3 Bank Negara, Monetary Policy

Chapter
Bank Negara Malaysia

Monetary Policy, Goals, Strategy and Tactics
BANK NEGARA MALAYSIA

OBJECTIVES
(a) Issues currency and manages

the nation's international reserves
Maintaining a strong reserves position is
also important to both the short-term
objective of economic recovery as well as
the long-term aim to maintain a sustainable
external position. Why important?
(How much? How many month?)
(a) Issues currency and manages

the nation's international reserves
The traditional policy for the Ringgit exchange
rate has been for market forces to determine the
rate and reflect underlying economic
fundamentals. Interventions are conducted only to
smooth excessively volatile fluctuations.
(Subjective?)
fixing of the exchange rate at RM3.80 per US$1
effective September 1, 1998.
(Why, valueless, RM1,000 & RM500 notes)
(b) Banker and financial adviser

to the Government
managing the Governments liabilities.
(How much, government guanrantee, vs
Singapore, Rating?)
It advises the Government on its loan
programmes.
trading, registering, settlement and redemption
of Government securities through its
computerised trading and settlement system.
(b) Banker and financial adviser

to the Government
to provide temporary advances, known as
"ways and means" advances, to the
Government to cover any deficit in the
budget revenue. (How many year deficit?
Role of petronas, GST)
maintains a close relationship with the
Ministry of Finance.
(c) Promote monetary stability

and a sound financial structure
goal of attaining monetary or price stability.
Price stability is a key prerequisite for
sustained economic growth, in the absence
of which the mobilisation of resources and
the efficient channelling of resources to
productive investment would be adversely
affected. (inflation rate? Reflect?
Measurement)

financial stability.
sound and stable financial system is necessary
for the conduct of monetary policy.
Maintaining financial stability, in turn,
requires stable monetary conditions so that the
balance sheets of corporations and financial
institutions are not adversely affected by
conditions of macroeconomic stress.

Having appropriate policies in place is
important to ensure a sound banking system
that provides a mechanism for the
intermediation process to enable the
economy to function efficiently.
An essential element for promoting
financial stability is the existence of a
strong and effective prudential framework.
(household debt, 70%, Net salary, DIBS)
(d) Influence the credit situation to

Malaysias advantage
BNM is obliged to ensure that the supply of
money and volume of credit are sufficiently elastic
to the demands of the domestic economy, without
creating undue pressure on resources and prices.
It regulates the volume of money and credit
generation by the banking system through a range
of instruments, including guidelines on lending to
priority sectors and selective credit and
administrative measures.
BANK NEGARA MALAYSIA

FUNCTIONS
(a) Bank for Currency Issue

The Central Bank of Malaysia Ordinance 1958 (CBO)
provides for the Bank Negara Malaysia (BNM) to be the
sole currency issuing authority in the country.
The BNM commenced issuing its own currency on June
12, 1967, thereby replacing the Currency Board as the
sole currency issuing authority in Malaysia.
The unit of currency was the Malaysian dollar, which
was divided into 100 cents. Under the Malaysian
Currency (Ringgit) Act 1978, the Malaysian dollar and
cent were renamed "Ringgit" and "sen" respectively.
(a) Bank for Currency Issue

The par value of the Malaysian Ringgit was
defined as equivalent to 0.290299 grammes
of fine gold.
The currency was then required under the
CBO to have a minimum cover of 80.59%
in gold and foreign exchange.
(b) Keeper of International

Reserves
The BNM' s international reserves comprise
gold, foreign exchange, reserve position with
the International Monetary Fund and holdings
of Special Drawing Rights.
To safeguard the external value of the
Ringgit, the CBO provides for the
maintenance of a minimum external reserves
backing of 80.59% against the currency issue.
(c) Governments Banker and

Financial Advisor
The BNM acts as banker, fiscal agent and financial
advisor to the Government.
cooperation between the Government and BNM is also
evident from the centralisation of Government deposits
with the Bank.
With this arrangement, government receipts, arising
mainly from the new issue of Government securities, tax
and dividend payments are placed with BNM and
managed by the Bank depending on the liquidity
situation of the system.
(e) Banker to the Banks

The BNM's relationship with the commercial banks,
finance companies, merchant banks, discount houses
and the Islamic Bank has its legal foundation in three
main pieces of legislation, namely: (a) the Central
Bank Ordinance 1958; (b) the Banking and Financial
Institutions Act (BAFIA) 1989; and (c) the Islamic
Banking Act 1983.
(Appointment of BOD, M&A, Loan)
(e) Banker to the Banks

