UNIVERSITI PUTRA MALAYSIA

MONEY SUPPLY PROCESS IN MALAYSIA

CHIDAMBARAM ASARY THANGAVELU

FEP 1994 4

MONEY SUPPLY PROCESS IN MALAYSIA

By

aUDAMBARAM ASPRf llWGAVELU

Thesis Submitted in Partial Fulfilment of the Requirements for the Degree of Master of Science in the

Faculty of Economics and Management Universiti Pertanian Malaysia

October 1 994

ACKtDlLEDGEHENTS

There are so many peopl e that I wi sh to acknowl edge for ai d i ng

i n the preparat i on and compl et i on of thi s study .

Fi rst of al l , I wou l d l i ke to express my s i ncere thanks to

Datuk Dr . Haj i Mohd . Mansor Haj i Sa 1 1 eh, ex-d i rector of MARA

Insti tute of Technology and al l members of the Schol arsh i p and

Trai n i ng Commi ttee for givi ng me a ful l staff schol arsh i p package to

pursue a graduate degree course.

I wou l d al so l i ke to appreci ate and thank Prof . Dr . Mohammed

bi n Yusoff , chai rman of the supervi sory commi ttee , not onl y for hi s

effect ive revi ew of thi s work but al so for h i s cont i nuous val uabl e

gui dance , encouragement and i nterest throughout the course of thi s

research . My thanks are extended to the other members of my

supervi sory commi ttee , Dr . Ahmad Zubai di b i n Baharomshah and

Associ ate Prof . Muzafar Shah b i n Hab i bul 1 ah for thei r hel pful

suggestions and comments . Zali 1 a b i nt i Samsudi n deserves much credi t

not only for her excel l ent j ob i n typi ng the manuscri pt but al so for

doi ng i t wi th i ncredi b l e speed . I al so take thi s opportuni ty to

spec i a l l y thank my brother , C . Si vaswami , a senior economi st at Bank

Negara Mal aysi a, for prbvi d i ng some necessary data and i nformat i on .

My deepest grat i tude goes to my wi fe , Chi t ra , for her

sacri f i ce, pat i ence , understandi ng and neverendi ng support . OUr

chi l dren, Si vachi dambaram and Sakthi ve 1 are too young to understand

ii

but I would like to thank them for sharing companionship during my

stress as a graduate student.

111

TABLE OF OONTENTS

Page

ACKNOWLEDGEMENTS i i

L IST OF TABLES vi i i

L IST OF F IGURES ix

GLOSSARY

ABSTRACT

ABSTRAK

CHAPTER

I

I I

x

xvi

xvi i i

INTRODUCTION 1

Background . . 1

P roblem Statement 2

Ob j ect i ves 5

Organ i sat ion of the Study . 6

MALAYSIAN MONETARY SYSTEM • • • • • • . 8

Structure of the Mal aysi an F i nanc i al System . . . • . . . . . . . . . . . . . . . . 8

Obj ect i ves and Functions of Bank Negara Mal aysi a . . . . . . . . . 10

As the So l e Currency I ssui ng Authori ty 1 1 To Keep Reserves Saf eguardi ng the Val ue of the Ri nggi t . . . . . . . . . • . 11 As Banker , F i scal Agent and F i nanci al Advi ser to the Government . . . . 1 2 As Banker to the Maj or Financi al Inst i tut i ons , Lender of Last Resort to these Inst i tut ions and as Regul ar Inspector of thei r Act i vi t i es . . . . . . . . . . . . • . . 14

iv

III

IV

Implementing Monetary Policy

Instruments of Monetary Control by Bank Negara Malaysia • . . . . . .

. . . . . . .

Statutory Reserve Requirements . • . . .

Minimum Liquidity Requirements . • . .

Discount "Arrangements" (Operations or Pol icy) . . . . . . . . . . . Open Market Operations . . . . . Interest Rates "Administration" (Management or Regulation) . . • . . Ceilings on Growth of Credit and Guidelines (Directives) on Bank Lending Moral Suasion . . . . . . . • . . .

Balance Sheet of Bank Negara Malaysia . .

Assets of Bank Negara Malaysia . . . . Liabilities of Bank Negara Malaysia

Functions of COmmercial Banks . . . . .

Assets and Liabilities of Commercial Banks . . . . . . . .. . . . . . .

Official Measures of Money Supply

REVIEW OF THE LITERATURE

THEORETICAL MODEL . . . .

Basic Elements of the Money Multiplier

16

1 6

1 7 1 8

21 23

24

27 29

30

30 33

35

38

39

42

63

Mode 1 .. . . . . . .. . .. .. . .. II .. .. 63 Formulation of the Money-Multiplier Model of Narrow Money Supply . . . . . . 66

Monetary Base of Narrow Money Supply (B) 66 Money Multiplier of Narrow Money Supply (k) 74 Summary of the Money Multiplier Model of Narrow Money Supply . • . . . . . . . 78

Prox i mate Determi nants and the Money Supply Process . . . . . . . . . . . 79

v

V

VI

VII

EMPIRICAL MODEL • · • · · · • · • · • 84

Currency Rat i o ( c ) Regressi on Model · 84

Bank Negara Mal aysi a Demand Deposi t Rat i o ( n ) Regressi on Model · · · . · · · · 88

