Monetary base
The total of banknotes in circulation and commercial bank reserves — every form of money that is a direct liability of the central bank.
Also called: M0, base money, high-powered money.
The base is what the central bank itself issues. Everything else people call money — the balance in a current account, a money market fund share — is somebody else's promise, ultimately settled in base money.
Its two components serve different users. Banknotes are the base money the public can hold; reserves are the base money only banks can hold. A cash withdrawal converts one into the other without changing the total.
A growing base does not mechanically produce inflation or lending. After 2008 the base grew enormously while broad money and bank credit grew far more slowly, which is the clearest evidence that the textbook multiplier is a ceiling rather than a description.
The mechanics
- Components
- Currency in circulation + reserve balances held at the central bank.
- Expands when
- The central bank buys assets or lends — quantitative easing being the largest example.
- Contracts when
- Holdings mature without reinvestment, or cash flows back and is retired.
The common misreading
That the base and 'the money supply' are the same thing. Most money people actually spend is broad money — commercial bank deposits — which is created by lending, not by the central bank.
Related terms
- Bank reservesDeposits that commercial banks hold at the central bank — the settlement asset banks use to pay each other, and a liability of the central bank rather than an asset it owns.
- Broad moneyMoney the public can actually spend — currency plus bank deposits and close substitutes — most of which is created by commercial banks when they lend.
- Quantitative easingLarge-scale central bank purchases of bonds, paid for with newly created reserves, used to ease financial conditions once the policy rate is already near its floor.
- Money multiplierThe textbook ratio m = 1/R describing the maximum deposit money a banking system could support on a given reserve base — a ceiling, not a description of how banks actually operate.
Primary sources
Post it yourself
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