Front Page Titles (by Subject) 6.1.: The Power to Create Money - The Collected Works of James M. Buchanan, Vol. 9 (The Power to Tax: Analytical Foundations of a Fiscal Constitution)
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6.1.: The Power to Create Money - James M. Buchanan, The Collected Works of James M. Buchanan, Vol. 9 (The Power to Tax: Analytical Foundations of a Fiscal Constitution) 
The Collected Works of James M. Buchanan, Vol. 9 The Power to Tax: Analytical Foundations of a Fiscal Constitution, Foreword by Geoffrey Brennan (Indianapolis: Liberty Fund, 2000).
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The Power to Create Money
Despite the widespread reference to inflation as a means of raising revenue, inflation is not the only aspect of government’s power to create money that has revenue significance. Even under a zero-inflation regime, the granting to government of a monopoly franchise in the creation of fiat money is worth something because this franchise carries with it the power to create at essentially zero cost an asset upon which individuals place economic value. In what follows, we offer a brief discussion of the nature of money in some very simple settings in order to establish elementary propositions about the revenue significance of the money-creation monopoly. This discussion also serves to set the analytic stage for the ensuing, and more detailed, discussion of inflation as a tax. Initially, however, we abstract from inflation entirely. We also abstract from the host of questions that have occupied the attention of monetary theorists relating to the issue of how money might emerge in a barter economy. We simply assume, for the purposes of our argument, that the government is to be assigned its monopoly franchise in money creation ab initio. We shall restrict the analysis to an economy that is stationary; there is no growth and the basic parameters (wants, resources, technology) are assumed to be unchanging through time. The basic analysis could, of course, be readily extended to allow for economic growth and, hence, for increasing demands for money. For simplicity and economy in exposition, we shall forgo this extension here. As elsewhere in our book to this point, we assume the economy to be closed. In this setting, the government can, if authorized to create money, ignore any constraints that are imposed on its behavior by the presence of competing monies.1
We consider initially a simple two-period model. In period 1, a set of transactions among individuals occurs in which a set of buyers, B, exchange cash for a set of goods initially in the possession of a group of sellers, S. In period 2, these sellers, S, must be able to exchange that cash for goods which they value, since the cash has no intrinsic value. If this were not so, the sellers would not accept cash for goods in period 1. The creation of money then requires that in the second period the money-creating authority must be in a position to replace cash with goods or their equivalent.2 If the money-creating authority is the government, how can this be done? There are two means:
It seems clear, from either perspective, that money is rather like a form of debt. Money creation permits the government to reallocate the fruits of its taxing power intertemporally: government can by virtue of its money-creation (and taxing) powers shift the period 2 tax revenues to period 1. In addition, however, because it needs to pay no interest on its implicit loan, government obtains from its power to create money the equivalent of the interest on the money stock. Government could invest the resources it obtains in return for cash in period 1, and “repay” an amount equal to the same absolute value of those resources in period 2, keeping the interest.
The power to create money therefore assigns to government the market value of the transactions services of money for revenue purposes. In this simple model, that power is contingent on the government’s preparedness to accept money as payment of tax liabilities, or equivalently on government’s preparedness not to use up the resource base that money creation initially provides. Here and throughout the subsequent discussion, we neglect the deposit banking: government fiat issue is the only money.
Let us now extend this model by removing the simplifying assumption of two periods. In the case with infinite time horizons, the value of the money stock to government is the present value of the infinite stream of transactions services it provides to citizens. In other words, the value to government of a perpetual interest-free debt is equal to the principal—the real value of the money stock itself, in this case. If government obtains r · M per period forever, the capitalized value of this is 1/r · rM, or M.
It is quite clear therefore that, even in the absence of inflation, the power to create money is of revenue significance. The question we must ask here, however, relates to whether a Leviathan government could be expected to be content with the zero-inflation regime. What pattern of inflation (or deflation) might we predict Leviathan to choose? And what is the significance of this for the assignment of an unconstrained money-creation authority to government?
In order to answer these questions, we need to focus on inflation per se. In our discussion, we aim to do several things. First, we seek to establish the connection between inflation and the tax on money balances. Second, on the basis of this connection, we shall be able to reiterate the main conclusions of Chapter 5 concerning wealth taxes in specific application to inflation.
[1. ] It is evident that any “opening” of the economy tends to place limits on the power of government to create money, quite apart from constitutionally imposed constraints. The revenue-maximizing rate of inflation could be expected to be lower in the presence of competing monies, simply because domestic monopoly power is reduced. See F. A. Hayek, The Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies (London: Institute of Economic Affairs, 1976).
[2. ] For a discussion of the necessity of repurchase or its equivalent in a wholly different analytical context, see Boris P. Pesek and Thomas R. Saving, Money, Wealth and Economic Theory (London: Macmillan, 1967).
[3. ] It would also be possible to imagine a situation in which government printed only “period 1 monies”—that is, money that explicitly is legal tender only for a specified period. The capital value of such a money stock would presumably be the value of the transaction services it provides over the period of its legality. In the case of the example cited here, this period 1 value would presumably be rM. There are some interesting aspects to a regime of annual monies, not the least of which is that it seems to deprive government of any possible benefits from inflation. However, money as we know it is a durable asset—a stock, not an annual flow of transactions services—and all our discussion here is predicated on that fact.