The MB concept

The monetary base (MB) is the total amount of money created by the central bank. Synonyms to monetary base are base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK narrow money . In some countries or out of habbit it also referred as M0 but it’s not quite correct, see Monetary Supply

Monetary Base includes:

  1. Currency: The total currency circulating in the public + currency physically held in the vaults of commercial banks
  2. The commercial banks reserves: Total of reserve that are held in the central bank.

In this sense MB can be seen as the sum of liabilities of the central bank towards the commercial banks. To make it precise:

MB = C + R

where:

  • C is Currency in circulation
  • R is Federal Reserve Deposits (Special deposits that only banks can have at the Fed)

Central Banks Accounting Details

In most countries each commercial bank has an account and some balance at the Central Bank. Commercial bank is able to withdraw cash from this account and this lowers the account’s balance. Physically it means Cash-in-transit companies transport the banknotes and coins from the central-bank to the commercial bank. It also works in the opposite direction of course (but probably happened rarely)

One way in which central bank balances arise is when the central bank extends a loan to a commercial bank. The central bank credits the loan amount to the commercial bank’s account and the commercial bank is required to pledge collateral against the loan. Collateral could be securities like stock market shares, government bonds etc. Also central banks requires commercial bank to pay interest on the loan.

As only the central bank can create this form of money, It’s basically exists in the balance of the central bank only , the Central Bank Money is used as synonym to MB

Central bank balances also arise if the central bank purchases assets such as government bonds, gold and property from a commercial bank. The central bank then credits the purchase amount to the commercial bank’s account as a result, the account balance goes up. By contrast, if the central bank sells an asset to the commercial bank, it debits the amount to be paid from the commercial bank’s account.

Why do commercial banks need to hold balances at the central bank

Commercial banks are in constant need of central bank money to meet their minimum reserve requirements, to be able to withdraw cash and to settle cashless payment transactions. Let’s break down:

  • to maintain a minimum reserve requirement. If the banks create additional funds (“book money”), they are also required to increase their minimum reserves held at the central bank.

  • Commercial banks need central bank reserves because their customers are withdrawing more and more cash. The commercial banks have to obtain this additional cash from the central bank. To do so, they need central bank reserves that they can draw upon.

  • to settle cashless payment transactions. It’s not obvious for not professional bankers, but in fact the system works like this: If Bob a customer of Bank A, transfers money to Alice, a customer of Bank B, Bob’s bank balance at Bank A goes down. At the central bank, the amount is transferred from Bank A’s account to Bank B’s account. Bank B credits the amount to Alice’s account. Central bank reserves are only ever transferred between accounts held at the central bank.

Managing Monetary Base

Monetary base is controlled by a country’s central bank. Central Banks changes the monetary base either by expanding or contracting through open market operations or monetary policies. E.g the Central bank ha the option of using the policy rate – that is to say, the rate at which the commercial banks pay interest on central bank money – to influence interest rate levels in region.

The government can maintain a measure of control over the monetary base by buying and selling government bonds in the open market.

United States Monetary Base example

United States M0 Total was $5.582.300.000 in August of 2022, according to the United States FED. Historically, reached a record high of $6.413.100.000 in December of 2021.