The Monetary SystemRubayyat Hashmi

OverviewThe functions and measurement of moneyThe Bank of Bangladesh and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

The Meaning of MoneyMoney is the set of assets in the economy that people regularly use to buy goods and services from other people.

Three Functions of Money Medium of Exchange: anything that is readily acceptable as payment. Unit of Account: serves as a unit of account to help us compare the relative values of goods. Store of Value: a way to keep some of our wealth in a readily spendable form for future needs.

The Two Types of MoneyCommodity Money: something that performs the function of money and has alternative, non-monetary uses.Examples: Gold, silver, cigarettesFiat Money: something that serves as money but has no other important uses.Examples: Coins, currency, debit cards

Money in the Bangladesh EconomyMoney Stock is the quantity of money circulating in the economy.Different ways of measuring the money stock in the economy: M1 M2

The most familiar form of money used includes:CurrencyDemand DepositsMeasurement of MoneyM1

Measurement of MoneyA broader measure of money than M1, includes:M1 +Savings Deposits +Personal Term Deposits M2

Where is All The Currency?In 2000 there was about $33 billion of Canadian currency outstanding ($1,300 in currency per adult).The outstanding currency may be in the hands of tax evaders, drug dealers and other criminals.

(Taka in million)ComponentsAugust, 2008July, 2008August, 2007Percentage Changes of August, 2008 over July, 2008August, 2007Currency Outside banks333097335583279435-0.7419.2Deposits of Financial Institutions with Bangladesh Bank (except DMBs)8127945852.2738.8Demand Deposits with DMBs*259416261880231497-0.9412.06Time Deposits with DMBs*1955260191425016196572.1420.72Money Supply (M1) (1+2+3)593325598257511517-0.8215.99Money Supply(M2) (4+5)2548585251250721311741.4419.59

Quick Quiz!List and describe the three functions of money.

OverviewThe functions and measurement of moneyThe Bank of Bangladesh and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

The Bank of CanadaThe Bank Of Bangladesh (B of B) serves as the nations central bank, which is designed to control the quantity of money in the economy.The B of B is owned by the Bangladesh government, established in 1972 by a president order in 16th Dec.

The B of Bs OrganizationThe B of C is run by its Board of Governors which is composed of:The Governor.The Senior Deputy Governor.Eight directors All members are appointed by the Finance Minister.

The B of Cs OrganizationThe Bank of Bangladesh is controlled by the Bangladeshi government which appoints the Board of Directors. As a last resort the government can issue a written directive to the Governor with which he must comply. In practice the Bank of Bangladesh is largely independent of the government.

Four Primary Functions of the B of C Issue currency. Act as a bankers bank, making loans to other banks and as a lender of last resort. Act as banker to the Bangladesh government. Control the money supply with monetary policy.

Money Supply Changes by the B of BOpen-Market Operations: The primary way in which the B of C changes the money supply is done through the purchase and sale of Bangladeshi government bonds. - To increase the money supply, the B of B buys government bonds from the public. -To decrease the money supply, the B of B sells government bonds to the public.

Quick Quiz!How does the B of B increase the supply of money in the economy?

OverviewThe functions and measurement of moneyThe Bank of Bangladesh and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

Banks and The Money SupplyThe behaviour of banks can influence the quantity of demand deposits in the economy and therefore, the money supply.Fractional Reserve Banking System: The practice of holding a fraction of money deposited as reserves and lending out the rest.

Fractional Reserve BankingDeposits into a bank are recorded as both assets and liabilities. Deposits that have been received but not lent out are called reserves. The supply of money in the economy is affected by the amount of deposits that are kept in the bank as reserves and the amount that is lent out. Loans become an asset to the bank.

Bank T-Account ExampleAssetsLiabilitiesFirst Bangladeshi BankReserves$10.00

Loans$90.00Deposits$100.00Total Assets$100.00Total Liabilities$100.00

Bank T-Account Example A T-Account illustrates the financial position of a bank that accepts deposits, keeps a portion as reserves and lends out the rest.AssetsLiabilitiesFirst Bangladesh BankReserves$10.00

Loans$90.00Deposits$100.00Total Assets$100.00Total Liabilities$100.00

Money Creation with Fractional-Reserve BankingWhen a bank makes a loan (from its reserves) the money supply increases. When banks hold only a fraction of deposits in reserve, banks create money.The creation of money through loans does not create any wealth, but allows banks to charge interest several times on the same bit of wealth.

OverviewThe functions and measurement of moneyThe Bank of Canada and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

The Money MultiplierWhen one bank loans money, that money is generally deposited into another or the same bank thus creating more deposits and more reserves to be lent out. The Money Multiplier is the amount of money that the banking system generates with each dollar of reserves.

The Money Multiplier

The Money Multiplier

The Money Multiplier

The Money MultiplierTotal Money Supply = $190.00!

What determines the size of the money multiplier?The money multiplier is the reciprocal of the reserve ratio.With a reserve requirement (R) of 20% or 1/5 . . .The multiplier will be 5. 1 RM =

OverviewThe functions and measurement of moneyThe Bank of Canada and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

Tools of Monetary Control The B of C has three instruments of monetary control:Open-Market Operations: Buying and selling bonds.Foreign Exchange Market Operations:Buying and selling foreign currency.Changing the Reserve Ratio: Increasing or decreasing the ratio.Changing the Bank Rate: The interest rate the B of C charges other banks for loans.

Problems in Controlling the Money SupplyTwo problems that the B of B must wrestle that arise due to fractional-reserve banking:The B of B does not control the amount of money that households choose to hold as deposits in banks.The B of B does not control the amount of money that bankers choose to lend.

OverviewThe functions and measurement of moneyThe Bank of Canada and its functionsFractional reserve banking - how does it work?The money multiplierTools of Monetary control

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