Seignorage generally denotes income from the issue of money. For central banks the revenue from seignorage can be defined as the flow of interest from the assets held against notes in circulation (or, more in general, against the monetary base). In the case of the Eurosystem, it is included in the definition of “monetary income” which according to Article 32.1 of the Statute of the ESCB and of the ECB is “The income accruing to the national central banks in the performance of the ESCB's monetary policy function.”
To understand the meaning and importance of seignorage it is necessary to examine its history.
From the Middle Ages until the nineteenth century anyone in Europe could take gold to the state mint and have it coined, in other words transformed into money. The mintage – images and inscriptions engraved on metal – represented the state’s guarantee or seal of the signore on the weight and fineness of the gold, that is on its value. Thanks to the coinage the money was universally accepted as a means of payment without having to be weighed and assayed by those receiving it. In return for this service the state withheld a small portion of the gold taken to the mint. This was the seignorage fee.
In ordinary circumstances seignorage represented a modest contribution to the state’s coffers. On many occasions, however, the seignorage entitlement was abused. States which found they were unable to cover their expenses with taxes and to obtain credit, responded by striking (and spending) numerous coins whose precious metal content was just a fraction of the original.
The new coins in circulation were added to the old, but the goods on the market did not increase as a result. Therefore very soon the coins began to lose value with respect to these goods and inflation ensued. It ought to be noted that inflation did not occur because the coins had a lower gold content but because they were struck in excessive quantities compared with the production of goods. What matters is not that the coins have an intrinsic value, a gold or silver content, but that a stable balance is maintained between the value of the monetary mass and that of the goods produced by the economy. A famous example of this mechanism was the price revolution that raged in Europe in the 1500s, triggered by the flow of gold and silver from America, in other words of good money issued by colonial Spain and not of bad money devoid of intrinsic value; basically there was a glut of gold and silver coins with respect to goods.
The advent of paper money in the early nineteenth century marked a decisive step forward because it freed humanity from the need to produce massive quantities of gold and silver which had no practical use. Paper money, a mere conventional sign which cost virtually nothing to make, facilitated the conduct of trade just as well as metal coinage.
The adoption of paper money increased the potential for extracting profit from seignorage, both owing to the low costs of production and because an arbitrarily high value could be imposed on the notes. Perhaps unsurprisingly there were further episodes of abuse, including some blatant ones. One of the most celebrated was the deluge of banknotes during the French Revolution, the assignats which between 1790 and 1796 were used to prop up the French state at the cost of a rate of inflation of ten thousand percent.
To avoid these political abuses, following complex institutional developments the idea finally took hold that the issue of money should be entrusted to entities independent of governments. Initially the power to issue banknotes was granted to private banks which undertook this activity in concession. The banks were obliged to comply with numerous obligations, chief among which was to guarantee the notes’ convertibility into gold or silver at a rate set by law. After the First World War, however, there was a general realization that the convertibility obligation, conceived in order to guarantee the value of money, in reality posed strong risks to economic stability because of the severe monetary restrictions it imposed in times of crisis which exacerbated rather than alleviated the situation. The obligation was accordingly abolished and the issue of money was entrusted to central banks. Nowadays in addition to the laws of the state (legal value), the value of banknotes is guaranteed by the central banks’ objective of maintaining a supply of money commensurate with the requirements of the economy and of avoiding both inflation and deflation. Central banks also guarantee the integrity and authenticity of the notes in circulation.
Today, then, seignorage is initially paid to the central banks, which then transfer it to the respective states in which monetary sovereignty ultimately resides. What has changed most is how seignorage accrues. When coins and banknotes are produced by the state it is the latter which, by spending them for example on goods and services, injects money into the economy and immediately realizes its equivalent value, net of production costs. When, instead, it is the central bank which issues the banknotes (or, more in general, the monetary base which also includes banks’ reserves held with the central bank), it does not use them to purchase goods and services but supplies them to commercial banks in the form of loans for economic purposes or uses them to buy financial assets, such as government bonds or foreign denominated assets. The value of the banknotes, entered on the liability side of the central bank’s balance sheet, matches that of the interest-bearing assets.
The central bank accordingly obtains seignorage over time, as the flow of interest on its profitable assets, net of the cost of production of the notes. The discounted value of this flow, which as was mentioned earlier is paid to the state, is equal to what the latter would have obtained had it directly introduced the notes into the economy.
The situation in the euro area and treatment under the Bank of Italy's Statute
In the euro area the ECB is responsible for the issue of banknotes in conjunction with the national central banks in the Eurosystem. The “monetary income” from each national bank is defined as the annual income obtained from the assets held against the banknotes in circulation and deposit liabilities to credit institutions. This is transferred to the ECB and from there redistributed to the national banks based on their share in the ECB’s capital. The national central banks, in turn, transfer the income to the state after deducting the operating costs and having made the necessary provisioning.
The Bank of Italy transfers its share of “monetary income” to the state through taxes and the distribution of profit, along with additional revenue from its own investments unrelated to the monetary policy function and from its banking activities, and net of management fees and provisions.
The latter are designed to preserve the Bank’s solidity and financial independence, allowing it to withstand independently and without external conditioning the risks stemming from the exercise of its institutional functions.
More specifically, Article 38.2 of the Statute of the Bank of Italy provides that the net profit be distributed as follows: to ordinary reserves, up to 20 per cent; to shareholders who have held shares since the end of the fortieth day prior to the date of the first call of the Shareholders’ Meeting, up to 6 per cent of the capital; to special reserves and provisions, up to 20 per cent; to the State, the remaining sum. For the years 2014 and 2015, dividends paid to shareholders came to €340 million for each year (4.5% of the capital), with the net profit distributed to the State equalling €1,909 million for 2014 (in addition to taxes totalling €1,159 million) and €2,157 million for 2015 (plus taxes amounting to €1,012 million).
Case law in Italy
Several years ago the Court of Cassation was called to rule on the legitimacy of assigning seignorage income in the first instance to the Bank of Italy. In its judgment the Court affirmed that the assignment of the "monetary income" to the central bank is the effect of a political decision sanctioned in European law, which the Italian State is bound to uphold.