Fiscal seigniorage from convenience assets determines price level in currency unions
A new ECB working paper examines how fiscal seigniorage from government securities with convenience yields determines the price level in a currency union. The study finds that changes in demand for these assets can cause price level shifts and wealth transfers across member countries.
How convenience assets back the union's price level
Investors value certain government securities, like those of Germany, for their liquidity and safety beyond pecuniary returns, leading to a 'convenience yield'.
This yield provides governments with an additional revenue source: fiscal seigniorage.
This paper, in the spirit of the fiscal theory of the price level, explores how these revenues determine the price level in a currency union.
The model features two countries within a union, each with a household, fiscal authority, and national central bank, forming a common central bank.
A key heterogeneity is that only one member country's government bonds offer non-pecuniary benefits, driving down their interest rates.
In equilibrium, the real value of total public sector liabilities equals the present discounted value of primary surpluses, monetary seigniorage, and fiscal seigniorage.
With appropriate policies, fiscal seigniorage revenues uniquely determine the union's price level.
Asymmetric wealth transfers in the union
The model reveals that heterogeneous convenience properties of government bonds can lead to an asymmetric distribution of wealth within the currency union.
Households holding convenience bonds effectively transfer real resources to the issuing fiscal authority.
If these seigniorage revenues reduce domestic taxes, resources are channeled from foreign to domestic households.
Furthermore, exogenous changes in demand for convenience assets impact the price level and redistribute wealth.
A drop in demand reduces the convenience yield and total seigniorage, increasing the price level.
This decline is asymmetric, with the convenience-bond-issuing country experiencing a larger revenue drop, resulting in a permanent loan from the other member country.
Such shocks also permanently alter consumption levels if initial wealth differs.
Beyond traditional fiscal theory
This paper significantly advances the fiscal theory of the price level by incorporating convenience yields, offering a more nuanced understanding for heterogeneous currency unions.
While the two-country model simplifies euro area complexities, its findings on price level determination and wealth transfers are highly relevant.
It underscores the critical, often underappreciated, interplay between national fiscal policies and union-wide monetary stability.