Monetary Base

Published Oct 25, 2023

Definition of Monetary Base

The monetary base, also known as high-powered money, refers to the total amount of currency in circulation and reserves held by commercial banks at the central bank. It is the foundation of a country’s money supply and forms the basis for the creation of additional money through the banking system.

Example

To better understand the concept of the monetary base, let’s consider a hypothetical example. Assume that the central bank of a country has issued currency worth $100 million and the commercial banks in the country hold reserves of $50 million at the central bank. In this case, the monetary base would be $150 million ($100 million in currency + $50 million in reserves).

When the central bank buys government securities from commercial banks, it increases the reserves held by the banks. This, in turn, expands the monetary base. Conversely, when the central bank sells government securities to commercial banks, it decreases the reserves and contracts the monetary base.

Why Monetary Base Matters

The monetary base is an essential tool used by central banks to influence the money supply and manage the economy. By adjusting the level of reserves held by commercial banks, the central bank can control the amount of money in circulation. This allows central banks to implement monetary policy, such as stimulating economic growth or controlling inflation rates. Understanding the monetary base helps economists, policymakers, and investors analyze and predict the impact of central bank actions on the economy.