Monetary Policy

• Discretionary monetary policy


  The action by BNM to change money supply with the use of monetary policy tools like open-market operation, reserve ratio, discount rate and interest rate to stabilize the economy
• Open-market operations


  1. Purchase of government bonds (securities) from and sales of it to general public, business and financial institution by Central Bank

  2. Government bonds are paper issued by government when they want to raise money
• Reserve requirement


  Specified minimum percentage of its deposits that a commercial bank must keep on deposit at Central Bank<|>Reserve adjustment will affect money supply in the economy<|>There are two types of reserve: required reserve and excess reserve<|>BNM has the power to alter the reserve requirements of member banks by changing the reserve ratio
• Discount rate


  Interest charged on borrowed reserves by commercial banks from Central Bank
• Interest rate


  Interest charged on loan by borrowers to the commercial bank<|>Interest rate is the source of profit for commercial bank as business organization<|>During recession, BNM will decrease the interest rate<|>When interest rate decreases, cost of borrowing will decrease and encourage the public to make loan hence increase the money supply
• Expansionary monetary policy


  Implemented during recession phase of business cycle to increase the level of GDP<|>Objective is to increase money supply and to expand the economy
• Expansionary monetary policy


  1. BNM buys government bonds from general public and commercial banks

  2. General public will have more money in their hand - increase the consumption expenditure

  3. Commercial banks receive payment from BNM - more excess reserve - increase money creation by giving more loans - increase consumption expenditure - will increase the production of the goods - increase GDP

  4. BNM reduces RR - Bank have more excess reserves - increase money creation by giving more loans - general public have more money - increase their consumption expenditure - increase the production of the goods and services - finally it will increase the GDP

  5. BNM will decrease the discount rate - increase of the excess reserve and availability of loan - general public have more money - increase consumption expenditure - Increase GDP
• Contractionary monetary policy


  Implemented during expansionary phase of business cycle to combat inflation<|>Objective is to reduce money supply and to slow down the rapid economic growth
• Contractionary monetary policy


  1. BNM will sell government bonds to general public and commercial banks

  2. General public will have less money in their hand - decrease the consumption expenditure

  3. Commercial banks make payment to BNM - less excess reserve - decrease money creation by reducing loans offering - decrease consumption expenditure - producers will decrease the production of goods - slow down economic growth

  4. BNM increases RR - Bank have less excess reserves - decrease money creation by giving less loans - general public have less money - decrease their consumption expenditure - decrease the production of the goods and services - finally it will slow down the economic growth

  5. BNM will increase the discount rate - decrease of the excess reserve and availability of loan - general public have less money - decrease consumption expenditure - Decrease Economic Growth
• When economic growth is too fast

  • It will create an overheating situation in economy
  • Economy reaches the limit of its capacity to meet all of the increasing demand from individuals, firms and government
  • Consequently, shortage will take place and causes inflation to spike
• Money creation


  Bank ABC has RM10,000 as excess reserves and loan it out to Mr. Z with interest rate of 2 percent. Upon the payment, Mr. Z has pay RM10,200 (principal amount plus interest rate) to Bank ABC. Therefore, Bank ABC has created RM200 from RM10,000 and has increased money supply by RM200
• Increase in Money Supply

  • Decrease in interest rate
  • Encourage people to make more consumption expenditure based on credit
  • Encourage investment loan to increase
  • Increase the GDP
• Decrease in Money Supply

  • Increase in interest rate
  • Discourage people to make purchasing based on credit
  • Discourage investment loan
  • Decrease the GDP