Monetary Base

8 Key excerpts on "Monetary Base"

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  eBook - ePub

  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  14 stands for the Monetary Base. It generic definition is:

  M 0 = currency in the hands of the non-bank public + currency held by the commercial banks + deposits held by the commercial banks at the central bank.

  The reserves held by the commercial banks are called bank reserves and are designated by the symbol R. Bank reserves for the banking system as a whole are defined as:

  R = currency held by the commercial banks + deposits held by the commercial banks at the central bank.

  Therefore, we have:

  M 0 = C + R.

  Note the difference between the Monetary Base M 0 and the money supply M 1. M 1 = C + D , where D is demand deposits of the public in commercial banks, while M 0 = C + R .

  2.8.1 The relationship between the Monetary Base and the money supply

  The central bank controls the Monetary Base through its purchases and sales of bonds to the public. A purchase of bonds means that the central bank pays for them by transferring funds from itself to the public, which increases the Monetary Base. A sale of bonds means that the central bank receives funds from the public, which decreases the Monetary Base. These sales or purchases of bonds in the financial markets are called open market operations. They are a major element in the central bank’s control of the Monetary Base and the money supply.

  The money supply is related to the Monetary Base by the equation: where:

  M 1	=	narrow money supply,
  M 0	=	Monetary Base, and
  α1	=	Monetary Base multiplier (= ∂M 1/∂M 0) for M1.

  The coefficient a1 represents the increase in the money supply M1 for a unit change in the Monetary Base M 0. Its value is usually greater than one. In fact, a value of three or four is not unusual for it for the modern economies. This implies that a change in the Monetary Base engineered by the central bank increases the money supply by the multiple α1 , so that it is called the Monetary Base (to the money supply) multiplier.15 The broader the definition of the monetary aggregate, the larger will be the relevant multiplier. For M

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  eBook - ePub

  Money and Banking, Second Edition

  • William D. Gerdes(Author)
  • 2017(Publication Date)
  • Business Expert Press

    (Publisher)

  M includes both convertible currency and bank deposit money, which is only indirectly convertible. Individuals can convert bank deposits into convertible currency and, then, convert that currency into monetary gold. The important issue here is that the money multiplier is now greater than one (m > 1). Banks are no longer just storing money, but are affecting the size of the money stock.

  As noted in Chapter 1 , the adoption of fiat money was not a spontaneous market development. Governments confiscated (through forced exchanges) all monetary gold. In addition, laws were passed making it illegal to use gold as an exchange medium. Hence, both elements on the right-hand side of equations (4.5) and (4.6) were no longer available for monetary use, at least in their previous capacities.

  The monetary system was reconstituted. The currency and bank deposits previously used as exchange media were still so employed. With no convertibility option (direct or indirect), however, these monies were now fiat money (FM). This is indicated in equation (4.8). Equation (4.7) is the new Monetary Base, which now consists of total bank reserves plus currency in circulation outside banks.

  B = R + C

  (4.7)

  M = FM = DD√ + C,

  (4.8)

  where R is total bank reserves, C is currency in circulation outside banks, FM is the total quantity of fiat money, and DD√ is total checkable deposits.

  It is possible to have 100% reserve banking with fiat money. In that case, R = DD√. In practice, fiat money invariably is coupled with fractional reserve banking. Consequently, the money multiplier for our current monetary system is greater that one.

  The Base Money Equation

  The base money equation is a relationship showing the total quantity of base money as well as the uses and sources of the base. This equation is an accounting identity, and is derived by combining the balance sheet for the central bank with the Treasury monetary account. In the United States, the combined balance sheet for all 12 Federal Reserve Banks is used as the central bank balance sheet. Exhibit 4.4 shows that balance sheet.

  Exhibit 4.4 Combined Balance Sheet for Federal Reserve Banks

  Equation (4.9) is the base money equation for the U.S. Nearly all the entries are from the Federal Reserve balance sheet. Because base money is either used as bank reserves (R) or circulating currency (C), the sum of R and C is known as the uses of base money. Total bank reserves (R) are viewed as the Federal Reserve defines them: total commercial bank balances at Federal Reserve Banks (MBD) plus total bank vault cash (BVC). Bank vault cash consists of currency holdings by commercial banks. It is in the form of coins issued by the U.S. Treasury (TCB ) and paper notes issued by Federal Reserve banks (FRNB