The BNM cooperates closely with the financial institutions
to promote and maintain a range of banking and other
services for the public, enhance efficiency and strengthen
the institutions' prudential standards, discipline and moral
fibre. In acting as banker to these institutions, the BNM
maintains special accounts for the major financial
institutions, inspects them regularly and performs the
functions of a lender of last resort. (MBF, Sime bank, RHB
Bank, How, Dana Harta)
Chapter Preview
Monetary policy refers to the management
of the money supply. Although the idea is
simple enough, the theories guiding the
Federal Reserve are complex and often
controversial. But, we are affected by this
policy, and a basic understanding of how it
works is, therefore, important.
2012 Pearson Prentice Hall. All rights reserved.
10-18
The Federal Reserves

Balance Sheet
The conduct of monetary policy by the Federal
Reserve involves actions that affect its balance sheet.
This is a simplified version of its balance sheet, which
we will use to illustrate the effects of Fed actions.
10-19

Balance Sheet: Liabilities
The monetary liabilities of the Fed include:
Currency in circulation: the physical currency in the
hands of the public, which is accepted as a medium of
exchange worldwide.
Reserves: All banks maintain deposits with the Fed,
known as reserves. The required reserve ratio, set by
the Fed, determines the required reserves that a bank
must maintain with the Fed. Any reserves deposited
with the Fed beyond this amount are excess reserves.
The Fed does not pay interest on reserves, but that
may change because of legislative changes for 2011.
10-20

Balance Sheet: Assets
The monetary assets of the Fed include:
Government Securities: These are the U.S. Treasury
bills and bonds that the Federal Reserve has
purchased in the open market. As we will show,
purchasing Treasury securities increases the money
supply.
Discount Loans: These are loans made to member
banks at the current discount rate. Again, an increase
in discount loans will also increase the money supply.
10-21
Open Market Operations

In the next two slides, we will examine the impact
of open market operation on the Feds balance
sheet and on the money supply. As suggested in
the last slide, we will show the following:
Purchase of bonds increases the money supply
Making discount loans increases the money supply
Naturally, the Fed can decrease the money supply

by reversing these transactions.
10-22
The Federal Reserve

Balance Sheet
Open Market Purchase from Public
Result R $100
10-23
The Federal Reserve

Balance Sheet
Discount Lending
Banking System
Assets
Liabilities
Reserves
Discount loans
+$100
+$100
The Fed
Assets
Discount loans
+$100
Liabilities
Reserves
+$100
Result R $100
10-24
Supply and Demand in the

Market for Reserves
We now have some understanding of the effect of
open market operations and discount lending on
the Feds balance sheet and available reserves.
Next, we will examine how this change in reserves
affects the federal funds rate, the rate banks charge
each other for overnight loans. Further, we will
examine a third tool available to the Fedthe ability
to set the required reserve ratio for deposits held by
banks.
10-25

Market for Reserves
1. Demand curve
slopes down
because iff ,
ER and Rd
up
2. Supply curve
slopes down
because iff ,
DL , Rs
3. Equilibrium iff
where Rs = Rd
10-26
Response to Open Market Operations:

Case 1downward sloping demand
1. Open market
purchase shifts
supply curve to the
right (NBR1 to
NBR2).
2. Rs shifts down, fed
funds rate falls.
3. Reverse for sale.
10-27
Response to Open Market

Operations: Case 2flat demand
1. Open market
purchase shifts
supply curve to the
right (NBR1 to
NBR2).
2. Rs parallel, fed
funds rate
unchanged.
3. Reverse for sale.
10-28

Market for Reserves
RR , Rd
shifts to
right, iff
10-29
Tools of Monetary Policy

Now that we have seen and understand the
tools of monetary policy, we will further
examine each of the tools in turn to see how
the Fed uses them in practice and how
useful each tools is.
10-30
Tools of Monetary Policy:

1. Dynamic: Meant to change Reserves
Advantages of Open Market Operations

1. Fed has complete control
2. Flexible and precise
3. Easily reversed
4. Implemented quickly
Information about the FOMC http://www.federalreserve.gov/fomc
10-31
Tools of Monetary Policy: Open Market

