grauwe, Paul (2012) “Why EU summit decisions may destabilise government bond markets”, VoxEU.org, 2 July.
Soros, George (2012). “Reversing Europe’s Renationalization”, Project Syndicate, 11 April.
Whittaker, John (2011) “Eurosystem debts, Greece, and the role of banknotes”,
Lancaster University Management School, 14 November.