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  Trading Economics

  A Guide to Economic Statistics for Practitioners and Students

  • Trevor Williams, Victoria Turton(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  The recent conjuncture suggests that there are economic factors pushing up on velocity relative to its histor-ical trend. These are likely to persist in the near term, suggesting that a given rate of growth in nominal spending is likely to be associated with weaker growth in broad money than was typically the case before the crisis. With consumer and business confidence low, as surveys repeatedly demonstrate, and debt levels high, households and businesses are not willing to increase debt by borrowing more. Having said that, although QE has not worked to aggressively raise the growth rate of money supply (though there has been some effect), there has been, on the plus side, a lower long-term interest rate and this must have helped to lower the rate of default for households and businesses, ensuring also that lenders have more funds to deal with issues of solvency. DECOMPOSITION OF MONEY There are two ways of thinking about money supply – as the physical stock (instruments they are in) or the counterparts (the holders of the money). Physical Stock – Instruments They Are In If you add up the entire stock of money, i.e. in current accounts, on deposit with banks, building societies and so on, it can be shown as measures of money supply, as follows: ∙ M0 – M0 is the narrowest definition of the quantity of money in circulation. The definition used in the UK is bank notes and coins in circulation, plus banks’ deposits with the Bank of England and money in banks’ tills. M0 is also known as the Monetary Base. This term refers to the fact that the money measured by M0 supplies the base on which other forms of money (such as bank deposits) are based. ∙ M1 – M1 is M0 plus saving accounts or sight deposits held by the private sector in banks and building societies in the UK. Sight deposits are sterling deposits that can be withdrawn on demand or that have been deposited overnight. It excludes non-sterling currencies.

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  – Central banks create Monetary Base either by purchasing assets that are below the line or by lending to banks that are below the line. They pay for these assets and fund these loans by writing checks on themselves, which increases the na-tion ’ s Monetary Base. – Monetary controls – The primary monetary controls of central banks are the required reserve ratio, open market operations, foreign exchange market intervention, discount rate, and interest paid on bank deposits at the central bank. – Reserve requirements – Reserve requirements are imposed to control bank lending and not to ensure liquidity or solvency. – The reserve ratio is a rather blunt monetary tool because changes indiscrimi-nately affect all banks regardless of their reserve or financial positions. – Open market operations – Open market operations are central bank purchases and sales of financial se-curities (usually, government-issued securities) in open (secondary) markets. 238 Chapter 9 Central Banks – Central bank security purchases increase a nation ’ s Monetary Base, and sales decrease it. – To increase their independence, many central banks do not purchase securi-ties directly from the government. – When a central bank enters into a “ repurchase agreement, ” it buys securities from a dealer with a simultaneous agreement to sell them back at a higher price in the future. Central bank repos increase a nation ’ s Monetary Base. Reverse repos reduce the Monetary Base. – Foreign exchange market intervention – Foreign exchange market intervention affects a nation ’ s Monetary Base in the same way purchases and sales of government securities do. – Discount rate – Discount loans increase a nation ’ s Monetary Base. The interbank market merely redistributes the existing Monetary Base. – Reducing the discount rate encourages banks to borrow from the central bank, which increases the Monetary Base.

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  Monetary Economics

  • Jagdish Handa(Author)
  • 2008(Publication Date)
  • Routledge

    (Publisher)

  6 However, note that the literature does also include other goal variables. One of these is the variance of the money supply, with the choice between the Monetary Base and the interest rate depending on which instrument minimizes this variance under shocks to money demand and money supply. In this analysis, when the interest rate is the policy instrument and the money supply is accommodated to money demand, shocks to both money demand and money supply affect the money supply. However, when the Monetary Base is the policy instrument, only the shock to the Monetary Base (to money supply) multiplier determines fluctuations in the money supply. Therefore, controlling the Monetary Base leads to smaller fluctuations in the money supply. We do not regard the objective of minimizing the variance of money supply to be an appropriate goal, and do not present the analysis related to it.

  7 Shocks originating in the commodity market are to consumption, investment, exports and government expenditures. Of these, investment is considered to be the most volatile element.

  8 However, Monetary Base targeting usually will not do so.

  9 These financial innovations included the payment of interest on checking accounts and the increasing degree of substitution between M1 and near-monies, telephone and on-line banking, etc.

  10 In this context, see the discussion in Chapter 11 on the Monetary Conditions Index used by the Bank of Canada.

  11 These are not the only actors in the money supply process. In particular, in open economies, the balance of payments surpluses (deficits) of a country can increase (decrease) its money supply.

  12 One estimate of the average total cost of demand deposits in 1970 was about 2.4 percent of their dollar volume. The cost of time deposits was, by comparison, 0.6 percent if the interest costs were excluded and between 5.3 percent and 5.7 percent if the interest costs were included. Approximately 70 percent of the cost associated with demand deposits was the cost of processing checks and involved wages, computer time costs, etc.

  13

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  Trading Economics

  A Guide to Economic Statistics for Practitioners and Students

  • Trevor Williams, Victoria Turton(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  Since the start of the 1980s, broad money velocity has trended downwards, reflecting the growing importance of financial intermediation in the economy. That trend might be expected to reassert itself at some point. But the experience of the 1990s would suggest that the trend could be interrupted for an extended period, if the forces pushing up on velocity are persistent enough. The recent conjuncture suggests that there are economic factors pushing up on velocity relative to its historical trend. These are likely to persist in the near term, suggesting that a given rate of growth in nominal spending is likely to be associated with weaker growth in broad money than was typically the case before the crisis.

