Reserve Money (M0)

Reserve money (M0), also called base money, high-powered money or the monetary base, is the money created directly by a central bank. It consists of the currency in circulation plus the deposits that commercial banks hold at the central bank, usually including the cash in banks' own tills. It is the narrowest measure of the money supply and the foundation on which banks build the much larger stock of deposits counted in broad money.

Reserve money is a liability of the central bank and is often described as central bank money. Terms vary between countries: the Bank of England once published a series called M0 (notes and coins plus banks' operational deposits) and later replaced it with other base-money measures, while in the United States the monetary base is measured as currency in circulation plus banks' reserve balances at the Federal Reserve. The State Bank of Pakistan (SBP) uses the term reserve money, with M0 as its shorthand.

Imagine a group of friends who play a board game using chips from the bank's box. The person running the box decides how many chips exist. Players then lend chips to each other and write IOUs, so the game soon has far more IOUs than chips, but every IOU is ultimately a promise to pay in chips.

Reserve money is the box of chips. The central bank alone can create it. Ordinary bank deposits are like the IOUs: banks create them when they lend, but they must always be able to turn them into central bank money when customers withdraw cash or pay another bank. Control the chips and you strongly influence the whole game.

• Currency in circulation. Notes and coins held by the public.
• Cash in bank tills. Notes and coins held in the vaults and tills of commercial banks.
• Banks' deposits at the central bank. Balances in each bank's reserve account, including amounts held to meet any reserve requirement and balances used to settle payments through Real Time Gross Settlement (RTGS).
• Other deposits. In some definitions, deposits held at the central bank by bodies other than banks and the government.

The SBP's monetary statistics define reserve money as:

• $\text{CiC}$ is currency in circulation, the cash held by the public.
• $\text{Till}$ is cash in the tills of scheduled banks.
• $\text{OD}$ is other deposits with the SBP.
• $\text{BD}$ is scheduled banks' deposits with the SBP.

Worked example: with currency in circulation of 10 trillion rupees, till cash of 0.6 trillion, other deposits of 0.1 trillion and bank deposits at the SBP of 1.8 trillion, reserve money is $10 + 0.6 + 0.1 + 1.8 = 12.5$ trillion rupees. Currency is about 80% of the total, a typical pattern in a cash-heavy economy.

The SBP also shows reserve money from its sources: the SBP's net foreign assets, such as foreign exchange reserves, plus its net domestic assets, mainly lending to the government and to banks. Its annual report put reserve money at about Rs 5.48 trillion at end-June 2018, of which currency in circulation was Rs 4.39 trillion.

Reserve money and Broad Money (M2) are linked by the money multiplier:

If reserve money is 12.5 trillion and M2 is 37.5 trillion, the multiplier is 3. The textbook story is that a central bank sets the base and banks multiply it through lending. In practice most central banks now set a short-term interest rate and supply whatever reserves banks need at that rate, so the base adjusts to lending rather than the other way round; banks create commercial bank money when they lend and then obtain reserves. The multiplier is still a useful description of how much broad money the system carries for each unit of base money.

• Open market operations. Buying or selling government securities, such as Treasury Bills (TBs) or Pakistan's Market Treasury Bills (MTBs), through open market operations (OMOs).
• Lending to banks. Short-term loans through a repo facility or as lender of the last resort (LLR); a reverse repo drains reserves.
• Foreign exchange operations. Buying foreign currency adds reserve money; selling it takes reserve money out.
• Lending to government. Direct monetary financing of a budget deficit adds reserve money and is limited or banned in many countries, including Pakistan since the SBP Act amendments of 2022.
• Large-scale asset purchases. Quantitative easing (QE) greatly expanded the monetary base in the US, UK, euro area and Japan after 2008.

Rapid growth of reserve money, especially from financing government deficits, has historically been linked to high inflation and, at the extreme, hyperinflation. That is why the IMF often sets limits on net domestic assets of the central bank in its programmes, and why reserve money remains a core indicator in monetary policy.

• State Bank of Pakistan
• Federal Reserve: Money Stock Measures (H.6)