Definition
The Monetary Base, also known as M0, represents the most narrow definition of the money supply. It includes the total amount of currency that is circulated among the public and the reserves that commercial banks hold at the central bank (such as the Federal Reserve Bank in the United States). This base is a fundamental element in the banking system and serves as the foundation for the broader constructs of the money supply.
Examples
-
Federal Reserve Bank in the United States: The Federal Reserve controls the monetary base by issuing currency and maintaining reserves for commercial banks. Actions like open market operations directly influence the amount of M0.
-
European Central Bank (ECB): Similar to the Federal Reserve, the ECB manages the euro area’s monetary base by controlling the issuance of currency and maintaining commercial bank reserves.
Frequently Asked Questions
1. How is the monetary base different from other measures of the money supply?
The monetary base (M0) is the narrowest measure of the money supply, including only currency in circulation and bank reserves. Other measures like M1, M2, and M3 add various components such as demand deposits, savings accounts, and other liquid assets.
2. Why is the monetary base important?
The monetary base is crucial for understanding the underlying support of the broader money supply. It directly influences the banking system’s ability to create loans and expand the money supply through the money multiplier effect.
3. Can the central bank control the monetary base?
Yes, the central bank has direct control over the monetary base through mechanisms like open market operations, discount rates, and reserve requirements.
4. What is included in ‘currency in circulation’?
Currency in circulation includes physical money such as coins and paper notes that are held by the public and not by banks.
5. How do reserves held by commercial banks impact the monetary base?
Reserves held by commercial banks at the central bank are part of the monetary base. Higher reserve amounts can limit the bank’s ability to make loans, whereas lower reserves can enhance loan-making capacity.
- Money Supply: The total amount of money in circulation or in existence in a country at any given time.
- Central Bank: A national bank that provides financial and banking services for the government and commercial banking system, also implementing the government’s monetary policy.
- Open Market Operations (OMO): Activities by the central bank to buy or sell government bonds in the open market to regulate the money supply.
- Money Multiplier: The process by which an increase in reserves leads to a larger increase in the total money supply through the banking system.
Online References
Suggested Books for Further Studies
- Money, Bank Credit, and Economic Cycles by Jesús Huerta de Soto.
- Principles of Economics by N. Gregory Mankiw.
- The Economics of Money, Banking, and Financial Markets by Frederic S. Mishkin.
Fundamentals of Monetary Base: Economics Basics Quiz
### What does the monetary base (M0) include?
- [x] Currency in circulation and reserves held by commercial banks at the central bank.
- [ ] Demand deposits and savings accounts.
- [ ] Only assets held by the public.
- [ ] All forms of electronic money.
> **Explanation:** The monetary base (M0) specifically includes the physical currency in circulation among the public and the reserves held by commercial banks at the central bank.
### Which entity controls the monetary base in the United States?
- [x] The Federal Reserve Bank
- [ ] The Department of the Treasury
- [ ] Commercial Banks
- [ ] The Internal Revenue Service (IRS)
> **Explanation:** The Federal Reserve Bank is responsible for controlling the monetary base in the United States through various monetary policy tools.
### What effect does an increase in the monetary base typically have?
- [x] It can lead to an increase in the money supply.
- [ ] It does not affect the money supply.
- [ ] It decreases the money supply.
- [ ] It only affects the amount of physical currency.
> **Explanation:** An increase in the monetary base often leads to a larger increase in the total money supply through the money multiplier effect in the banking system.
### What is the money multiplier?
- [x] The process through which an increase in reserves leads to a larger increase in the money supply.
- [ ] A tool for measuring inflation.
- [ ] A measure of economic growth.
- [ ] A ratio of physical currency to electronic currency.
> **Explanation:** The money multiplier is the process through which an initial increase in reserves can lead to a more significant expansion of the overall money supply.
### What is meant by 'currency in circulation'?
- [x] Physical money such as coins and paper notes held by the public.
- [ ] All electronic money transfers.
- [ ] Money stored in central bank vaults.
- [ ] All deposits in savings accounts.
> **Explanation:** 'Currency in circulation' refers to physical money like coins and paper notes held by the public and does not include money stored in banks or electronically transferred funds.
### How can the central bank alter the monetary base?
- [ ] By changing foreign exchange rates.
- [ ] By setting tax policies.
- [x] Through open market operations.
- [ ] Through income redistribution policies.
> **Explanation:** The central bank can alter the monetary base through open market operations, including buying or selling government securities to influence the amount of money in the banking system.
### Which of the following does not directly contribute to the monetary base?
- [x] Savings deposits in commercial banks.
- [ ] Currency held by the public.
- [ ] Reserves held by commercial banks at the central bank.
- [ ] Physical bank notes.
> **Explanation:** Savings deposits in commercial banks do not directly contribute to the monetary base. The base includes only physical currency in circulation and reserves held by commercial banks.
### Why might the central bank want to increase the monetary base?
- [x] To stimulate economic growth by increasing the money supply.
- [ ] To directly increase the country's GDP.
- [ ] To decrease inflation directly.
- [ ] To increase employment through government spending.
> **Explanation:** Increasing the monetary base can stimulate economic growth by increasing the money supply, which encourages lending and investment activity.
### In which situation would the monetary base decrease?
- [ ] When commercial banks receive more deposits.
- [x] When the central bank sells government securities.
- [ ] When inflation rates rise.
- [ ] When tax rates are reduced.
> **Explanation:** The monetary base decreases when the central bank sells government securities, which reduces the reserves of commercial banks and the overall money in circulation.
### What does M0 stand for?
- [ ] The broadest measure of the money supply.
- [ ] Money multiplied by eight.
- [x] The monetary base.
- [ ] The gross domestic product.
> **Explanation:** M0 stands for the monetary base, which is the most narrow measure of the money supply, including only currency in circulation and reserves held at the central bank.
Thank you for exploring the intricate details of the monetary base with us and challenging yourself with our comprehensive quiz. Your journey through the world of economics is just beginning!
