Monetary Policy

Week 5
Today’s discussion
• Introduction:
- Meaning and function of money
- The Types of Money
• Money Supply
- Introduction: Why MS is important?
- Players in the MS
- The Central Bank: Definition, Functions
- Banks and Money Supply
- The Money Multiplier
- The Policies of CB
Meaning and Function of Money
Meaning of money
Money is the set of asset in an economy that people regularly use to buy goods and services from other people.
→Jadi, uang adalah anything yang diterima untuk pembayaran barang dan jasa.

Wealth ≠ money
Money is part of wealth, but money is not wealth
Wealth can be in terms of : money, shares, land, etc.

Functions of Money
1. Medium of exchange : an item that buyers give to sellers when they want to purchase goods and services
2. Unit of account: The yardstick (ukuran) people to use to post prices and records debts
3. Store of value : an item that people can use to transfer
4. Liquidity : the ease with which an asset can be converted into the economy’s medium of exchange.
Evolution of Payments System
1. Precious metals like gold and silver
2. Paper currency (fiat money)
3. Checks
4. Electronic means of payment
5. Electronic money: Debit cards, Stored-value cards, Smart cards, E-cash
2 Types of Money
a. Commodity Money b. Fiat Money
Intrinsic value → the item would have value even Without Intrinsic value → notes digunakan sebagai uang
if it is not used as money. karena berdasarkan gov’t decree.
Example: Gov’t decree means the notes is valid as money.
Gold Example:
“this note is legal tender for all debts, public and private”

Evolution of Payments System

1. Precious metals like gold and silver
2. Paper currency (fiat money)
3. Checks
4. Electronic means of payment
5. Electronic money: Debit cards, Stored-value cards,
Smart cards, E-cash
Introductions: Why money supply is important?

• Money supply (MS) can affect interest rate, inflation, and economy’s output (GDP).
• THUS, Central bank around the world attempts to manage the MS.
• To understand a central bank manage the MS, we need to know:
1. What factors determine the MS
2. How Central bank can increase or decrease the amount of money in the circulation.
Players in the Money Supply Process (1)
1.Central bank: the Fed → BI
2.Banks
3.Depositors
4.Borrowers from banks
Players in the Money Supply Process (2): Central Bank
Why CB is important?
- CB conducts Monetary Policy → can change the MS which profoundly affect the economy.
- Regulates commercial banks
How does CB change MS?
• The Fed (CB) has the power to increase or decrease MS in the economy.
• The primary tools of the fed → Open Market Operation (OMO) → the purchase and sale
of US gov’t bonds.
- to increase the MS
the Fed buy gov’t bonds from the public in the nation’s bond market.
- to decrease the MS
the Fed sells gov’t bonds from its portfolio to the public in the nation’s bond market.
Banks and Money Supply (1): How Banks Affect Money Supply

Money Supply: Narrower Definition

Money supply is defined as currency with the public and demand deposits with commercial banks.

Demand deposits are savings and current accounts of

depositors in a commercial bank.

Demand deposits are the liquid form of money because

depositors can draw cheques for any amount lying in their
accounts and the hank has to make immediate payment
on demand.
Banks and Money Supply (2)

Money Supply: Wider Definition

Money supply is
▪ the number of dollars people are carrying' around in their pockets,
▪ the number of dollars they have to their credit at banks or
▪ the number of dollars they have their credit at banks in the form of
demand deposits, and also commercial bank time deposits.
Banks and Money Supply (3)
• Banks refers to commercial banks
• The behavior of banks can influence the quantity of demand deposit in the economy
and thus the MS.
• Banks affect MS through:
a. Reserve Banking: a tool for money creation in the economy
b. Money Multiplier
c. Capital Requirement
Banks and Money Supply (4): Reserve Banking
Reserve → artinya deposit yang diterima bank tapi tidak dipinjamkan.

2 Types of RB

100% Reserve Banking

- Banks cannot make a
loan
Fractional Reserve Banking
- all deposit are held as
reserve - Banks hold only a fraction of deposit as reserve.
- Reserve ratio → fraction of deposit that banks hold as reserve
- Example:
Total Deposit : Rp 1000
Reserve ratio : 10%
Loans : Rp 900
Total MS : Loans (Rp900) + Demand Deposit(Rp1000) = Rp1900
Banks and Money Supply (5): Money Multiplier
Definition
Money Multiplier is the amount of money the banking system generates with each dollar of reserves.
→ Jadi pengganda uang adalah jumlah uang yang dapat di generate oleh bank pada tiap 1 dollar reserve.

Formula
1
𝑀𝑜𝑛𝑒𝑦 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = , dimana rr = Reserve ratio
𝑟𝑟
Example:
rr = 10%, berapa Money multiplier???
1 1
Money multiplier = = = 10 → means: each dollar of reserve will generate $10
𝑟𝑟 10%

rr =20%
1 1
Money multiplier = = = 5
𝑟𝑟 20%

→ Jadi, semakin tinggi rr, semakin rendah jumlah loan yang dapat dilakukan oleh bank → semakin rendah
money multiplier.
Banks and Money Supply (6): Money Multiplier
How much money is created in the economy?
dst

Original deposit =$100.00 (assume rr = 10%)

1 First National lending = $ 90.00 (= 0.9 x $100.00)
2 Second National lending = $ 81.00 (= 0.9 x $90.00)
Bank Bank Firm
3 Third National lending = $ 72.90 (= 0.9 x $81.00) 3 1 1

Total MS = $1,000.00
→ So the multiplier money is = 10 (1000/100) Firm Bank Firm
3 2 2

→Jadi, multiplier dari uang merupakan berapa kali uang dapat diputar dalam perekonomian
Banks and Money Supply (7): Capital Requirement
Definition
Capital requirement is a government regulation specifying a minimum amount of bank capital

The use of Capital Requirement

To ensure that banks will be able to pay off their depositor
→ Jadi, CR digunakan untuk menjamin dana nasabah dapat ditarik sewaktu-waktu.
Banks and Money Supply (8): Capital Requirement
• Example insolvent: Financial crisis 2008-2009
- Many borrowers can’t pay their loans.
- Causes bank falls in the shortage of capital, thus bank reduce its lending→ called as credit crunch
- To solve, the fed put many billions of dollars of public funds into the banking system to increases the
amount of capital

• Capital Requirement
- To avoid bank has “insolvent” status , requires bank to hold a certain amount of capital
- Jumlah capital requirement depends on the kind of assets a bank hold:
→ If the bank holds safe asset, ex: gov’t bonds→ CB asks less capital requirement
→ If the bank holds risk asset, ex loans to borrower→ CB asks higher capital requirement
Problems in Controlling the Money Supply
a. The CB does not control the amount of money that households choose to hold as deposits in banks.
Example:
Masyarakat hilang kepercayaan dan menarik uangnya dari bank
Banking reserve menurun drastic → money creation menurun → MS menurun even without CB’s action

b. The CB does not control the amount that bankers choose to lend
Bank can choose to hold excess reserve and choose to give less loan
Thus, CB cannot ensure how much money the banking system will create.
Thank You