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Adjusted monetary base

What Is Adjusted Monetary Base?

The adjusted monetary base represents a refined measure of the monetary base, which is the total amount of a nation's currency in circulation and the commercial banks' reserves held at the central bank. It is a key concept within monetary policy, designed to offer a more precise understanding of the raw material for the overall money supply by accounting for changes in reserve requirements35, 36. This adjustment aims to reflect the actual impact of central bank actions on the financial system's capacity to create money.

History and Origin

The concept of the adjusted monetary base evolved from the need to create a more accurate gauge of central bank influence on the money supply. Historically, the unadjusted monetary base included currency in circulation and total bank reserves. However, changes in statutory reserve requirements could distort the interpretation of the raw monetary base's movements, making it less clear how much of the change was due to active central bank intervention versus regulatory adjustments34.

To address this, the Federal Reserve Bank of St. Louis, particularly through the work of economists like Richard G. Anderson and Robert H. Rasche, developed and popularized the adjusted monetary base. This measure aimed to combine the Federal Reserve's actions affecting the supply of base money—such as open market operations and discount window lending—with actions affecting the demand for base money, specifically changes in reserve requirements. By33 mapping changes in reserve requirements into equivalent changes in the unadjusted monetary base, the adjusted monetary base provides a more consistent indicator of monetary policy stance over time. The Federal Reserve's approach to defining and calculating monetary aggregates, including the monetary base, has evolved significantly since the early 20th century, with major redefinitions occurring in periods like 1980 and May 2020 to reflect changes in financial instruments and practices.

#31, 32# Key Takeaways

  • The adjusted monetary base provides a more refined measure of the money supply's foundational components.
  • It accounts for changes in reserve requirements, offering a clearer signal of central bank policy.
  • This aggregate includes physical currency held by the public and bank reserves at the central bank, adjusted for regulatory changes.
  • While once a prominent indicator, its direct relevance as a real-time policy guide has diminished due to shifts in banking practices and the Federal Reserve's operational framework.
  • It serves as a critical tool for historical analysis of macroeconomics and monetary policy effects.

Formula and Calculation

The adjusted monetary base can be conceptualized as the sum of the monetary base and a reserve adjustment magnitude (RAM). The RAM translates changes in reserve requirements into an equivalent change in the unadjusted monetary base, thereby normalizing the series for such regulatory shifts.

T30he basic formula for the monetary base itself is:

Monetary Base=Currency in Circulation+Bank Reserves at Central Bank\text{Monetary Base} = \text{Currency in Circulation} + \text{Bank Reserves at Central Bank}

To derive the adjusted monetary base, the historical data on currency and reserves are adjusted to reflect what the monetary base would have been if reserve requirements had remained constant, or to reflect the equivalent impact of reserve requirement changes. This is often done by adding or subtracting a "reserve adjustment magnitude" (RAM) to the unadjusted monetary base.

$29$
\text{Adjusted Monetary Base} = \text{Monetary Base} + \text{Reserve Adjustment Magnitude (RAM)}

