Front Page Titles (by Subject) 6.7.: The Monetary Constitution - The Collected Works of James M. Buchanan, Vol. 9 (The Power to Tax: Analytical Foundations of a Fiscal Constitution)
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6.7.: The Monetary Constitution - 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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Foreword and coauthor note © 2000 Liberty Fund, Inc. © 1980 Cambridge University Press.
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The Monetary Constitution
The Leviathan exploitation of the revenue potential of the money-creation power is a possibility that will be among those to be reckoned with in the constitutional deliberations of the citizen when he considers the possible efficacy of granting independent powers of money creation to government. As the analysis is intended to suggest, it is difficult, if not impossible, to construct an argument that could offer coherent logical support for such a delegation of power in any open-ended sense. Equally, the analysis suggests that constitutional rules for money creation may be among the alternatives considered in any efficient set of fiscal-monetary arrangements. If, on the one hand, conventional tax instruments are chosen that will generate an approximately efficient level of public-goods supply when exploited to their maximum revenue potential, the citizen will wish to guard against additional revenue raising through money creation. Government franchise in money creation may be constitutionally prohibited. Alternatively, the individual may deny government access to standard tax arrangements sufficient to finance desired public expenditure levels and instead allow government access to the inflationary financing option. Whereas with most taxes the assignment of the base is sufficient, however, it seems likely here that rate limitations will also be desirable, probably even to Leviathan itself. In this sense, the monetary constitution, embodying some set of rules relating to the extent of monetary expansion, is necessarily more restrictive than the fiscal limitations we have been discussing heretofore—both base and (maximum) rate limits are involved.
A constitutionally selected and enforced rate of inflation that would provide government with funds sufficient to finance an estimated desired quantity of public goods would not run into the confidence dilemma previously discussed. But this difference emerges precisely because the rate of inflation is chosen constitutionally, as a rule to be enforced on government, rather than an announcement of intent by government. In this context of a constitutionally selected institution for financing governmental outlays, inflation does become a simple tax on money balances, and, as such, it might be considered along with other taxes on capital stocks, which would also have to be designed to embody constitutionally designated rates to prove at all acceptable.
Our purpose in this book is not to discuss properties of an optimal or desired monetary constitution, which may or may not include a constitutionally designated rate of inflation as a viable alternative for consideration. Our more limited purpose here has been to consider, even if briefly, inflation as a tax and to determine the prospects of reconciling this sort of fiscal instrument with the choice calculus of the citizen who models government in Leviathan terms.
However, in the light of our earlier discussion of wealth taxes more generally, there is one aspect of the “monetary constitution” that Bailey’s analysis and indeed all the relevant literature seems to have overlooked and that is important in the setting outlined here. Bailey’s analysis and the subsequent literature focus solely on the welfare losses attributable to different rates of inflation. But it is clear that inflation—of the steady, totally preannounced, and legally binding type—not only distorts asset choices and not only determines the magnitude of government revenues; it also determines the timing of the revenue stream which the money-creation power makes possible.
For example, assuming a stationary economy, a zero-inflation monetary constitution implies that the full revenue value of the money-creation power under this constraint, 0JCS in Figure 6.3, accrues in the initial period when the money supply is introduced. By contrast, the less constrained monetary constitution embodying a positive fixed inflation rate of i* increases the total present value of the money-creating power to the capitalized value 0HFT in Figure 6.3. But only a portion of this present value can be secured by government in period 1. The additional value accrues in equal annual increments, as inflation proceeds, and the present value of those increments in real terms is the area SGFT. Analogously, the “optimal” rate of inflation in the Friedman analysis involves an initial value of the money stock of 0SVK but annual interest payments which in present-value terms are exactly equal to that initial value.
If the money-creation power is to be used for financing desired public goods and services under a Leviathan government or the possibility of one, this timing pattern is clearly of some account in its own right. To provide the desired time stream of public goods, one presumably requires continuous spending. Under a continuous benevolent government, we might conceive of a situation in which the “sale” of money in the initial period serves to establish a sinking fund, the interest from which is used to finance ongoing spending. Once one allows the possibility of revenue-maximizing Leviathan, however, this possibility seems unlikely to be feasible: any sinking fund would surely not survive beyond the period in which Leviathan is in office. Since inflation involves spreading revenue over time, the problem of lumpiness in the time stream of revenues becomes less severe under a monetary rule with a positive inflation rate. For example, as the constitutionally specified rate of inflation rises from zero to i* in Figure 6.3, the initial real value of the money stock in period 1 falls from 0SCJ to 0HGS, but the present value of the revenue attributable to future inflation rises from zero to SGFT. To equalize the revenue stream in every period would require an inflation rate of 100 percent: the proportionate increase in the nominal money stock in every period would be the same.
Consequently, the timing characteristics of the revenue flows become more desirable as the constitutionally appointed rate of inflation increases, over the range up to 100 percent. On the other hand, welfare losses increase and beyond some point the aggregate revenue may decline as the rate of inflation embodied in the monetary rule rises. Some trade-off here is presumably required. What seems clear is that the Friedman “optimal” money rule may not be optimal, even in the restricted limits of the model used, once these timing problems are confronted. Negative or zero inflation rates may not be preferred: moderately high rates of inflation may be.
One implication here is that there is no way that the power to create money can be divested of its revenue implications by a money rule alone. This may be viewed as a persuasive argument for relying on possibly imperfect market alternatives, and denying government the power to create money under any circumstances at all.