Chapter 10: Monetary Policy: Bank Negara Malaysia
Chapter 10: Monetary Policy: Bank Negara Malaysia
Chapter 10: Monetary Policy: Bank Negara Malaysia
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Learning Outcomes
On completion of the chapter, the student will be
able to:
Define monetary policy
Explain the tools of monetary policy used and
how they affect the money supply
Distinguish between easy money policy
(expansionary monetary policy) and tight money
policy (contractionary monetary policy)
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What is Monetary
Policy?
A central bank’s deliberate
changing of the money supply
(by manipulating size of excess reserves
held by banks) to influence interest
rates and thus the total level of
spending in the economy.
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GOALS OF MONETARY POLICY
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Tools of Monetary Policy
Three tools of monetary policy used
by the BNM to alter the reserves of
commercial banks include:
1. Open-market operations
2. The reserve ratio
3. The discount rate
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A Quick Recap…
Monetary tools (OMO, the reserve ratio
and the discount rate) ∆ER∆CD
∆MS ∆interest rate ∆ AD (i.e.,
C and Ig) ∆P and ∆Real GDP
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1. Open-Market Operations (OMOs) by BNM
Bond markets are ‘open’ to all buyers & sellers of corporate &
govt. bonds (securities).
Bond
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1. Open-Market Operations (OMOs) by BNM
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1. Open-Market Operations (OMOs)
Example:
- Assume reserve ratio = 20%.
- The BNM’s purchase of a RM1000 bond from
the public creates a RM1000 new Checkable
deposit RM800 (excess deposits) & RM200
(required reserves to back up the RM1000
new CD)
- The banks expand the MS by RM4000
(RM800 x 1/0.2) through making loans.
- Total increase in MS = RM5000.
In short, when BNM buys bonds bank reserves↑ &
the MS ↑ by a multiple of these reserves via monetary
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multiplier.
BANK NEGARA MALAYSIA
PURCHASE OF BONDS
New reserves RM200
Purchase of a RM800 Required
RM1000 bond Excess
Reserves reserves
from the public...
RM1000
RM4000 Initial
Bank System Lending Deposit
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2. The Reserve Ratio
The BNM can manipulate the reserve ratio in
order to influence the ability of commercial banks
to lend.
Raising the reserve ratio: If the BNM raised the
reserve ratio, it would increase the amount of
required reserves banks must keep.
As a consequence:
- banks would lose excess reserves,
diminishing their ability to create money by
lending, or
- banks may find their reserves deficient and
are forced to contract checkable deposits and
therefore the money supply. 12
2. The Reserve Ratio
r ER loans new CD created through lending
Raising the reserve ratio forces banks to reduce
the amount of checkable deposits (CD) they can
create through lending.
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Tight Money Policy
(Contractionary/ Restrictive monetary
policy)
Suppose the economy faces inflation problem. Then
the BNM should try to reduce aggregate demand by
limiting the supply of money. That means reducing
the reserves of commercial banks through:
1. Sell securities
2. Increase the reserve ratio
3. Raise the discount rate
These actions are called a tight money policy.
The objective is to tighten the supply of money in
order to reduce spending and control inflation.
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Which Tool Does the BNM Prefer to Use?
The BNM can use open market operations, the
required-reserve ratio, or the discount rate to
influence the money supply.
The BNM prefers to use Open Market Operations.
– Open market operations are flexible
– Open market operations can be reversed
– Open market operations can be implemented
quickly
Reserve Ratio rarely as this could destabilize
bank’s lending & profit positions.
Discount Rate little direct effect since there is a
very small portion of bank reserves that are
borrowed from BNM 19
BNM Monetary Tools & their
Effects on the Money Supply
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