The RAM is a complex calculation that considers changes in required **reserves** due to shifts in deposit categories and reserve requirement ratios over time. ## Interpreting the Adjusted Monetary Base Interpreting the adjusted monetary base involves understanding its role as a foundation for the broader money supply. A rise in the adjusted monetary base generally indicates an expansionary **monetary policy**, where the central bank is increasing the amount of high-powered money available in the economy. Co[^28^](https://www.studysmarter.co.uk/explanations/macroeconomics/economics-of-money/monetary-base/)nversely, a decrease suggests a contractionary stance. Economists and analysts once closely watched the adjusted monetary base as an indicator of the Federal Reserve's intentions and the potential for future **inflation** or economic activity. Wh[^27^](https://www.chicagofed.org/publications/chicago-fed-letter/1995/december-100)en the adjusted monetary base expands, it provides commercial banks with more reserves, which can then be lent out, potentially increasing **demand deposits** and leading to a larger overall money supply through the **money multiplier** effect. Ho[^26^](https://www.studysmarter.co.uk/explanations/macroeconomics/economics-of-money/monetary-base/)wever, the actual impact on the broader money supply and economic variables like **interest rates** depends on various factors, including banks' willingness to lend and the public's demand for credit. ## Hypothetical Example Consider a hypothetical economy where the central bank wants to stimulate **economic growth**. * **Initial State:** The unadjusted monetary base is $1,000 billion, consisting of $800 billion in currency and $200 billion in bank reserves. Reserve requirements are 10% on all deposits. * **Central Bank Action 1 (Open Market Operation):** The central bank buys $50 billion in government bonds from commercial banks. This directly increases bank reserves by $50 billion. The new unadjusted monetary base is $1,050 billion ($800 billion currency + $250 billion reserves). * **Central Bank Action 2 (Change in Reserve Requirements):** Separately, the central bank reduces the reserve requirement from 10% to 5%. This action, while not directly adding new base money, frees up existing reserves for lending. To "adjust" the monetary base for this change, an equivalent amount of reserves that *would have been required* under the old rule is calculated and effectively added back to the base, as if new money were supplied. If, for instance, this change effectively "released" $100 billion in reserves from being held as required, the adjusted monetary base calculation would reflect this increased availability for lending. The adjusted monetary base aims to capture the combined effect of these actions, providing a cleaner signal of the central bank's efforts to influence the liquidity in the banking system and the broader economy, beyond simply looking at raw currency and reserve figures. ## Practical Applications While the adjusted monetary base is not as widely used for real-time policy analysis today as broader **monetary aggregates** like M1 or M2, it remains valuable in several areas: * **Historical Analysis:** It is crucial for studying long-term trends in monetary policy and understanding how central banks have influenced the financial system over decades. Researchers use adjusted monetary base data to analyze past policy responses to economic crises and periods of **inflation** or deflation. Th[^25^](https://www.federalreserve.gov/newsevents/speech/bernanke20061110a.htm)e Federal Reserve maintains historical data for various money stock measures, including the monetary base, accessible through their H.6 release. * [^23^](https://www.federalreserve.gov/releases/h6/current/default.htm), [^24^](https://www.federalreserve.gov/releases/h6/20240924/) **Academic Research:** Academic economists often employ the adjusted monetary base in their models to understand the theoretical relationship between a central bank's core liabilities and overall economic activity and price levels. * [^22^](https://files.stlouisfed.org/files/htdocs/wp/2000/2000-002.pdf) **Understanding Monetary Transmission:** It helps illustrate the initial impact of central bank operations on the banking system before the money multiplier process expands the broader **money supply**. Actions like **quantitative easing**, for instance, significantly impact the adjusted monetary base by swelling bank reserves. * [^21^](https://www.numberanalytics.com/blog/monetary-base-101-primer-2024) **Comparison to Other Aggregates:** Analysts use it to compare against other monetary aggregates to observe how different measures of money evolve and whether their relationships hold stable over time. #[^19^](https://www.richmondfed.org/~/media/richmondfedorg/publications/research/economic_review/1989/pdf/er750102.pdf), [^20^](https://www.bis.org/publ/econ7.pdf)# Limitations and Criticisms Despite its historical significance, the adjusted monetary base has faced limitations and criticisms, particularly concerning its utility as a primary real-time guide for **monetary policy**. One significant limitation is the evolving nature of banking and financial innovation. As financial systems become more complex, the direct link between the monetary base and the broader **money supply** or economic activity can