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FIN4212

MONEY, BANKING AND FINANCE


SESSION: F1
Apr 2017
Lecturer:
Bee Lan Lee

Short-term rates to remain stable on Bank Negara


intervention
Name: Luo Guixing
ID: J13013903

I declare that this assignment is my own work entirely and suitable acknowledgement has been made for

any sources of information used in preparing it

SIGNATURE________________________

DATE_______________________
According to news, under the intervention of the Bank Negara, short-term interest rates
remaining stable. This is the central bank in the use of monetary policy tools to adjust
the market interest rate, by adjusting the market interest rate to achieve the central
bank's established goals. The three monetary policy tools are reserve requirements,
discount policies and open market operations (Bofinger, Reischle and Schchter, 2001).

In general, the reserve requirement refers to deposits deposited by the financial


institution in the central bank under the law, which is prepared by the financial
institution to ensure that the client withdraws cash and liquidation. The central bank
can use the reserve requirement to adjust the bank's money supply. In the process of
economic development, investment is essential. If the investment grows too fast, the
central bank will need to raise the reserve requirement to reduce the amount of money
available for the bank, thereby reducing the money supply to the market. On the
contrary, if the market economy is sluggish, the central bank will reduce the reserve
requirement. This will allow the bank to increase the available funds, the market money
supply increased, increasing investment. But the Reserve Requirement is not binding
on most banks and can lead to liquidity problems. Similarly, if the reserve requirement
ratio is too high, it will increase the bank's uncertainty (Gray, 2011). From February
2016, Bank Negara's Statutory Reserve Requirement Rates was 3.5%.
The discount policy is that the central bank intervenes in the market interest rate and
the supply and demand of the money market by adjusting the discount rate (Beckhart,
1924). Discount policy is divided into two, one is the long-term discount policy, the
other is a short-term discount policy. Long-term discount policy is divided into two
types of inhibition and support. Inhibition of the discount policy refers to the central
bank long-term use of the market interest rate higher than the discount rate, improve
the discount costs, thereby inhibiting the demand for funds and reduce the market
money supply. On the contrary, it is to support the discount policy. Short-term discount
policy refers to the central bank according to the market supply and demand situation,
at any time to develop the discount rate, used to influence the cost of commercial banks
and excess reserves, thus affecting the market interest rate adjust to money market
supply and demand. Although the discount policy is like a very good policy, but it still
has limitations. Discount policy is mainly used to control the money supply, but
regardless of the discount rate is high or low, it cannot inhibit the commercial banks
borrow or not to borrow money from the central bank. Second, because the central bank
has the flexibility to regulate the market's money supply, the central bank must adjust
the discount rate at any time, which often causes market interest rates to fluctuate.

Open market operations refer to the central bank through the securities trading, adjust
the money supply (Axilrod, 1995). According to the recent economic situation, the
central bank that the need to reduce the money supply, they will sell the securities, to
recover part of the circulation of the currency. On the contrary, when the central bank
that the need to increase the money supply, they will buy securities, will be part of the
currency into the market. Compared to reserve requirement and discount policy, open
market operations can more directly and effectively control the number of loans to
commercial banks. For example, in the economic expansion, the central bank to sell
government bonds, it will reduce the loanable funds of the commercial banks and
borrowing rates will rise, to curb excessive investment demand. In the recession, the
central bank will buy government bonds, it will increase the loanable funds of the
commercial banks, and reduce borrowing rate, expand investment demand.

