Base money is the most liquid layer of the monetary system, consisting mainly of currency in circulation and reserves held by commercial banks at the central bank.
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Why it matters
Base money is the foundation on which the broader banking and payment system operates. It is directly created or extinguished by the central bank through its balance-sheet operations.
A simple expression
In stylized form:
$$
\text{Base money} = \text{Currency in circulation} + \text{Bank reserves}
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This makes base money narrower than broad money, which includes many deposit-like claims created by the banking system.
Economic significance
Changes in base money affect liquidity conditions, short-term interest-rate implementation, and the interaction between the central bank and commercial banks. But increases in base money do not automatically translate one-for-one into broad money or inflation, because banks, households, and firms all respond endogenously.
Knowledge Check
### Base money mainly consists of:
- [x] currency in circulation and bank reserves
- [ ] only household savings accounts
- [ ] all private credit
- [ ] only tax receipts
> **Explanation:** Base money is the most immediate central-bank money used by the payment system and banks.
### Why is base money narrower than broad money?
- [x] Because broad money includes deposit-like claims created by banks
- [ ] Because base money includes all private loans
- [ ] Because broad money excludes currency
- [ ] Because narrow money and broad money are identical
> **Explanation:** Commercial bank money goes beyond the monetary base.
### A rise in base money does not automatically mean:
- [x] inflation will rise one-for-one
- [ ] central-bank liquidity has changed
- [ ] reserves may increase
- [ ] the monetary base has expanded
> **Explanation:** The macroeconomic effect depends on how banks and the public respond, not just on the accounting increase itself.