Monetary Base Explained

What the monetary base is

The monetary base (also called base money or high-powered money) is the total amount of highly liquid money created by a country’s central bank. It comprises:
* Currency in circulation (banknotes and coins)
* Reserves held by commercial banks at the central bank (required and excess reserves)

The monetary base underpins broader measures of the money supply because bank reserves can be transformed into deposits and loans through the banking system.

Components and formula

Formula: Monetary Base (MB) = Currency in Circulation (CC) + Reserves (R)

Example: If Country Z has 600 million units of currency in circulation and 10 billion units in central bank reserves, MB = 600 million + 10 billion = 10.6 billion units.

Relationship to the money supply

The monetary base is distinct from, and narrower than, measures of the money supply such as M1 and M2:
* M1: Currency in circulation + demand (checking) deposits and other checkable funds.
M2: M1 plus near-money assets like savings deposits, small time deposits, and retail money market funds.
M3 (where published): M2 plus larger time deposits and institutional money market funds; the U.S. Federal Reserve discontinued M3 publication in 2006.

Reserves in the monetary base can be “multiplied” into a larger volume of deposits and loans via fractional reserve banking, so small changes in the base can lead to larger changes in M1/M2 depending on banking behavior.

How central banks manage the monetary base

Central banks control the monetary base directly and indirectly through tools such as:
* Open market operations — buying government bonds increases bank reserves and the monetary base; selling bonds reduces it.
Discount window and lending to banks — increases reserves when banks borrow from the central bank.
Reserve requirements — lowering reserve ratios lets banks create more deposits from a given base; raising them reduces deposit creation.
* Quantitative easing — large-scale asset purchases that expand reserves and the monetary base.

These tools are used to influence liquidity, short-term interest rates, inflation, and overall economic activity.

Money multiplier (brief)

The money multiplier describes how much the money supply can expand for a given change in the monetary base. In a simplified model:
Money multiplier ≈ 1 / reserve ratio
Reality is more complex: currency preferences, excess reserves, and central bank policies affect the actual multiplier.

Example figures

As of March 2024 (Federal Reserve data):
* U.S. monetary base: about $5.88 trillion
M1: about $17.98 trillion
M2: about $20.9 trillion

Key takeaways

• The monetary base = currency in circulation + bank reserves at the central bank.
• It is the foundation of the money supply and is often called high-powered money.
• Central banks adjust the monetary base via open market operations, lending facilities, reserve rules, and asset purchases.
• The broader money supply (M1, M2) includes many items beyond the monetary base and can expand through the banking system via the money multiplier.

Short FAQs

Q: What is the monetary base formula?
A: MB = Currency in Circulation + Reserves.

Q: How does the monetary base differ from M1 and M2?
A: The base is limited to currency and bank reserves; M1 and M2 include those plus deposits and other liquid assets that circulate in the economy.

Q: Can central banks directly set the money supply?
A: They directly control the monetary base; the broader money supply is influenced but also depends on banks’ lending behavior and public demand for cash and deposits.