  With consumer and business confidence low, as surveys repeatedly demonstrate, and debt levels high, households and businesses are not willing to increase debt by borrowing more. Having said that, although QE has not worked to aggressively raise the growth rate of money supply (though there has been some effect), there has been, on the plus side, a lower long-term interest rate and this must have helped to lower the rate of default for households and businesses, ensuring also that lenders have more funds to deal with issues of solvency.

  DECOMPOSITION OF MONEY

  There are two ways of thinking about money supply – as the physical stock (instruments they are in) or the counterparts (the holders of the money).

  Physical Stock – Instruments They Are In

  If you add up the entire stock of money, i.e. in current accounts, on deposit with banks, building societies and so on, it can be shown as measures of money supply, as follows:

  • M0 – M0 is the narrowest definition of the quantity of money in circulation. The definition used in the UK is bank notes and coins in circulation, plus banks' deposits with the Bank of England and money in banks' tills. M0 is also known as the Monetary Base. This term refers to the fact that the money measured by M0 supplies the base on which other forms of money (such as bank deposits) are based.
  • M1 – M1 is M0 plus saving accounts or sight deposits held by the private sector in banks and building societies in the UK. Sight deposits are sterling deposits that can be withdrawn on demand or that have been deposited overnight. It excludes non-sterling currencies.
  • M2 – M2 is M1 plus retail deposits or savings accounts.
  • M3 – M3 has been replaced by M4 in the UK as the main broad money measure. It is still, however, calculated as part of certain European aggregates. It consists of:
    • notes and coins in circulation (defined as for M1 and M2);
    • overnight deposits and sight deposits (as for M1);

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  The Financial System, Financial Regulation and Central Bank Policy

  • Thomas F. Cargill(Author)
  • 2017(Publication Date)
  • Cambridge University Press

    (Publisher)

  First – can the central bank control base money, the Monetary Base or high-powered money? Yes. The Federal Reserve, as well as any central bank, essen-tially controls base or high-powered money even though base money has many non-Federal-Reserve influences. This point can be illustrated by a simple central bank balance sheet that applies to all central banks, though specific central bank balance sheets, such as that of the Federal Reserve, are far more complex. The simple balance sheet in Table 12.1 is sufficient to demonstrate how central banks control base money. 274 Chapter 12. Central Banks, Base Money and the Money Supply Central bank assets consist of loans made to depository institutions, L; securities, S; foreign exchange, FE; and other assets, OA. L represents lender of last resort services provided by the central bank; that is, when the central bank advances funds to depository institutions, L increases, and when these loans are repaid, L decreases. S represents securities held by the central bank and, most of the time, consists of government securities. When the central bank purchases securities, S increases, and when the central bank sells securities, S decreases. FE represent holdings of non-home-currency-denominated financial assets and OA represents other assets, such as buildings, etc. Central bank liabilities consist of banknotes, CBN, such as Federal Reserve notes; reserve deposits, RD, held by depository institutions; government deposits, GD, since central banks are fiscal agents of their respective governments; other deposits, OD, such as deposits of other central banks, other governments or inter-national government organizations; and other liabilities, OL. The central bank, as a public corporation, has a capital account, CAP, consisting of paid-in capital stock and retained earnings.

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  Federal Reserve Policy Reappraised, 1951–1959

  • Daniel S. Ahearn(Author)
  • 2019(Publication Date)
  • Columbia University Press

    (Publisher)

  9 But such a plan would also involve a number of difficulties. Question of Definition of Money Supply. One problem is to insure that the quantity which is to be increased every year is in fact what the economy is using as money. The crux of the difficulty is the arti-ficiality of any legal definition. The moneyness of assets is a fluid and shifting quality, depending on business habits and institutions which themselves shift over time. At any point of time there is a question as to what should be included in a definition of the money supply, as a glance at any money and banking textbook will indicate. 10 It can reasonably be asked whether the money supply should also include commercial bank time deposits, savings bank deposits, savings and loan shares, and perhaps some or even all U.S. Government securi-9 The conception that steady growth in the money supply at the same rate of growth as that of real production would be the maximum contribution that monetary management could make to economic stability and growth is not a new one. In 1931 Lionel Edie said: The most important legislative mandate would be a provision that one of the objectives of Federal Reserve policy shall be the maintenance of the annual rate of growth of volume of credit in the United States in balance with the long-term average annual rate of growth of production in the United States. . . . Central banks should aim at so regulating the reserves of the banking system that the outstanding credit built upon those reserves will expand at the same rate as the long-term growth of production. The Banks and Prosperity (New York: Harper & Bros., 1931), pp. 47, 117-18. In 1936 Angeli said, If the ultimate objective of policy is to induce a greater degree of stability in national and individual money income . . . then the most effective procedure is to stabilize the quantity of money itself.

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