FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Monetary Base

Updated on January 30, 2024
Article byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Monetary Base?

The monetary base refers to a measure of money supply in the economy consisting of Federal Reserve System (Central Bank) issued currency circulating outside of Treasury and Federal Reserve through the public and Federal Reserve balances of depository institutions. It is also known as MB or M0.

A major portion of MB accounts for the money a country’s citizens use in their everyday lives. As a result, it throws insight into a nation’s nominal GDPNominal GDPNominal GDP (Gross Domestic Product) is the calculation of annual economic production of the entire country's population at current market prices of goods and services generated by four main sources: land appreciation, labour wages, capital investment interest, and entrepreneur profits calculated only on finished goods and services.read more, the price level in the economy Economy An economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read moreor the level of inflationInflationThe rise in prices of goods and services is referred to as inflation. One of the measures of inflation is the consumer price index (CPI). Rate of inflation = (CPIx+1–CPIx )/CPIx. Where CPIx is the consumer price index of the initial year, CPIx+1 is the consumer price index of the following year.read more, short term or long-term economic directions. Hence it acts as a guideline or reference for monetary policyMonetary PolicyMonetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.read more determination.

Key Takeaways

  • The monetary base consists of currency in circulation outside of Treasury and Federal Reserve and the Federal Reserve (Central Bank) balances of depository institutions.
  • It is a measure of money supply and is also known as MB, M0, or base money. Other measures of money supply are M1 and M2.
  • It throws insight into a nation’s nominal GDP, the price level in the economy or the level of inflation, short term or long-term economic directions.  
  • According to the data listed on the Federal Reserve website, the United States MB value of December 2021 is 6,413.2 (Billions of Dollars), and January 2022 is 6,103.5 (Billions of Dollars).

Monetary Base Explained

The monetary base definition illustrates an important concept in monetary economicsEconomicsEconomics is an area of social science that studies the production, distribution, and consumption of limited resources within a society.read more. Every country has a central bank that formulates, controls, and manages currency circulation. For example, the Federal Reserve in the United States central bank is responsible for the US monetary base.

Central banks control the MB by applying common monetary policy tools or open market operationsOpen Market OperationsAn Open Market Operation or OMO is merely an activity performed by the central bank to either give or take liquidity to a financial institution. The aim of OMO is to strengthen the liquidity status of the commercial banks and also to take surplus liquidity from them.read more. For example, when Federal Reserve engages in selling and buying US Treasury BondsTreasury BondsA Treasury Bond (or T-bond) is a government debt security with a fixed rate of return and relatively low risk, as issued by the US government. You can buy treasury bonds directly from the US Treasury or through a bank, broker, or mutual fund company.read more, the MB value of the US changes. By purchasing government bondsGovernment BondsA government bond is an investment vehicle that allows investors to lend money to the government in return for a steady interest income.read more as open market operations. Another example is that when it comes time to reduce the MB, the Fed might stop the lending programs. For implementing monetary policy, a country’s monetary policymakers must study money supply indicators, including MB specifics, even though these aspects are only a subset of the vast array of financial and economic data that policymakers examine.

MB reflecting an important portion of a nation’s money supply is also indicated as MO. In some instances, it is also called M0, money base, or base money. Other measures of money supply are M1 and M2. M1 is the total currency held by the public and transaction deposits at depository institutions. M2 is the sum of M1, savings deposits, small-denomination time depositsTime DepositsTime deposit, also known as term deposit, refers to the deposit account with fixed maturity and interest rate.read more, and retail, money marketMoney MarketThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders.read more, mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, shares.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Monetary Base Formula

The MB in numerical terms is expressed as the sum of the total value of the currency in circulation and reserve balances.

Monetary Base Formula

MB indicates the monetary base in the above formula, C is the currency in circulation, and R is the reserve balances. Reserve balances are the total deposits of all kinds of depository institutions in their accounts at the Federal Reserve or the nation’s central bank. These are the basic input values required for MB calculation, even as the input for Monetary base calculators.

Example

The following is a simple example for a better understanding of the concept and formula usage. 

A country has $300 million currency in circulation, and its central bank holds $70 million as deposits from banks and other depository institutions. In total, the country’s MB is $370 million. The calculation is as follows:

MB = C + R

MB = $300 million + $70 million = $370 million.

In a real-world scenario, let’s look into the U.S. monetary base.

According to the data listed on the Federal Reserve website, the MB values of December 2021 and January 2022 are as follows:

MB = C + R

December 2021: MB = 2,225.3+ 4,187.9= 6,413.2 (Billions of Dollars)

January 2022: MB = 2,232.9+ 3,870.5= 6,103.5 (Billions of Dollars)

Monetary Base vs Money Supply

Monetary Base vs Money Supply

When the MB encompasses currency in circulation and reserve balances, money supply indicates the total currency in circulation and checkable or demand depositsDemand DepositsMoney deposited with a bank or financial institution that can be withdrawn without notice is known as a demand deposit. Due to the shorter lock-in time, it does not pay any interest or a nominal amount of interest.read more. Reserve balances are not included in the money supply calculation, and it is evident that the money supply concept aligns with the money available for immediate use.

Frequently Asked Questions (FAQs)

What is the monetary base definition?

The monetary base is the total amount of money that can be seen circulating among the public and deposits of depository institutions in the central bank’s reserves of the nation. Generally, a country’s central bank, like the federal reserve, is entitled to manage the MB value. They use monetary policies and open market operations to maintain the intended level of MB.

What is the monetary base formula?

The formula for MB is:
MB = C + R
Where C is the total value of the currency in circulation and R is the reserve balances.

What is the difference between the monetary base and the money supply?

MB is the total value of the currency in circulation and reserve balances, whereas the money supply refers to the quantity of currency in circulation and checkable or demand deposits. The difference evident from its formula is that reserve balances are not included in the money supply calculation, showing that the money supply concept is more about the money available for immediate use.

This has been a Guide to What is Monetary Base & its definition. We explain its working, formula, examples, comparison between Monetary Base vs. Money Supply. You can learn more from the following articles – 

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *