Monetary Base Definition What It Includes Example

Monetary Base Definition What It Includes Example

Monetary Base: Definition, What It Includes, Example

What Is the Monetary Base?

The monetary base is the total amount of currency in circulation or held in reserves. Money in circulation is anything used by the public, while reserves refer to bank deposits and money held at the central bank. This measure of the money supply is not often cited as it excludes other non-currency money forms.

Key Takeaways

– The monetary base includes physical paper and coin currency in circulation, plus bank reserves.

– The monetary base is sometimes referred to as high-powered money, as it can be expanded through the money multiplier effect.

– The monetary base is part of the money supply.

– Economists typically focus on more comprehensive monetary aggregates like M1 and M2.

– Governments can manage the monetary base by buying and selling government bonds.

Understanding the Monetary Base

The monetary base is a component of a nation’s money supply. It refers to highly liquid funds, including notes, coinage, and current bank deposits. When the Federal Reserve creates new funds to purchase bonds from commercial banks, the banks’ reserve holdings increase, causing the monetary base to expand.

The monetary base is a monetary aggregate not widely cited but important. It includes currency in circulation and the stored portion of commercial bank reserves at the central bank, known as high-powered money.

The monetary base is divided into levels, listed as M0 through M3 or M4, representing different facets of a nation’s assets:

– M1: This narrow measure includes physical currency, reserves, demand deposits, traveler’s checks, and other checkable deposits.

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– M2: This calculation includes M1 and near money, which includes savings deposits, money market securities, mutual funds, and other time deposits.

– M3: This measure includes M2 and large-time deposits, institutional money market funds, repurchase agreements, and larger liquid assets.

The monetary base’s funds are generally held within the lower levels of the money supply, such as M1 or M2, which encompass cash in circulation and specific liquid assets like checking and savings accounts.

The Federal Reserve stopped publishing data on M3 in 2006.

Monetary Base and the Money Supply

The money supply extends beyond the monetary base to include other less liquid assets. The funds must represent the final settlement of a transaction to qualify.

For example, paying a debt with cash is a final transaction. Writing a check against a checking account or using a debit card is also considered final once the transaction has cleared.

Using credit to pay a debt does not qualify as part of the monetary base. This is because using credit transfers a debt owed from one party to another.

Smaller Scale Monetary Bases and Money Supplies

The monetary base consists of notes, coins, and funds in deposit accounts. The money supply of a household may include available credit on credit cards, unused portions of credit lines, and other accessible funds that translate into debt.

The monetary base in the United States as of July 2023 was $5.32 trillion. M1 stood at $18.45 trillion, while M2 was about $20.9 trillion.

Managing Monetary Bases

Most monetary bases are controlled by a country’s central bank. This institution can change the monetary base through open market operations or monetary policies. This can be done by implementing expansionary or contractionary policies.

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For many countries, the government can control the monetary base by buying and selling government bonds in the open market.

Example of a Monetary Base

A hypothetical example shows how a monetary base works. Suppose Country Z has 600 million units of currency circulating publicly and a central bank with 10 billion currency units in reserve from commercial banks. In this case, the monetary base for Country Z is 10.6 billion currency units.

What Is the Definition of a Monetary Base?

A country’s monetary base is the total amount of money created by its central bank. This includes currency in circulation, money held in reserves at commercial banks, and money held in reserves by banks at the central bank.

What Is the Difference Between the M1 and M2 Money Supplies?

The money supply refers to the total amount of currency and liquid assets in a country’s economy. M1 includes physical money and money in liquid vehicles like bank accounts. M2 is broader and includes M1 plus money market funds and short-term time deposits like CDs.

What Is the Total Monetary Base of the United States?

The monetary base of the United States was estimated to be $5.52 trillion in July 2023, according to the Federal Reserve.

What Is the Monetary Base Formula?

The formula to calculate a country’s monetary base is to add the currency in circulation and reserves: MB = CC + R. For example, if there is $1 billion worth of currency in circulation and $2 billion in reserves, the monetary base is $3 billion.

What’s the Difference Between Monetary Base and Money Supply?

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A country’s monetary base includes currency in circulation, reserves at banks, and reserves at the central bank. The money supply includes banknotes, coins, and money held by consumers in bank accounts.

The Bottom Line

Central banks have various functions for their economies, including providing money and bank reserves. The money they provide is called the monetary base, which is used to complete transactions and pay off debt.

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