Monetary Base: Currency and Reserve Balances

In the Federal Reserve’s U.S. statistical framework, the monetary base equals currency in circulation plus reserve balances held by depository institutions at Federal Reserve Banks.

The measure focuses on specified central-bank liabilities rather than on all deposits or liquid assets in the economy. Its two components are defined separately in U.S. H.6 statistics: currency in circulation and reserve balances.

Currency in circulation consists of Federal Reserve notes and coin outside the U.S. Treasury and Federal Reserve Banks. Currency held inside those institutions is therefore not included in this particular H.6 definition of currency in circulation.

Reserve balances are balances held by depository institutions in master accounts and excess balance accounts at Federal Reserve Banks. These balances are the reserve component of the U.S. monetary base.

Putting the definitions together:

Monetary base = Federal Reserve notes and qualifying coin outside the U.S. Treasury and Federal Reserve Banks + qualifying depository-institution reserve balances at Federal Reserve Banks.

Use this sequence when analyzing whether an item belongs to the U.S. monetary base:

1. Ask whether the item is currency in circulation or a reserve balance. 2. For currency, check whether it is a Federal Reserve note or coin outside the U.S. Treasury and Federal Reserve Banks. 3. For reserves, check whether it is held by a depository institution in a master account or excess balance account at a Federal Reserve Bank. 4. Add the qualifying currency and reserve components. 5. Do not automatically include deposits or other monetary aggregates simply because they are money-like; M1 and M2 use different component definitions.

1. Define the monetary base and identify the major components included in it.

2. Explain why the monetary base is not the same thing as all money used by households and businesses.

3. Trace what happens to reserve balances when the central bank conducts a transaction that changes the quantity of reserves in the banking system.

4. Compare physical currency held by the public with reserve balances held by eligible financial institutions. Who can directly use each form?

5. Why can a large increase in the monetary base fail to produce an equal percentage increase in broader measures of money or in consumer prices?

6. Correct this statement: “Every dollar in the monetary base is a paper dollar circulating in stores.”