Monetary Base Explained

by Investing School on June 28, 2011

Perhaps the most important thing you will learn about the monetary base at this moment is that in economics it is a term relating to the overall money supply, but it is not equivalent to it. The money supply is the total amount of money in the economy.

Very liquid, the monetary base consists of not only coins and paper money, but also reserves held by commercial bank reserves and the central bank. So, let’s imagine that a particular country has 450 million units of currency in circulation and the central bank holds another 7 billion units. The total monetary base for that particular country would be 7.45 billion currency units.

Many countries maintain some level of control over their monetary base by offering government bonds for sale on the open market and purchasing them back as needed. Another way to control the base is to produce new coinage or paper currency or to collect it once again and potentially destroy it. This is a function that the mint carries out under the direction of the central bank or the Federal Reserve.

During normal financial times the monetary base will increase or decrease equally along with changes in the quantity of assets held by the Reserve. When purchasing an asset the Fed essentially writes a check drawing upon its own funds.

Of late the Fed has created a number of programs to ease the burden on financial markets. This has caused the Fed to hold a greater number of assets, commensurately increasing the monetary base. Concerns have been raised that unless the situation is reversed soon, an improvement in the economic situation will cause inflationary increases. Not all analysts agree with this evaluation.

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