MONEY SUPPLY

PROCESS
CHAPTER 12

Content
Definition and the functions of money
Types of money supply
Factors that influence the money supply
Participants in the money supply process
in the context of Malaysia
The relationship between money supply,
interest rates and foreign exchange with
the Malaysian economy as a whole

MONEY - Definition
Money is the set of assets in an economy that people
regularly use to buy goods and services from other
people.

Introduction
Money is created for the purpose of exchange
Previously, there was a barter system
Money plays an important role in the economy because
its quantity and credit ability will affect the level of
production and the prices of goods and services
The demand and supply on the money will determine its
price or interest rates that are fixed by BNM

PROBLEMS OF BARTER SYSTEM

Definition of Money
Money can be observed as:
an instrument to pay
An instrument to determine the value
An instrument to keep/save purchasing power

The acceptance of money is based on the confidence of

others to accept it
Three types of money:
Coins
considered currency
Paper money
Demand or checking deposit (current account)

The Kinds of Money

Commodity money takes the form of a commodity with
intrinsic value.
Examples: Gold, silver, cigarettes.

Fiat money is used as money because of government

decree.
It does not have intrinsic value.
Examples: Coins, currency, check deposits.

Currency is the paper bills and coins in the hands of the

public.
Demand deposits are balances in bank accounts that
depositors can access on demand by writing a check.
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The Functions of Money

Money has three functions in the
economy:
Medium of exchange
Unit of account
Store of value
Tools for standard of deferred
payment
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Functions of Money
As a medium of exchange
The transfer of goods and services from providers to
consumers
The money must be accepted and received the confidence of
the community
Should be able to be divided and hard to copy

To determine the value and as a calculation unit (Unit of

account)
To value goods and services in terms of prices, and based on
the prices, comparison can be made between goods or
services
Transactions can be done easily because the transactions can
be recorded with the value agreed
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Functions of Money
To keep value
Can be used at any times
The most liquid instrument

To determine the value of deferred payment

Enables people to purchase now but make the payment later

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Monetary Aggregates: M1, M2 and M3 (Money Supply)

M1 = Currency in Circulation + Demand Deposits
Currency in Circulation refers to the notes and coins issued by BNM less the amount held by
the commercial banks and Islamic banks.
Demand Deposits refer to the current accounts (includes SPI current accounts) of the nonbank private sector placed with the commercial banks and Islamic banks.

M2 = M1 + Narrow Quasi- Money

Narrow Quasi - Money = Savings Deposits + Fixed Deposits + NIDs + Repos + Foreign
Currency Deposits
Narrow Quasi-Money refers to the sum of deposits/ interest bearing instruments (including
SPI deposits and instruments) placed by the non-bank private sector with the commercial
banks and Islamic banks (excluding interplacements among these banking institutions).
Foreign currency deposits refer to the deposits of foreign currencies held by residents (nonbank) and foreign entities with the commercial banks and Islamic banks.

M3 = M2 + Deposits Placed with Other Banking Institutions

Deposits placed with other Banking Institutions refer to the sum of deposits/interest bearing
instruments (including SPI deposits and instruments) placed by the non-bank private sector
with finance companies, merchant banks, and discount houses (excluding interplacements
among these institutions)

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Bank Negara Malaysia as the Financial

Intermediary
Bank Negara two types of money known as M2 and M3.
M2 = M1 +
Private sector saving deposits with commercial banks and
Islamic banks
Private sector matured fixed deposits with commercial banks
and Islamic banks
Negotiable certificate of deposits issued by commercial banks
to the private sector
Repo transactions conducted by commercial banks

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Bank Negara Malaysia as the Financial

Intermediary
M3 = M2 +
Private sector saving deposits with finance company,
merchant bank/investment banks, discount houses
Private sector fixed deposits with finance company, merchant
bank, discount houses
Net negotiable certificate of deposits issued by finance
company, merchant bank, discount houses to the private
sector
Repo transactions conducted by finance company, merchant
bank, discount houses

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Bank Negara Malaysia as the Financial

Intermediary
BNM uses the M3 as the focus of money supply influence
for the purpose of monetary management
The monetary aggregate (M3) used is based on the
belief that there is a stable relationship between:
Monetary instrument and monetary aggregate
Monetary aggregate and the final objective intended by BNM

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The Demand for Money

What are the three motives for holding money according
to keynes's theory of money demand?
1.

Transaction motives:

To make payments or purchases

2.

Precautionary motives:

To meet unforseen contingencies

3.

Speculative motives:

It being the safest asset in wealth portfolio. Other assets possess

uncertainty and no liquidity.

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Factors that Influence the Money Supply

Factors that influence the money supply include:
Loans offered by BNM and the banking system (commercial
banks, finance company, merchant banks, Islamic banks and
discount houses)
Overall condition of a countrys balance of international
payment and receipt
Other factors

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Factors that Influence the Money Supply

Governments actions
The ability of banks to give loans depends on banks reserves
The issuance of government debt instruments
Loans given by the Government to the banking system

Balance of Payment
Deficit or surplus
In a surplus condition, the receipt of foreign currencies would
add to deposits in a country, which will increase the money
supply and vice versa

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Participants
Bank Negara Malaysia on behalf of the Government
Banking system

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Relationship between Money

Supply, Interest Rates and
Exchange Rates
Let say the government decides to increase the level of
money supply to reduce unemployment.
Higher money supply leads to higher price level and a
lower expected future exchange rate
The rise in the money supply causes the domestic
interest rate to fall
Conclusion: a higher domestic money supply causes the
domestic currency to depreciate

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