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Topic 8- Banking System and Monetary Policy (12)

This document outlines the concepts of monetary policy, including its definition, objectives, and tools used to manage inflation and deflation. It details the money supply, the banking system's lending potential, and the mechanisms of open market operations, statutory reserve requirements, and the discount rate. Additionally, it distinguishes between easy and tight money policies as strategies for economic management.

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Kae Yi Siew
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13 views17 pages

Topic 8- Banking System and Monetary Policy (12)

This document outlines the concepts of monetary policy, including its definition, objectives, and tools used to manage inflation and deflation. It details the money supply, the banking system's lending potential, and the mechanisms of open market operations, statutory reserve requirements, and the discount rate. Additionally, it distinguishes between easy and tight money policies as strategies for economic management.

Uploaded by

Kae Yi Siew
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Banking Sys

tem
and Moneta
ry
Policy
TOPIC 8
Learning Outcome
By the end of this chapter, students should be able to:
0 Understand and define monetary policy
0 Use and suggest a suitable / appropriate monetary
policy to solve an economic problem
0 Identify and explain tools of monetary policy tools to
fight inflation and deflation.
0 Identify and explain tools of monetary tools as used in
Malaysia.
Learning Objective
0 Various monetary policy tools generally used to tackle
problems of inflation and deflation
Chapter Outline
0 Money Supply
0 Tools of monetary policy
0 The monetary multiplier.
0 The banking system’s lending potential
0 Easy money and tight money
The Supply of Money
• Money supply is the total amount of
money available in an economy at a
particular point in time.
Supply for Money
Interest Rate (percent per year)

Money supply
The amount of
money supplied
9 E2
not depends on
7 E1 interest rates

0 Qm
Quantity Of Money (billions of dollars)
The Money Market (equilibrium and
changes in equilibrium)
The interest rate of 7.2 20

percent is found at the 18 M


16
intersection of the total 14
demand for money and 12
the supply of money (M) 10
Total demand
8 7.2%
for money
6

Since at any given time the 4

supply of money (M) is fixed 2

it can be represented as a 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800

vertical line Quantity of money (in $ billions)


What is Monetary Policy?
0 Monetary policy is action taken by the central bank to
change money supply or interest rates so as to change
the level of aggregate demand, output, levels of
employment and prices in the economy.
0 Monetary policy is a process where the central bank
or monetary authority of a country uses to control:
(a) availability of money
(b) cost of money; or rate of interest
0 There are two types of monetary policies:
0 (a) Contractionary – to solve inflation by decrease
the rate of growth of money supply

0 (b) Expansionary – to solve deflation by increase the


rate of growth of money supply
Tools of monetary policy
0 There are 3 tools of monetary use to alter the money
supply:
(a) Open-market operations.
(b) Statutory reserve requirement .
(c) The discount rate / Bank rate .

0 Other one: Selective credit controls.


Open Market Operations
0 OMO is the buying and selling of government securities
in the open markets by the central bank so as to
influence the size of commercial banks’ deposits
0 Bond markets are open to all buyers and sellers of
corporate and government bonds (securities).
0 CB Buying securities ---> Ms increase
(a) From commercial banks
(b) From the public
0 CB Selling securities ---> Ms decrease
(a) To commercial banks
(b) To the public
Statutory Reserve
Requirement
0 SRR is an obligation on a bank or other financial
intermediary to maintain specified proportion of total
assets in liquid form with the central bank.
0 The ratios can be increased or decreased in relation to
problems faced by the country.
0 The Bank Negara can also manipulate the reserve
ratio in order to influence the ability of commercial
banks to lend. 2 ways to do this:
0 (a) Raising the reserve ratio --->Ms decrease.
0 (b) Lowering the reserve ratio ---> Ms increase
The Bank Rate or Discount
Rate
0 Just as commercial banks charge interest on their loans, so
too Bank Negara charge interest on loans they grant to
commercial banks. The interest rate they charge is called the
discount rate.

0 Changes in the bank rate affect the cost of borrowing.


0 Increase in the bank rate discourages borrowing ---> Ms
decrease
0 Decrease in the bank rate encouragees borrowings ---> Ms
increase
The monetary multiplier and banking system’s
lending potential.
0 The money multiplier is the number of deposit (loan)
dollars that the banking system can create from $1.
1
Money multiplier =
Required reserve req uirement

0 The lending potential of the banking system is calculated as


excess reserves times the monetary multiplier.

B.L.P = Deposit x multiplier


0 If the original deposit is $100 and the reserve ratio is 10
percent, then multiplier is:

1 1
 10 %
r 10
0 Please note that “r” is represented as reserve ratio/ required
reserve requirement/ Statutory Reserve Requirement.

And bank lending potential is;


0 10 X $100 = $1,000

0 The higher the reserve ratio, the smaller the money multiplier,
and the less money will be created.
Easy and Tight Money Policies
Easy money
0 The central bank is trying to expand the amount of
money in the economy.
0 The motive is to curb recession.

Tight money
0 The central bank is trying to shrink the amount of
money in the economy.
0 The motive is curb inflation.
THE END OF TOPIC 8

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