Question

Evaluate whether the follow statements are true or false and EXPLAIN why.

1. While welfare is maximum at a negative inflation rate, seigniorage increases when inflation increases.
2. Seigniorage is maximum for negative inflation rates.
3. In the money in the utility function model, money demand is always bounded above whenever the utility function satisfies that as money goes to zero, the marginal utility of money goes to infinity.

Answer 1

a) False.

Seigniorage is the difference between the face value of a currency and the cost incurred to produce the currency such as $100 bill, a coin, etc. When inflation increases the raw materials for the producing the currency increases, or in simple the cost incurred in producing a piece of currency increases for the same face value of currency. Hence Seigniorage decreases due to the increase in costs incurred.

b) True

During negative inflation (or deflation), the prices in the market decrease drastically, thereby the cost incurred to produce a currency decreases due to the price decrease in the raw materials like paper, steel, etc. Therefore the Seigniorage is maximum at this scenario.

c) False

The money being bounded in the physical terms says that it stops being useful beyond a certain point. Hence the Marginal utility touches zero as there is no happiness after a certain point as the money is being bounded and goes to 0.

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