Principles of Economics: Anizah Md Ali 1

CHAPTER 13
MONEY AND MONEY SUPPLY

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Introduction
 Money is very important in human life in
terms of spending.
 Money is usually an indicator of how wealthy
or rich a person.
 Before the money system was introduced in
the economy, transaction was performed
using the barter system.
 Barter is a process of exchanging goods and
services without using money.
 The exchange or transaction in a money
system in an economy takes less time
compared to barter because there is no need
for a double coincidence of wants.

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Definition of Money
 Money as anything that is
generally accepted and fixed as a
medium of exchange for the
purchase of goods and services.
 For example, nowadays most
people use coins or notes as well
as cheque as a medium of
exchange.

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Characteristic of Money

Measureable

Scarce In
Divisible
Supply

Characteristics

Standardize Easy To Carry

Connot Be Widely
Imitated Accepted

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Functions of Money

Functions Of Money

Medium of Exchange A Unit of Account A Store of Value A Deffered Payment

A store of value means

it makes transaction a uniform unit that Some transactions in
that money is saved or
easier to perform and provides a consistent the economy are
delayed in purchasing
buyers can directly buy method of quoting performed as delayed
resources for future
goods and services prices payment or credit
usage

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Commodity And Fiat (Token) Money

Commodity Fiat
money is a function
money in commodity of money because of
terms and has a government decree
higher intrinsic value and has no or lower
intrinsic value.

For example, fiat

monies in Malaysia
for instance, gold, are coins and notes
silver and diamonds with the monetary
unit of Ringgit
Malaysia (RM).)

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Money Supply In Malaysia

Money Supply

M1 M2 M3

Currency in M3 = M2 + Deposits Placed

M2 = M1 + Narrow with Other Banking
Circulation + Demand
Quasi-Money Institutions
Deposits

Narrow Quasi Money =Savings Deposits

+ Fixed Deposits + NIDs + Repos +
Foreign Currency Deposits

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Money Supply In Malaysia

Table 13.1 Money Supply in Malaysia (RM million)

2015 2016 20174

Broad money (M3)1 1,594,587 1,643,902 1,684,956
Currency in circulation2 76,643 85,460 91,769
Demand deposits 282,874 294,313 300,146
Board quasi money 1,235,071 1,264,129 1,293,041
Saving deposit 135,591 145,129 151,099
Fixed deposits 746,186 772,189 799,888
Negotiable instruments of deposits (NIDs) 9,255 8,327 5,205
Repurchase agreements (Repos) 0 0 0
Foreign currency deposits 137,547 129,079 123,962
Others deposits 206,492 210,406 212,887

Factors Affecting M3
Net claim on Government 95,472 113,199 137,206
Claims on Government 153,784 166,431 210,105
Less Government deposits 58,312 53,232 72,899
Claims on private sector 1,559,534 1,648,792 1,701,408
Loans 1,396,418 1,480,417 1,512,970
Securities 163,116 168,375 188,437
Net foreign assets 526,448 520,433 522,267
Bank Negara Malaysia3 401,087 415,756 423,552
Banking system 125,362 104,677 98,715
Other influences -586,868 -638,522 -675,924
Note:
1 Exclude interplacements among banking institutions.
2 Exclude holding by the banking system
3 Includes exchange rate revaluation losses/gains
4 End August 2017
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Source: Bank Negara Malaysia
Creation Of Money: Private (Commercial) Bank

 Commercial banks are the main

financial intermediaries that link
depositors and money borrowers.
 For instance, commercial banks receive
deposits from bank customers and loan
money to others to purchase cars,
houses, etc.
 This transaction will generate money
supply in the economy

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Creation Of Money
 To understand how creation of money works, there needs to be some
understanding of the fundamental concepts of accounting, T account
or balance sheet.
 T account or balance sheet is a set and claim statements to summarize a
firm or commercial bank’s financial position.
 T account has two sides which are assets and liabilities.
 Assets are things of worth that a firm owns. For example, bank assets
such as bank office block, cabinets, equipment, cash in its vault, bonds
and others.
 Liabilities are bank’s debts which include deposits and net worth.
 Net worth is the value of the company to its investors or shareholders,
or the difference between assets and liabilities. Its value is positive if
there is gain and negative if there is loss

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Creation of Money
The summarize;

Assets  Liabilities + Net Worth

Asset – Liabilities  Net Worth

Figure 13.1 : T Account (RM million)

Assets Liabilities

Total Reserve 160 Demand Deposit 150

Required Reserve 15 Net Worth/Value 10
Loans 145

Total 160 Total 160

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Creation of Money: Reserve

 Total reserves is defined as the deposit that a bank has at

the central bank plus its cash on hand.
 Excess reserves or loans is the difference between total
reserves and required reserves. Excess reserves will be
loaned to customers for the bank’s income sources.
 The required reserve ratio (RRR) is the per cent of its
total deposits that the bank should hold as reserves in the
central bank.

