Monetary Base
The monetary base (also called base money, high-powered money, or M0) is the total amount of currency in circulation plus the reserves held by commercial banks at the central bank. It is the foundation on which the broader money supply is built, and it is directly controlled by the central bank.[1]
Definition
The monetary base comprises:
| Component | Description |
|---|---|
| Currency in circulation | Banknotes and coins held by the public and by banks. |
| Bank reserves | Deposits held by commercial banks at the central bank, plus vault cash. |
Because the central bank can create base money, it is described as "high-powered": each unit of base money can support a multiple of broader money through the lending activities of banks.[1]
Relationship to money supply
The relationship between the monetary base and the broader money supply is captured by the money multiplier:
- Money multiplier = Money supply ÷ Monetary base
The size of the multiplier depends on the reserve ratio and on the public's preference for holding currency. In periods of financial stress, the multiplier may fall as banks hold excess reserves and the public hoards cash, weakening the link between base money and broader money.[1]
Policy significance
The monetary base is a central instrument and indicator of monetary policy. Central banks expand the base through Open Market Operations and lending to banks, and contract it by selling securities. Large expansions of the base, such as those undertaken during quantitative easing, are intended to lower interest rates and stimulate lending.[1]