Operations at the Trading Desk
The staff reviews the activities of the prior day and issue
forecasts of factors affecting the supply and demand
for reserves.
This information is used to determine reserve changes
needed to obtain a desired fed funds rate.
Government securities dealers are contacted to better
determine the condition of the market.
Projections are compared with the Monetary Affairs Division
of the BOG, and a course of action is determined.
Once the plan is approved, the desk carries out the required
trades, via the TRAPS system.
10-32
Tools of Monetary Policy: Open Market

Operations at the Trading Desk
The trading desk typically uses two types of
transactions to implement their strategy:
Repurchase agreements: the Fed purchases
securities, but agrees to sell them back within about
15 days. So, the desired effect is reversed when the
Fed sells the securities backgood for taking defense
strategies that will reverse.
Matched sale-purchase transaction: essentially a
reverse repro, where the Fed sells securities, but
agrees to buy them back.
10-33
Discount Policy
The Feds discount loans are primarily of
three types:
Primary Credit: Policy whereby healthy banks
are permitted to borrow as they wish from the
primary credit facility.
Secondary Credit: Given to troubled banks
experiencing liquidity problems.
Seasonal Credit: Designed for small, regional
banks that have seasonal patterns of deposits.
10-34
Discount Policy (why)

Lender of Last Resort Function
To prevent banking panics
Example: Continental Illinois
10-35
Discount Policy
Lender of Last Resort Function
Can also help avoid panics
Ex: Market crash in 1987 and terrorist attacks in 2001
bad events, but no real panic in our financial system (FR
pump in cash)
But there are costs!

Banks and other financial institutions may take on
more risk (moral hazard) knowing the Fed will
come to the rescue (risk taker, Lehman brother,
Bear sterns )
10-36
Inside the Fed (Example)

The 20072009 Financial Crisis tested the Feds
ability to act as a lender of last resort. Here are
some of the details of the Feds efforts during this
period to provide liquidity to the banking system:
The great Depression (1930s)
The Fed lowered the discount rate to 0.5% above the
fed funds rate, and then by March 2008, lowered that
to just 0.25%.
Discount loan maturity was extended from overnight
loans to loans maturity in 30 days, and then 90 days.
10-37
Price Stability Goal

& the Nominal Anchor
Policymakers have come to recognize the
social and economic costs of inflation. (UK
experience)
Price stability, therefore, has become a primary focus.
High inflation seems to create uncertainty, hampering
economic growth.
Indeed, hyperinflation has proven damaging to countries
experiencing it.
10-38
Other Goals of Monetary Policy

Goals
High employment (BOE 7%)

Economic growth
Stability of financial markets
Interest-rate stability
Foreign exchange market stability
Reasonable Inflation rate
Goals often in conflict

10-39
Should Price Stability be the

Primary Goal?
However, there are short-run trade-offs. For
example, an increase in interest rates will
help prevent inflation, but does increase
unemployment in the short-run.
10-40
Inflation Targeting
Inflation targeting involves:
1. Announcing a medium-term inflation target
2.Commitment to monetary policy to achieve the
target
3. Inclusion of many variables to make monetary
policy decisions. CPI, IPI, HPI
4. Increasing transparency through public
communication of objectives
5. Increasing accountability for missed targets
10-41
Inflation Targeting:
Pros and Cons
Advantages
Easily understood by the public
Helps avoid the time-inconsistency problem
since public can hold central bank accountable
to a clear goal
Forces policymakers to communicate goals
and discuss progress regularly
10-42
Pros and Cons
Advantages (continued)
Allows for better private sector planning since
the central bank must communicate
Inflation goals
Regular measures of inflation
How to achieve the goals given current conditions
Explanation of deviations from targets
Performance has been good!
10-43
Pros and Cons
Disadvantages
Signal of progress is delayed
Affects of policy may not be realized for several
quarters.
Policy tends to promote too much rigidity

Limits policymakers ability to react to unforeseen
events
Usually flexible targeting is implemented, focusing
on several key variables and targets modified as
needed
10-44
Pros and Cons
Disadvantages
Usually accompanied by low economic growth
Probably true when getting inflation under control
However, economy rebounds
10-45
Central Banks Responses to Asset-Price

Bubbles: Lessons from 20072009
Asset pricing bubbles occur when an assets

prices diverge significantly from fundamental
values, and then subsequently return to the
fundamental value (or lower) quite rapidly.
(House price 100k to 500k in five years)
(Stock, penny stock to $1-2)
10-46

What should central banks do about pricing

bubbles?
Should monetary policy be used to end a
pricing bubble?
Are there measures that would be effective
to rein in a bubble?
10-47