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Creation Of Money : Assumption

Required reserve ratio is fixed by central

bank

All excess reserves in transaction will be

Assumption loaned to bank customers

All transactions using cheques and

customer’s deposit is demand deposits

No leakage in the banking system

Assets items only include required

reserves and loans (excess reserves) and
liabilities item only involves demand
deposits

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The process of money creation

 Assuming there are four banks in the economy: Bank A,

Bank B, Bank C and Bank D.
 Required reserve ratio (RRR) is fixed by the central bank at
10 per cent and the first customer deposits in Bank A, the
amount of RM1,500.
 If RRR is 10 per cent, it means that Bank A must hold
RM150 as a reserve in the central bank.
 The excess reserve which is RM1,350 will be loaned to the
second customer.
 The transactions are shown in Figure 13.2.

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The process of money creation
Figure 13. 2: T Account in Multiple Bank

Bank A
Assets Liabilities
Total Reserve 1,500 Demand Deposit 1,500
Required Reserve 150
Excess Reserve (Loans) 1,350
Total 1,500 Total 1,500

Bank B
Assets Liabilities
Total Reserve 1,350 Demand Deposit 1,350
Required Reserve 135
Excess Reserve (Loans) 1,215
Total 1,350 Total 1,350

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The process of money creation

Figure 13. 2: T Account in Multiple Bank

Bank C
Assets Liabilities
Total Reserve 1,215 Demand Deposit 1,215
Required Reserve 121.5
Excess Reserve (Loans) 1,093.5
Total 1,215 Total 1,215

Bank D

Assets Liabilities
Total Reserve 1,350 Demand Deposit 1,093.5
Required Reserve 109.35
Excess Reserve (Loans) 984.15
Total 1,093.5 Total 1,093.5

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Money Multiplier

 The process will continue until excess reserves equals

to zero which means that the bank does not have
money to loan. The process takes time.
 The useful method to calculate how much money
supply is in the economy after the transactions have
finished is by using the money multiplier.

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Money Multiplier

 Money multiplier is the multiple by which deposits

can be raised with each unit of money rise in the
required reserves.
 The formula;
1
𝑀=
𝑅𝑅𝑅

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Money Multiplier
 Based on the above example (Figure 13.2), money
multiplier is 10.

1 1
𝑀= = = 10
𝑅𝑅𝑅 10%

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Money Multiplier
 Based on the above example (Figure 13.2), the total
money supply in the economy is RM15,000
(transactioncompleted).

𝑇𝑜𝑡𝑎𝑙 𝑚𝑜𝑛𝑒𝑦 𝑠𝑢𝑝𝑝𝑙𝑦 = 𝑀𝑜𝑛𝑒𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 (𝑀) 𝑥 𝑒𝑎𝑟𝑙𝑖𝑒𝑟 𝑑𝑒𝑝𝑜𝑠𝑖𝑡𝑠

= 10 𝑥 1500 = 𝑅𝑀15,000

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Money Creation
Table 13.2: Summarize the process of credit or money creation.

Bank Demand Required Reserve (RR) Excess Total current

Deposit (10% of Demand Deposit) Reserve saving
(ER)
Bank A 1500 150 1350 1500
Bank B 1350 135 1215 2850
Bank C 1215 121.5 1093.5 4065
Bank D 1093.5 109.35 984.15 5158.5
Others 9841.5 515.85 8857.35 9841.5
Deposit
Total 15,000 1,500 13,500 15,000

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Financial System in Malaysia

Malaysian financial system

Financial Institutions Financial Market

Non-bank Financial Money and Foreign

Banking System Capital Market,
Intermediaries Exchange Market, and

Derivatives Market Offshore

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Money Supply Curve

Interest rate Ms/P

 Assumed that
(r) money supply is
controlled by
central bank.
 Therefore, the
supply of money is
vertical

Quantity of
Figure 13.3 Money Supply Curve Money (M)

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Bank Negara Statement
Table 13.3: Bank Negara Statement (15 August 2018)
Asset RM

Gold and Foreign Exchange and Other Reserves including SDR 421,721,660,474

Malaysian Government Papers 4,303,481,932

Deposits with Financial Institutions 2,246,076,000
Loans and Advances 7,155,262,743
Land and Buildings 4,179,614,080
Other Assets 8,838,339,408
448,444,434,637

Capital and Liabilities RM

Paid-Up Capital 100,000,000
Reserves 129,349,148,144
Currency in Circulation 104,792,417,640
Deposits by:
Financial Institutions 161,814,492,971
Federal Government 21,577,809,029
Others 813,983,292
Bank Negara Papers 98,109,381,925
Allocation of Special Drawing Rights 17,877,137,101
Other Liabilities 7,644,785,191
448,444,434,637

Source: Bank Negara Malaysia

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THESE TEACHING MATERIALS ARE TAKEN FROM THE
PRINCIPLES OF ECONOMICS WRITTEN BY ANIZAH MD ALI
AND PUBLISHED BY UUM PRESS 2021. ISBN 978-967 2486-
65-72626

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