In finance, the term seigniorage refers to the profits earned by a central bank or other national monetary authority through the production and maintenance of the base money which makes up a currency.
Typically, seigniorage is earned on the difference between the cost of issuing base money and the face value of the issued money. It is also earned on the difference between the cost of maintaining a currency and the face value of that currency.
Seigniorage provides a clear indicator of the cost or profitability of producing and maintaining a currency. If the cost of producing and maintaining an item of currency is lower than the face value of the item of currency, then the central bank or national monetary authority earns a profit (positive seigniorage). If the cost of producing and maintaining an item of currency is lower than the face value of the item of currency, then the central bank or national monetary authority makes a loss on the production of that item of currency (negative seigniorage).
When coins and banknotes are produced, the difference between the cost of producing the coins and banknotes and the face value of those coins and banknotes makes up the seigniorage.
Banknotes generally have high seigniorage because the cost of the paper and production process is typically low in relation to their face value. Coins generally have low seigniorage because the cost of the metals and production process is typically high in relation to their face value. This means that central banks and monetary authorities earn higher profits or make lower losses on the production of banknotes than on the production of coins.
In terms of total seigniorage, both banknotes and coins have relatively high seigniorage because once in circulation, transactions of banknotes and coins generate few administrative costs for a central bank.
Seigniorage on electronic base money produced and maintained by central banks is typically profitable because the cost of producing electronic balances is negligible and the fact that only base money reserves of commercial banks can be held in this form means that electronic base money transactions – and the resulting administrative costs – are relatively low.
However, because a large part of the seigniorage earned by private banks through their monopoly on the production of base money is earned through the production of banknotes, an increase in cashless transactions of book money (balances of commercial bank accounts) in place of banknotes and coins can lead to a decline in profits earned by central banks in the form of seigniorage, causing them to become dependent on government funding.
In a broader sense, the term seigniorage can also be used to denote the difference between the production costs and the face value of precious metal coins, alternative currencies, cryptocurrencies and other forms of currency.