Bank Negara Malaysia (BNM) show that it would add 4.6 billion money market tenders
in the short term. This indicates that BNM is using open market operations to intervene
in the money market. Under normal circumstances, an increase of 4.6 billion tender
means that BNM is selling securities, reducing the money supply. But why does BNM
increase the bidding of $ 4.6 billion? According to the relevant data provided by
tradingeconomics (2017), Malaysia's inflation rate in March was 5.1%, while interest
rates were 3%. This shows that the current inflation rate in Malaysia is higher than the
interest rate. So, in order to adjust the inflation rate in Malaysia, BNM decided to
increase the tender to reduce the money supply, so as to achieve the purpose of raising
interest rates. BNM raising interest rates is a way for reducing inflation. Taking interest
rates increase as an example. First, the increase in interest rates will reduce investor
desire for investment, because the bank interest rate increase will increase the interest
income of deposits, which will attract a part of the risk averse investors funds. At the
same time, higher interest rates will lead to higher interest rates on bonds. BNM sells
4.6 billion short-term securities, for some investment funds, they can get better low-
risk income. Which will lead to 4.6 billion of funds will flow to BNM, and will not flow
to the real economy. Thus reducing the investment in the real economy, the total
economic expenditure decreased, while demand will decline. The final result is the
decline in commodity prices, which has led to a decline in inflation. Second, the
increase in loan interest rates will also increase the financing costs of enterprises, it will
also increase the business operating costs of enterprises. In general, in the situation
when loan interest rate is low, enterprises will borrow money to expand production. But
if the loan interest rate increases, this will increase the operating costs of the enterprise.
Therefore, when the loan interest rate is high, the enterprise will not expand the
production through the loan. This means that the market product is reduce, and the total
economic expenditure will decrease, which will lead to lower commodity prices. Finally,
due to higher interest rates, that will attract foreign capital inflows, while domestic
currencies will face the pressure of appreciation. In the case of rising interest rates, the
company's product costs have risen. If the appreciation of the domestic currency, which
will undoubtedly greatly reduce the competitiveness of these export enterprises. This
will also reduce the total expenditure on the economy, leading to a reduction in inflation.

Keynes argues that interest rates are purely monetary phenomena, and interest rates are
determined by the supply and demand of money. Short the term interest rate is often
able to respond to money supply and demand in the money market in a virtue and
change rates at any time. As the short-term exchange rate is flexible, so this is the central
bank is an important tool used to control the money supply and adjust the money supply
and demand condition. Such as the Fed's Treasury bill rate and the Fed funds rate, the
British London Interbank Offered Rate, these are short-term interest rates. Long-term
interest rates as the intermediate target of monetary policy, relative to short-term interest
rates, and cannot be changed at any time. And long-term interest rates for the control of
money supply and demand situation, and no short-term interest rates so efficient. The
expected theory holds that the full expectation of future short-term interest rates is the
basis for the formation of long-term interest rates (Quiggin, 1993). If the expected short-
term interest rate is on the rise, the long-term interest rate is higher than the short-term
interest rate. If the expected short-term interest rate is expected to decline, the long-
term interest rate is lower than the short-term interest rate. But the market segmentation
theory is that investors and borrowers are time-bound preference (Wedel and Kamakura,
2012). These investor and borrowers require financial market segmentation, long-term
interest rates and short-term interest rates determined by their respective markets. The
two are not substitutes. According to the Liquidity Preference Theory (Bibow, 2013),
the long-term interest rate is higher than the future spot rate, because long-term interest
rates must complement the liquidity and risk of the funds.

Whether long-term interest rates or short-term interest rates, the central bank to use
their purpose is to control the market supply and demand of money. Both of them are
indispensable. In the modern economy, the interest rate as the use price of funds, by the
economic society, many factors. The interest rate theory commonly used in the modern
economy is the IS-LM model proposed by Hicks (Young and Zilberfarb, 2000).
According to this model, the decision on interest rates depends on four factors: savings
supply, investment demand, money supply and money demand. The core of this theory
is that interest rates are determined by the average profit rate. But this is not a theory
that fully explains the structure of interest rates and changes. Interest rates are usually
controlled by the central bank of the country, such as the US Federal Reserve,
Malaysia's Bank Negara. Interest rates are one of the important means of
macroeconomic regulation and control for each country. When the economy is
overheated and inflation rises, the central bank will raise interest rates; when the
economy is overheated and inflation is under control, the central bank will lower
interest rates appropriately. Thus, interest rates are one of the most important
fundamental economic factors and an important financial variable in economics. At
present, the world's frequent use of interest rate leverage to implement macro-control,
the central bank in addition to the use of interest rates to adjust the money supply, but
also used to control investment, inflation and unemployment and other issues, thus
affecting economic growth. According to data provided by tradingeconomics(2017),
Malaysia's inflation rate was 5.1% in March, with a long-term interest rate of 3.0%,
while Kuala Lumpur's bank lending rate (short-term interest rate) was about 3.43%.
And on March 14, Bank Negara made a RM4.6 billion tenders and declared Malaysia's
short-term interest rate remained stable. According to the information provided by Bank
Negara (Singh, 2011), Malaysia uses the monetary policy strategy for interest rate
targeting. According to the above information, Malaysia's inflation rate is higher than
long-term interest rates and short-term interest rates, while short-term interest rates are
higher than long-term interest rates. The inflation rate is higher than the interest rate,
the amount of money in circulation is more than the actual amount demand of money,
the central bank needs to reduce the circulation of money through some tools. In this
example, Bank Negara regulates the money supply in the money market through open
market operations. Through the RM4.6 billion tenders, making the circulation of the
currency in the market to reduce, and maintain a short-term interest rates higher than
the long-term interest rates, is conducive to attracting part of the market capital. In the
Bank Negara dual measures, making the total money supply and demand balance. In
May 2017, Malaysia's inflation rate fell to 3.9% from 5.1% (Tuah, 2017).

