The Monetary Base of the Economy

The 'monetary base' is the amount of money in circulation compared with production.

When he appeared on "Dateline" at the beginning of May. Beetham spoke at great length about the supposed contraction in the monetary base of the economy over the last twenty years.

To understand what he was talking about it is necessary to know a simple and commonly accepted equation which expresses the relationship between money supply and production:

This equation expresses the fact that there needs to be enough purchasing power in every year to buy the goods produced at their current prices. Since every dollar is used several times in the course of a year (ie. it circulates from hand to hand) there doesn't have to be one dollar of money for every dollar of goods produced, but only a certain proportion.

For example, suppose that the economy produces 10 products at an average price of $10 each. The total value of production therefore equals $100. Suppose further that the 'velocity of circulation' is 5 (ie. each dollar is used for five transactions in the course of a year), then there would have to be a money supply of $20, if all goods are to be sold.

In terms of the above equation:

M(20) × V(5) = Q(10) × p(10)

If one of these variables is altered for any reason (eg. increased production, a credit squeeze, inflation etc) then one or more of the other variables must change as well to keep both sides of the equation in balance.