In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is the total amount of bank notes and coins circulating in the economy. This includes:
- the total currency circulating in the public,
- plus the currency that is physically held in the vaults of commercial banks,
- plus the commercial banks' reserves held in the central bank .
The monetary base is manipulated during the conduct of monetary policy by a finance ministry or the central bank. These institutions change the monetary base through open market operations: the buying and selling of government bonds. For example, if they buy government bonds from commercial banks, they pay for them by adding new amounts to the banks’ reserve deposits at the central bank, the latter being a component of the monetary base.
Typically, a central bank can also influence banking activities by manipulating interest rates and setting reserve requirements (how much money banks must keep on hand instead of loaning out to borrowers). Interest rates, especially on federal funds (ultra-short-term loans between banks), are themselves influenced by open market operations.
The monetary base has traditionally been considered high-powered because its increase will typically result in a much larger increase in the supply of demand deposits through banks' loan-making, a ratio called the money multiplier. However, for those that do not agree with the theory of the money multiplier, the monetary base can be thought of as high powered because of the fiscal multiplier instead.
If a country’s gross domestic product is declining or growing sluggishly, monetary policy by the central bank can offset this with open market purchases of bonds, which expand the monetary base. This expansion of the base in turn leads to expansion of the money supply and to downward pressure on interest rates, making it less expensive for consumers to buy consumer goods and for companies to purchase new physical capital. The increase in expenditure gives an upward push to gross domestic product. On the other hand, if gross domestic product is growing at an unsustainably high rate, threatening to cause an increase in the inflation rate, contractionary open market operations can be used to slow the economy.
- See, e.g., U.S. Federal Reserve System regulations at 12 C.F.R. section 204.5(a)(1) and 12 C.F.R. section 204.2.
- See, e.g., U.S. Federal Reserve System regulation at 12 C.F.R. section 204.5(a)(1)(i).
- Mankiw, N. Gregory (2002), "Chapter 18: Money Supply and Money Demand", Macroeconomics (5th ed.), Worth, pp. 482–489
- "Monetary Base; Total". Economic Research – Federal Reserve Bank of St. Louis.
- "The Fed - What were the Federal Reserve's large-scale asset purchases?". Board of Governors of the Federal Reserve System. Retrieved 23 May 2019.
- Brunner, Karl (1987). "High-powered money and the monetary base". In Newman, Peter K.; Eatwell, John; Palgrave, Robert Harry Inglis; Milgate, Murray (eds.). The New Palgrave Dictionary of Economics. New York: Macmillan. doi:10.1057/9780230226203.2726. ISBN 0-935859-10-1. Retrieved 8 February 2011.
- Goodhart, Charles (1987). "Monetary base". In Newman, Peter K.; Eatwell, John; Palgrave, Robert Harry Inglis; Milgate, Murray (eds.). The New Palgrave Dictionary of Economics. New York: Macmillan. doi:10.1057/9780230226203.3102. ISBN 0-935859-10-1. Retrieved 8 February 2011.
- Cagan, Phillip (1965). "High-Powered Money". Determinants and Effects of Changes in the Stock of Money, 1875-1960 (PDF). Cambridge, Massachusetts: National Bureau of Economic Research. pp. 45–117. ISBN 0-87014-097-3. Retrieved 8 February 2011.
- Aggregate Reserves Of Depository Institutions And The Monetary Base (H.3)