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LECTURE 6
Monetary Policy
What is Monetary
Policy?
• Monetary policy refers to actions
that the Central Bank takes to
change the interest rates and the
money supply. It is aimed at
affecting the economy.
Tools of Monetary
Control
• There are 3 tools of monetary
control it can use to alter the
reserves of commercial banks:
(a) Open-market operations.
(b) The reserve ratio.
(c) The discount rate.
Open Market
Operations
• Bond markets are open to all buyers and
sellers of corporate and government bonds
(securities). The Bank Negara’s open
market operations consist of the buying of
government bonds from, of the selling of
government bonds to, commercial banks
and the general public.
• Buying securities
(a) From commercial banks
(b) From the public
• Selling securities
(a) To commercial banks
(b) To the public
The Reserve Ratio
• The Bank Negara can also manipulate
the reserve ratio in order to
influence the ability of commercial
banks to lend. 2 ways to do this:
(a) Raising the reserve ratio.
(b) Lowering the reserve ratio.
The Discount Rate
• Just as commercial banks charge
interest on their loans, so too Bank
Negara change interest on loans they
grant to commercial banks. The
interest rate they charge is called
the discount rate.
Easy Money Policy
• Suppose the economy faces recession and
unemployment. The Bank Negara decides that an
increase in the supply of money is needed to
increase aggregate demand so as to employ idle
resources. To increase the supply of money, the
Bank Negara must increase the excess reserves
of commercial banks. How can it do that?
(a) Buy securities
(b) Lower the reserve ratio
(c) Lower the discount rate
Tight Money Policy
• On the other hand, suppose excessive spending is
pushing the economy into an inflationary spiral.
Then the Bank Negara should try to reduce the
aggregate demand by limiting or contracting the
supply of money. That means reducing the
reserves of commercial banks. How is that done?
(a) Sell securities
(b) Increase the reserve ratio
(c) Raise the discount rate