Monetary base
Encyclopedia
In economics
, the monetary base (also base money, money base, high-powered money, reserve money, or, in the UK
, narrow money) is a term relating to (but not being equivalent to) the money supply
(or money stock), the amount of money in the economy. The monetary base is highly liquid money that consists of coin
s, paper money (both as bank vault cash and as currency
circulating in the public), and commercial bank
s' reserves
with the central bank
. Measures of money are typically classified as levels of M, where the monetary base is smallest and lowest M-level: M0. Base money can be described as the most acceptable (or liquid
) form of final payment. Broader measures of the money supply also include money that does not count as base money, such as demand deposits (included in M1), and other deposit account
s like the less liquid savings accounts (included in M2) etc.
(The narrow money supply is an earlier term used in the U.S
to describe currency held by the non-bank public and demand deposits of banks, M1).
tools that affect directly the monetary base; the monetary base can be expanded or contracted using an expansionary policy
or a contractionary policy
, but not without risk.
The monetary base is typically controlled by the institution in a country that controls monetary policy. This is usually either the finance ministry or the central bank
. These institutions print currency and release it into the economy, or withdraw it from the economy, through open market transactions (i.e., the buying and selling of government bonds). These institutions also typically have the ability to influence banking activities by manipulating interest rates and changing bank reserve requirements (how much money banks must keep on hand instead of loaning out to borrowers).
The monetary base is called high-powered because an increase in the monetary base (M0) can result in a much larger increase in the supply of bank money, an effect often referred to as the money multiplier
. An increase of 1 billion currency units in the monetary base will allow (and often be correlated to) an increase of several billion units of "bank money". This is often discussed in conjunction with fractional-reserve banking
banking systems. A system of full-reserve banking
would not allow for an increase of currency in the banking system on top of the monetary base.
The Austrian School
of economics is critical of fractional-reserve banking
, stating that the increase of money in the banking system is equivalent to an artificial injection of credit, which is the source of the business cycle
. This is elaborated in the Austrian business cycle theory, for which Friedrich Hayek
won the Nobel Prize
in economics in 1974. However, in 1976, in a paper on The Denationalization of Money
, Hayek advocated that rather than re-instituting a government-mandated gold standard, a free market in money be allowed to develop, with issuers of money competing with each other to produce the best, most stable and healthy currency. This sparked an entire school of thought within economics, Free Banking
, with banks not being banned from having fractional reserves as other Austrians such as Murray Rothbard
advocated, but instead being free to experiment and discover the best method of conducting business.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the monetary base (also base money, money base, high-powered money, reserve money, or, in the UK
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
, narrow money) is a term relating to (but not being equivalent to) the money supply
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
(or money stock), the amount of money in the economy. The monetary base is highly liquid money that consists of coin
Coin
A coin is a piece of hard material that is standardized in weight, is produced in large quantities in order to facilitate trade, and primarily can be used as a legal tender token for commerce in the designated country, region, or territory....
s, paper money (both as bank vault cash and as currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
circulating in the public), and commercial bank
Commercial bank
After the implementation of the Glass–Steagall Act, the U.S. Congress required that banks engage only in banking activities, whereas investment banks were limited to capital market activities. As the two no longer have to be under separate ownership under U.S...
s' reserves
Bank reserves
Bank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...
with the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
. Measures of money are typically classified as levels of M, where the monetary base is smallest and lowest M-level: M0. Base money can be described as the most acceptable (or liquid
Market liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
) form of final payment. Broader measures of the money supply also include money that does not count as base money, such as demand deposits (included in M1), and other deposit account
Deposit account
A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...
s like the less liquid savings accounts (included in M2) etc.
(The narrow money supply is an earlier term used in the U.S
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
to describe currency held by the non-bank public and demand deposits of banks, M1).
Management
"Open market operations" are monetary policyMonetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
tools that affect directly the monetary base; the monetary base can be expanded or contracted using an expansionary policy
Expansionary monetary policy
In economics, expansionary policies are fiscal policies, like higher spending and tax cuts, that encourage economic growth. In turn, an expansionary monetary policy is monetary policy that seeks to increase the size of the money supply...
or a contractionary policy
Contractionary monetary policy
Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or a finance ministry....
, but not without risk.
The monetary base is typically controlled by the institution in a country that controls monetary policy. This is usually either the finance ministry or the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
. These institutions print currency and release it into the economy, or withdraw it from the economy, through open market transactions (i.e., the buying and selling of government bonds). These institutions also typically have the ability to influence banking activities by manipulating interest rates and changing bank reserve requirements (how much money banks must keep on hand instead of loaning out to borrowers).
The monetary base is called high-powered because an increase in the monetary base (M0) can result in a much larger increase in the supply of bank money, an effect often referred to as the money multiplier
Money multiplier
In monetary economics, a money multiplier is one of various closely related ratios of commercial bank money to central bank money under a fractional-reserve banking system. Most often, it measures the maximum amount of commercial bank money that can be created by a given unit of central bank money...
. An increase of 1 billion currency units in the monetary base will allow (and often be correlated to) an increase of several billion units of "bank money". This is often discussed in conjunction with fractional-reserve banking
Fractional-reserve banking
Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...
banking systems. A system of full-reserve banking
Full-reserve banking
Full-reserve banking, also known as 100% reserve banking, is a banking practice in which the full amount of each depositor's funds are kept in reserve, as cash or other highly liquid assets...
would not allow for an increase of currency in the banking system on top of the monetary base.
The Austrian School
Austrian School
The Austrian School of economics is a heterodox school of economic thought. It advocates methodological individualism in interpreting economic developments , the theory that money is non-neutral, the theory that the capital structure of economies consists of heterogeneous goods that have...
of economics is critical of fractional-reserve banking
Fractional-reserve banking
Fractional-reserve banking is a form of banking where banks maintain reserves that are only a fraction of the customer's deposits. Funds deposited into a bank are mostly lent out, and a bank keeps only a fraction of the quantity of deposits as reserves...
, stating that the increase of money in the banking system is equivalent to an artificial injection of credit, which is the source of the business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
. This is elaborated in the Austrian business cycle theory, for which Friedrich Hayek
Friedrich Hayek
Friedrich August Hayek CH , born in Austria-Hungary as Friedrich August von Hayek, was an economist and philosopher best known for his defense of classical liberalism and free-market capitalism against socialist and collectivist thought...
won the Nobel Prize
Nobel Prize
The Nobel Prizes are annual international awards bestowed by Scandinavian committees in recognition of cultural and scientific advances. The will of the Swedish chemist Alfred Nobel, the inventor of dynamite, established the prizes in 1895...
in economics in 1974. However, in 1976, in a paper on The Denationalization of Money
The Denationalization of Money
The Denationalization of Money is a paper written by Friedrich Hayek, and published in 1977, in which he advocated the establishment of a free market in money.-Message:...
, Hayek advocated that rather than re-instituting a government-mandated gold standard, a free market in money be allowed to develop, with issuers of money competing with each other to produce the best, most stable and healthy currency. This sparked an entire school of thought within economics, Free Banking
Free banking
Free banking refers to a monetary arrangement in which banks are subject to no special regulations beyond those applicable to most enterprises, and in which they also are free to issue their own paper currency...
, with banks not being banned from having fractional reserves as other Austrians such as Murray Rothbard
Murray Rothbard
Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...
advocated, but instead being free to experiment and discover the best method of conducting business.