The Monetary System

Rubayyat Hashmi

Overview
The

functions and measurement of

money
The Bank of Bangladesh and its
functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools of Monetary control

The Meaning of Money

Money

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 Money

Commodity

Money: something that

performs the function of money and
has alternative, non-monetary uses.
Examples: Gold, silver, cigarettes

Fiat

Money: something that serves

as money but has no other important
uses.
Examples: Coins, currency, debit
cards

Money in the Bangladesh Economy

Money

Stock is the quantity of money

circulating in the economy.
Different ways of measuring the money
stock in the economy:
M1
M2

Measurement of Money
The

most familiar form of

money used includes:
Currency
Demand Deposits

M1

Measurement of Money
A

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.

Components
Currency
Outside banks

(Taka in million)

August, 2008

333097

July, 2008

August, 2007

Percentage Changes of August,

2008 over
July, 2008

August, 2007

335583

279435

-0.74

19.2

Deposits of
Financial
Institutions with 812
Bangladesh Bank
(except DMBs)

794

585

2.27

38.8

Demand Deposits
259416
with DMBs*

261880

231497

-0.94

12.06

Time Deposits
with DMBs*

1955260

1914250

1619657

2.14

20.72

Money Supply
(M1) (1+2+3)

593325

598257

511517

-0.82

15.99

2512507

2131174

1.44

19.59

Money
2548585
Supply(M2) (4+5)

Quick Quiz!

List

and
describe the
three functions
of money.

Overview
The

functions and measurement of

money
The Bank of Bangladesh and its
functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools of Monetary control

The Bank of Canada

The

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 Organization
The

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 Organization
The

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 B

Open-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?

Overview
The

functions and measurement of

money
The Bank of Bangladesh and its
functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools of Monetary control

Banks and The Money Supply

The

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 Banking

Deposits

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 Example

First Bangladeshi Bank
Assets
Reserves
$10.00

Liabilities
Deposits
$100.00

Loans
$90.00
Total Assets
$100.00

Total Liabilities
$100.00

Bank T-Account Example

First Bangladesh Bank A T-Account
Assets
Reserves
$10.00

Liabilities
Deposits
$100.00

Loans
$90.00
Total Assets
$100.00

Total Liabilities
$100.00

illustrates the
financial position
of a bank that
accepts deposits,
keeps a portion as
reserves and lends
out the rest.

Money Creation with

Fractional-Reserve Banking
When

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.

Overview
The

functions and measurement of

money
The Bank of Canada and its functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools of Monetary control

The Money Multiplier

When

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

First Bangladeshi Bank
Assets
Reserves
$10.00

Liabilities
Deposits
$100.00

Loans
$90.00
Total Assets
$100.00

Total Liabilities
$100.00

The Money Multiplier

First BdSh Bank

Second BdSH Bank

Assets

Assets

Liabilities

Reserves
$9.00

Deposits
$90.00

Reserves
$10.00

Liabilities
Deposits
$100.00

Loans

Loans

$90.00
Total Assets
$100.00

$81.00
Total Liabilities
$100.00

Total Assets
$90.00

Total Liabilities
$90.00

The Money Multiplier

First BDSH Bank

Second BDSH Bank

Assets

Assets

Liabilities

Reserves
$9.00

Deposits
$90.00

Reserves
$10.00

Liabilities
Deposits
$100.00

Loans

Loans

$90.00
Total Assets
$100.00

$81.00
Total Liabilities
$100.00

Total Assets
$90.00

Total Liabilities
$90.00

The Money Multiplier

First BdSH Bank

Second BdSh Bank

Assets

Assets

Liabilities

Reserves
$9.00

Deposits
$90.00

Reserves
$10.00

Liabilities
Deposits
$100.00

Total Money Supply = $190.00!

Loans

Loans

$90.00
Total Assets
$100.00

$81.00
Total Liabilities
$100.00

Total Assets
$90.00

Total Liabilities
$90.00

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.

M =1
R

Overview
The

functions and measurement of

money
The Bank of Canada and its functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools 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

Supply
Two

problems that the B of B must

wrestle that arise due to fractionalreserve 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.

Overview
The

functions and measurement of

money
The Bank of Canada and its functions
Fractional reserve banking - how does
it work?
The money multiplier
Tools of Monetary control