Interest rates are usually used by the central bank to regulate the supply and demand of
money, but in addition to interest rates can affect other. Maintain short-term interest
rates is stable, not just to keep the circulation of money stable in market, but also to
stabilize prices and inflation, stabilize the exchange rate and maintain a stable
investment. Maintain short-term interest rate stability, can stabilize prices and inflation.
There is a lot of evidence that the price stability is good. In the mid of 1960s, American
inflation began to rise. The rate of inflation has risen sharply, and in the short term the
US economy has shown an accelerated pace of employment and economic growth. But
the Fed did not take action to control inflation and stabilize prices. Leading to rising
commodity prices, which for most of the US exporters are undoubtedly reduced
competitiveness. And because of the inflation period, land prices rose rapidly, although
the interest rate is high, but there are many people to buy land loans. Finally, in the
1980s, the rapid decline in inflation, land prices also fell, and this part of the loan to
buy land cannot pay the debt, resulting in bankruptcy (Poole and Wheelock, 2017)
Therefore, it is necessary to maintain the stability of the price. In addition, maintaining
a stable short-term interest rate is conducive to maintaining the stability of the exchange
rate. If interest rates are reduced, this will reduce the inflow of foreign capital and
increase the outflow of the national currency. This means that the country's currency
will face devaluation. And at the same time, lower interest rates for the importer is
undoubtedly increased their operating costs. This is also detrimental to economic
development.

In summary, central bank uses the tools of monetary policy to achieve the goal of
developing the economy. The central bank mainly through the reserve requirement,
rediscount policy and open market operation these three tools to achieve economic
intervention. Among the three tools, interest rates are the most important and important
intermediate target. Whether it is to adjust the Reserve Requirement rate, or to adjust
the rediscount policy or through the open market business trading securities, are in order
to achieve the goal of regulating the supply of money. And in the process of completing
this goal, interest rates are indispensable. In addition, Malaysia uses the monetary
policy strategy for interest rate targeting. Therefore, Bank Negara for the right to adjust
interest rates is related to the key to economic development can achieve the expect
objectives. Through the above argument, it is also proved that Bank Negara is effective
and necessary for interest rate intervention. Finally, through the analysis of the United
States in the 1980s, it also proved the need for Bank Negara's interest rate to remain
stable.

Reference
Axilrod, S. (1995). Transformation of markets and policy instruments for open market
operations. [Washington, DC]: Internat. Monetary Fund, Monetary and Exchange
Affairs Dep, p.5.

Beckhart, B. (1924). The discount policy of the federal reserve system. New York: University
of California, pp.30243-264.

Bibow, J. (2013). Keynes on Monetary Policy, Finance and Uncertainty. Abingdon, Oxon:
Taylor and Francis.

Bofinger, P., Reischle, J. and Schchter, A. (2001). Monetary Policy: Goals, Institutions,
Strategies, and Instruments. 2nd ed. Oxford University Press, pp.241-251.

Gray, S. (2011). Central Bank Balances and Reserve Requirements. [Washington, DC]:
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Poole, W. and Wheelock, D. (2017). Stable Prices, Stable Economy: Keeping Inflation in
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Tradingeconomics.com. (2017). Malaysia Inflation Rate | 1973-2017 | Data | Chart |


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Tuah, Y. (2017). Easing fuel prices drag Malaysias inflation lower. [online] BorneoPost
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lower/ [Accessed 29 Jun. 2017].

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