2007 Thomson South-Western

THE MEANING OF MONEY

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

2007 Thomson South-Western

The Functions of Money

Money has three functions in the economy:
Medium of exchange
Unit of account
Store of value

2007 Thomson South-Western

The Functions of Money

Medium of Exchange
A medium of exchange is an item that buyers give to
sellers when they want to purchase goods and
services.
A medium of exchange is anything that is readily
acceptable as payment.

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The Functions of Money

Unit of Account
A unit of account is the yardstick people use to post
prices and record debts.

Store of Value
A store of value is an item that people can use to
transfer purchasing power from the present to the
future.

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The Functions of Money

Liquidity is the ease with which an asset can be
converted into the economys medium of
exchange.

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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.

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Money in the Economy

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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Monetary Aggregates by BNM (Table 1.3)

2008 Data
(RM billions)

Currency in circulation 40.4

plus demand deposits 142.4

equals M1
plus savings deposits

182.8

plus fixed deposits

plus NIDs
plus Repos
plus foreign currency deposits
plus other deposits
equals M2

92.2
411.2
33.5
158.5
39.3
144.0

903.2

plus deposits with other banking institutions 28.4

equals M3

931.7

2007 Thomson South-Western

Bank Negara Malaysia - BNM

Bank Negara Malaysia is the central bank for
Malaysia.
It was established on 26 January 1959, under
the Central Bank of Malaya Ordinance, 1958

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The governor of BNM

Section 9 (1) of the Central Bank of Malaysia Act 1958
provides that the Governor shall be appointed by the Yang Di
Pertuan Agong, and the Deputy Governors by the Minister of
Finance. Since the Bank's inception in 1959, there has been 7
Governors.

Tan Sri Dato' Sri Dr. Zeti Akhtar Aziz

Since May 2000
Tan Sri Dato' Seri Ali Abul Hassan bin Sulaiman
September 1998 - April 2000
Tan Sri Dato' Ahmad bin Mohd Don
May 1994 - August 1998
Tan Sri Dato' Jaffar bin Hussein
June 1985 - May 1994
Tan Sri Abdul Aziz bin Taha
July 1980 - June 1985
Tun Ismail bin Mohamed Ali
July 1962 - July 1980
Tan Sri W.H. Wilcock
January 1959 - July 1962
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BNM : Objectives
1. To issue currency and keep reserves safeguarding the
value of the currency;
2. To act as a banker and financial adviser to the
Government;
3. To promote monetary stability and a sound financial
structure;
4. To promote the reliable, efficient and smooth operation
of national payment and settlement systems and to
ensure that the national payment and settlement systems
policy is directed to the advantage of Malaysia; and
5. To influence the credit situation to the advantage of the
country.

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Organisation Structure
The Governor is the Chief Executive Officer of the
Bank and is assisted by 2 Deputy Governors and 5
Assistant Governors.
1.
2.
3.
4.
5.

Departments in the Bank are organised in 5 divisions:Economics,

Investments & Operations,
Organisational Development,
Supervision
Regulation.

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BANKS AND THE MONEY SUPPLY

Banks can influence
the quantity of
demand deposits in
the economy and the
money supply.

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BANKS AND THE MONEY SUPPLY

Reserves are deposits that banks have received
but have not loaned out.
In a fractional-reserve banking system, banks
hold a fraction of the money deposited as
reserves and lend out the rest.

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BANKS AND THE MONEY SUPPLY

The reserve ratio is
the fraction of
deposits that banks
hold as reserves.

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Money Creation with Fractional-Reserve

Banking
When a bank makes a loan from its reserves,
the money supply increases.
The money supply is affected by the amount
deposited in banks and the amount that banks
loan.
Deposits into a bank are recorded as both assets and
liabilities.
The fraction of total deposits that a bank has to keep
as reserves is called the reserve ratio.
Loans become an asset to the bank.
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Banking Money Creation with FractionalReserve

This T-Account
shows a bank that
accepts deposits,
keeps a portion
as reserves,
and lends out
the rest.

It assumes a
reserve ratio
of 10%.

First National Bank

Assets

Reserves
RM10.00

Liabilities
Deposits
RM100.00

Loans
RM90.00
Total Assets
Total Liabilities
RM100.00
RM100.00

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Money Creation with Fractional-Reserve

Banking
When one bank loans money, that money is
generally deposited into another bank.
This creates more deposits and more reserves to
be lent out.
When a bank makes a loan from its reserves,
the money supply increases.

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The Money Multiplier

How much money is eventually created by the
new deposit in this economy?

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The Money Multiplier

The money multiplier is the amount of money
the banking system generates with each ringgit
of reserves.

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The Money Multiplier

Increase in the Money Supply = RM190.00!
First National Bank
Assets

Liabilities

Second National Bank

Assets

Reserves
Deposits
Reserves
RM10.00
RM100.00
RM9.00
Loans
RM90.00

Liabilities
Deposits
RM90.00

Loans
RM81.00

Total Assets
Total Liabilities
Total Assets
RM100.00
RM100.00
RM90.00

Total Liabilities
RM90.00

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The Money Multiplier

Original deposit = RM100.00
1st Natl. Lending = 90.00 (=.9 x RM100.00)
2nd Natl. Lending = 81.00 (=.9 x RM 90.00)
3rd Natl. Lending = 72.90 (=.9 x RM 81.00)
and so on.
Total money created by this RM100.00 deposit
is RM1000.00. (= 1/.1 x RM100.00)

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The Money Multiplier

The money multiplier is the reciprocal of the
reserve ratio:
M = 1/R
Example:
With a reserve requirement, R = 20% or .2:
The money multiplier is 1/.2 = 5.

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Tools of Monetary Control

The BNM has 3 tools in its monetary toolbox:
Open-market operations
Changing the reserve requirement
Changing the discount rate

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Tools of Monetary Control

Open-Market Operations
BNM conducts open-market operations when it
buys government bonds from or sells government
bonds to the public:
When BNM sells government bonds, the money supply
decreases.
When BNM buys government bonds, the money supply
increases.

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Tools of Monetary Control

Reserve Requirements
BNM also influences the money supply with
reserve requirements.
Reserve requirements are regulations on the
minimum amount of reserves that banks must hold
against deposits.

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Tools of Monetary Control

Changing the Reserve Requirement
The reserve requirement is the amount (%) of a
banks total reserves that may not be loaned out.
Increasing the reserve requirement decreases the
money supply.
Decreasing the reserve requirement increases the
money supply.

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Tools of Monetary Control

Changing the Discount Rate
The discount rate is the interest rate BNM charges
banks for loans.
Increasing the discount rate decreases the money supply.
Decreasing the discount rate increases the money supply.

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Problems in Controlling the Money

Supply
BNMs control of the money supply is not
precise.
BNM must wrestle with two problems that arise
due to fractional-reserve banking.
BNM does not control the amount of money that
households choose to hold as deposits in banks.
BNM does not control the amount of money that
bankers choose to lend.

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Summary
The term money refers to assets that people
regularly use to buy goods and services.
Money serves three functions in an economy:
as a medium of exchange, a unit of account,
and a store of value.
Commodity money is money that has intrinsic
value.
Fiat money is money without intrinsic value.
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Summary
Bank Negara Malaysia, BNM regulates
Malaysias monetary system.
It controls the money supply through openmarket operations or by changing reserve
requirements or the discount rate.

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Summary
When banks loan out their deposits, they
increase the quantity of money in the
economy.
Because BNM cannot control the amount
bankers choose to lend or the amount
households choose to deposit in banks, BNMs
control of the money supply is imperfect.

2007 Thomson South-Western