weaken. Fo[^17^](https://www.chicagofed.org/publications/chicago-fed-letter/1995/december-100), [^18^](https://www.minneapolisfed.org/article/1997/maintaining-price-stability)r example, the **money multiplier** concept, which posits a predictable expansion of the money supply based on the monetary base, has become less stable due to factors like banks holding excess **reserves** and changes in the public's preference for cash versus deposits. F[^15^](https://prepnuggets.com/cfa-level-1-study-notes/economics-study-notes/monetary-policy/limitations-of-monetary-policy/), [^16^](https://economistwritingeveryday.com/2023/10/27/more-or-less-money/)urthermore, central banks, including the Federal Reserve, have shifted their operational frameworks. Modern **monetary policy** often focuses on influencing the **federal funds rate** and other short-term **interest rates** directly through administered rates (like interest on reserve balances and the overnight reverse repurchase agreement rate), rather than primarily managing the quantity of reserves via the monetary base. Th[^13^](https://www.stlouisfed.org/publications/page-one-economics/2022/05/02/how-does-the-fed-use-its-monetary-policy-tools-to-influence-the-economy), [^14^](https://www.federalreserve.gov/monetarypolicy/challenges-associated-with-using-rules-to-make-monetary-policy.htm)is shift means that fluctuations in the adjusted monetary base might not always translate predictably into changes in market interest rates or aggregate demand, making it a less reliable indicator for forward-looking policy decisions. So[^11^](https://www.chicagofed.org/publications/chicago-fed-letter/1995/december-100), [^12^](https://analystprep.com/cfa-level-1-exam/economics/limitations-monetary-policy/)me critics also argue that simple rules based on monetary aggregates have limitations because they might not account for the complexities and dynamic nature of the economy. #[^10^](https://www.cato.org/blog/feds-critiques-rules-based-monetary-policy-are-invalid)# Adjusted Monetary Base vs. Monetary Base The key distinction between the adjusted monetary base and the **monetary base** lies in how they treat changes in **reserve requirements**. The **monetary base** (often called the "unadjusted" monetary base or "high-powered money") is simply the sum of **currency in circulation** and **bank reserves** held at the **central bank**. It represents the direct liabilities of the central bank that can serve as a foundation for the money supply. The **adjusted monetary base**, however, takes this raw figure and modifies it to account for regulatory changes, specifically shifts in required **reserves**. Wh[^9^](https://www.fedinprint.org/item/fedlwp/9911/original)en a central bank changes reserve requirements, it effectively alters the amount of money banks must hold, thus influencing their capacity to lend, without necessarily changing the *total* monetary base. The adjusted monetary base attempts to normalize this effect, providing a measure that reflects the central bank's direct and indirect influence on the availability of funds for credit creation, independent of pure regulatory shifts. Th[^8^](https://www.fedinprint.org/item/fedlwp/9911/original)is adjustment aims to offer a clearer signal of the central bank's intended **monetary policy** stance. ## FAQs ### What is the primary purpose of the adjusted monetary base? The primary purpose of the adjusted monetary base is to provide a refined measure of the money supply's foundation, taking into account changes in **reserve requirements** that affect banks' capacity to lend. It offers a clearer signal of central bank policy actions than the unadjusted **monetary base**. #[^7^](https://www.fedinprint.org/item/fedlwp/9911/original)## Who calculates and publishes the adjusted monetary base? In the United States, the Federal Reserve Bank of St. Louis, as part of the Federal Reserve System, has historically calculated and published data on the adjusted monetary base. Th[^5^](https://www.fedinprint.org/item/fedlwp/9911/original), [^6^](https://fred.stlouisfed.org/categories/124)e Federal Reserve Board also publishes data on the monetary base as part of its H.6 Money Stock Measures release. #[^4^](https://www.federalreserve.gov/releases/h6/current/default.htm)## Is the adjusted monetary base still relevant for current monetary policy? While historically significant for analysis, the adjusted monetary base is generally less central to current, day-to-day **monetary policy** decisions made by central banks like the Federal Reserve. Central banks now often prioritize managing **interest rates** directly and consider a broader range of economic indicators. #[^3^](https://www.stlouisfed.org/publications/page-one-economics/2022/05/02/how-does-the-fed-use-its-monetary-policy-tools-to-influence-the-economy)## How does quantitative easing affect the adjusted monetary base? **Quantitative easing (QE)** significantly increases the adjusted monetary base. When a central bank implements QE, it purchases large quantities of assets (like government bonds) from commercial banks, which directly increases the **bank reserves** held at the central bank. This injection of reserves directly expands the monetary base, and thus the adjusted monetary base.[^1^](https://www.numberanalytics.com/blog/monetary-base-101-primer-2024), [^2^](https://www.studysmarter.co.uk/explanations/macroeconomics/economics-of-money/monetary-base/)