To help answer this, we first must define the types
of pricing bubbles.
A credit-driven bubble is created when easy
credit terms spill over into asset prices. And as
asset prices increase, further lending is
encouraged.
Very dangerous when the bubble ends. Just the
opposite occurs, and the downward spiral may be
more extensive than the asset bubble.
10-48

To help answer this, we first must define the types
of pricing bubbles.
An optimism-driven bubble is driven only by
overly optimistic expectations of asset pricing. The
tech bubble of the late-1990s is a good example.
Banks had little involvement.
These bubbles are less dangerous, as the impact
on the financial system is limited. But the resulting
wealth transfers are still not good for the economy.
10-49
Should Central Banks

Respond?
Under Greenspan, the answer was no! We
have to assume that the government is
smarter than the market. Greenspan
preferred to let the market sort these things
out. However, this policy is dangerous when a
bubble is also accompanied by a credit boom.
As we just experienced, such a bubble has
far reaching impacts when the bubble bursts.
10-50
Should Central Banks

Respond?
But even if we agree that a response is appropriate,
what response is not clear. For example, should the
Fed take actions to raise interest rates to stem a
bubble? Or create another bubble after another crisis
Not clear that rates can fix the problem
Too blunt of an instrument to affect only one asset
price in the economy
The collateral damage (slow economy,
unemployment, etc.) may be worse than the bubble we
are trying to avoid
10-51
10-52
7) A discount loan by the Fed to a bank causes

a(n) ________ in reserves in the banking system
and a(n) ________ in the monetary base.
A) increase; decrease
B) decrease; decrease
C) decrease; increase
D) increase; increase
10-53
10-54
10-55
10-56
10-57
10-58
10-59
10-60
10-61
10-62
10-63
10-64
10-65
10-66
1: C
7: D
10: A
14: A
19: D
22: c
23:c
27:B
25:B
28: A
33: A 43: c 54: c 5:A
10-67

3 Bank Negara, Monetary Policy

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

3 Bank Negara, Monetary Policy

Uploaded by

Copyright:

Available Formats

Chapter

Bank Negara Malaysia

BANK NEGARA MALAYSIA

(a) Issues currency and manages

(a) Issues currency and manages

(b) Banker and financial adviser

(b) Banker and financial adviser

(c) Promote monetary stability

(c) Promote monetary stability

(c) Promote monetary stability

(d) Influence the credit situation to

BANK NEGARA MALAYSIA

(a) Bank for Currency Issue

(a) Bank for Currency Issue

(b) Keeper of International

(c) Governments Banker and

(e) Banker to the Banks

(e) Banker to the Banks

2012 Pearson Prentice Hall. All rights reserved.

The Federal Reserves

2012 Pearson Prentice Hall. All rights reserved.

The Federal Reserves

The Federal Reserves

2012 Pearson Prentice Hall. All rights reserved.

Open Market Operations

Naturally, the Fed can decrease the money supply

2012 Pearson Prentice Hall. All rights reserved.

The Federal Reserve

The Federal Reserve

2012 Pearson Prentice Hall. All rights reserved.

Supply and Demand in the

2012 Pearson Prentice Hall. All rights reserved.

Supply and Demand in the

Response to Open Market Operations:

2012 Pearson Prentice Hall. All rights reserved.

Response to Open Market

2012 Pearson Prentice Hall. All rights reserved.

Supply and Demand in the

2012 Pearson Prentice Hall. All rights reserved.

Tools of Monetary Policy

2012 Pearson Prentice Hall. All rights reserved.

Tools of Monetary Policy:

Advantages of Open Market Operations

Tools of Monetary Policy: Open Market

Tools of Monetary Policy: Open Market

2012 Pearson Prentice Hall. All rights reserved.

Discount Policy (why)

2012 Pearson Prentice Hall. All rights reserved.

But there are costs!

Inside the Fed (Example)

Price Stability Goal

2012 Pearson Prentice Hall. All rights reserved.

Other Goals of Monetary Policy

High employment (BOE 7%)

Goals often in conflict

Should Price Stability be the

2012 Pearson Prentice Hall. All rights reserved.

2012 Pearson Prentice Hall. All rights reserved.

Performance has been good!

2012 Pearson Prentice Hall. All rights reserved.

Policy tends to promote too much rigidity

2012 Pearson Prentice Hall. All rights reserved.

Central Banks Responses to Asset-Price