Definitions

Monetary_base

Monetary base

In economics, the monetary base, or the money base (often called narrow money in the UK) is a term relating to the volume of money in the economy, or money supply. The monetary base comprises only currency (banknotes and coins) and commercial banks' reserves with the central bank. As such, it is a narrow definition of money supply, consisting of only the most liquid forms of money. Wider definitions of the money supply include the public's bank deposits and are therefore larger in volume and encompass money of a lower liquidity.

"Open market" operations are monetary policy tools that affect directly the Monetary Base

Equation

M0 ("M-zero")= Monetary Base = "narrow money" because it is the most liquid and therefore also the smallest measure of money supply = physical currency circulating in the economy + physical currency held within a central bank.

M1 = M0 + Demand Deposits (includes checking accounts and other deposits held available on demand).

M2 = M1 + Individual Term deposits.

M3 = M2 + institutional money-market funds, short-term repurchase agreements and all other larger liquid assets not included in M0,M1,or M2. M3 is the broadest measure of money. It is used by economists to estimate the entire supply of money within an economy.

Monetary Base = M0 = "High-powered money" = Currency (C) + Reserves (R) = Currency (C) + (Deposits (D) * Required Reserve Ratio (r))

Money Supply = M3 = all currency,loans,credit and other liquid instruments in a country's economy. Monetary Policy = the actions of a central bank, or other regulatory committee, that determines the size and rate of growth of the money supply and interest rates.

An Expansionary Policy seeks to expand the money supply to encourage economic growth or combat deflation. A central bank employs expansionary policies whenever it lowers its "benchmark" rate or discount rate or when it buys Treasury Bonds on the open market, thereby injecting capital directly into the economy.

Expansionary Policy is a useful tool for managing low-growth periods in the business cycle, but it also comes with risks. First and foremost, economists must know when to expand the money supply to avoid causing side effects like high inflation. There is also a time lag between when a policy move is made (whether expansionary or contractionary) and when it works its way through the economy. This makes up-to-the-minute analysis nearly impossible, even for the most seasoned economists. And finally, prudent central bankers and legislators must know when to halt money supply growth or even reverse course and switch to a contractionary policy. - Source Investopedia

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