T i me Deposi t Rat i o ( t ) Regression Model · · · · · · · · · · · · · · · · · 90 Excess Reserve Rat i o ( e ) Regressi on Model · · · · · · · · · · · · · · · · 93 Government Deposi t Rat i o ( g ) Regression Model · · · · · · · · · · · · · · · · 96 statutory Reserve Rati o ( r ) Regressi on Model · · · · · · · · · · · · · · 97 Monetary Base ( B ) Regressi on Model 98

Sources of Data . · · · · · · · · · · · . · · · · 1 01

EMPIRICAL RESULTS · · · · · · · · · · · · · 1 02

Currency Rat i o ( c ) Regression Model . 1 03

Bank Negara Mal ays i a Demand Deposi t Rat i o ( n ) Regressi on Model . . . . 1 04

T i me Deposi t Rat i o ( t ) Regressi on Model 1 05

Excess Reserve Rat io ( e ) Regression Model . 1 06

Government Deposi t Rat i o ( g ) Regressi on Mode 1 • . . • . . . • . . • . • • . •

Statutory Reserve Rat i o ( r ) Regressi on

1 07

Model . . . . . . . . . . 1 08

Monetary Base ( B ) Regressi on Model 1 09

Ul t imate Determi nants and the Money Suppl y Process . . . . . . . . . . . . . . . . . . 1 1 0

Part i al Deri vat i ve of the Money Mul t i pl i er Wi th Respect to the Currency Rat i o . . . • 1 1 2

CONCLUSION 1 1 4

Summary . . 1 1 4

vi

Limi tat i ons and Suggest i ons for Further Research

LITERATURE CITED . .

ADD ITIONAL REFERENCES .

APPENDIX

V ITA

vii

1 20

• • • • 1 22

• • • 1 24

1 26

• • • 1 33

Tab l e

1

LIST OF TABLES

Money Suppl y ( M1 )Growth and Inflat i on i n Mal ays i a , 1 972- 1 99 1 . . . . . . . . .

2 Bank Negara Mal aysi a: Statement of Assets

Page

4

And Li abi l i t i es as at November 30 , 1 993 . . . . . . . . . 31

3 Rel at i ve Si zes of the Monetary Aggregates as at end of June 1 993 • . . • . • • 41

4 Part i al Der i vat i ve of the Money Mul t i pl i er Wi th Respect to the Currency Rat i o (pdkc ) •

vi i i

1 1 3

LIST OF FIQ.RES

Fi gure Page

1 Structure of t�e Financi al System i n Ma 1 ays i a . . . . • . . . • . . • . . . . . . . . . • • . 9

i x

The Glossary presents a detai l ed descri pt i on of the vari abl es

used i n thi s study .

ASDR =

APTR =

B =

BS =

BU =

BLR =

BNM =

BODP =

BOMP =

CAP =

CBMC =

CBTA =

CC =

GGBN =

Bank Negara Mal aysi a's al l ocat i on of Spec i al Drawing Rights i n mi l l ions of RM

Average personal tax rate

Monetary base of Narrow Money Supp l y i n mi l l i ons of RM

Sources of the monetary base of Narrow Money SUppl y i n mi l l i ons of RM

Uses of the monetary base of Narrow Money Suppl y i n mi l l i ons of RM

Base l endi ng rate i n per cent per annum

Bank Negara Mal aysi a

Number of commerci al bank off i ces def l ated by popu l at i on

Number of commerci al bank off i ces per mi l l i on popu l at i on

Capi tal of Bank Negara Mal ays i a i n mi l l i ons of AM

ODmmerci al banks ' hol d i ngs of money at cal l i n Mal ays i a i n mi l l i ons of RM

Commerc i al banks' total assets i n mi l l i ons of RM

Currency i n ci rcu l at ion i n mi l l ions of RM

CUrrency in circulat i on as def i ned i n the " bal ance sheet" ( statement of assets and 1 i abi l Hi es ) of Bank Negara Mal ays i a i n mi l l ions of RM

GLB = C l eari ng bal ances of commerci al banks wi th Bank Negara Mal ays i a i n mil l i ons of RM

CPI = COnsumer Pri ce Index

c = Rat i o of currency i n ci rcu l at i on to demand deposits of private sector wi th commerci al banks , that i s , currency rat io

x

DCFM

DeN

DOPe

DDPN

DDR ( DISR )

DFGN

DFMN

DIR ( INTR )

DISR (ODA)

OOFN

DSGN

=

;::

=

;::

=

=

=

;::

;::

=

;::

Deposi ts of commerc i al banks, fi nance companies and me rchant banks wi th Bank Negara Mal ays i a i n mi 1 1 ions of AM

Deposi ts of comme rci al banks wi th Bank Negara Mal ay s i a i n mi l l ions of RM

Demand deposits of private sector wi th comme rci al banks i n mi 1 1 ions of RM

Demand deposi ts of pri vate sector wi th Bank Negara Ma l aysia i n mi l l i ons of RM

D:>mest ic dis::;ount rate i n � r Ca1 t per annun ( di scount rate i n pe r cent pe r annum )

Deposi ts of the Fede ral Gove rnment wi th Bank Negara Mal aysi a in mi l l ions of RM

Deposi ts of finance compa"l ie s a"Id me rchant banks wi th Bank Negara Mal ays i a i n mi l l i ons of AM

Domest i c i nte rest rate ( i nte rest rate )

Di scount rate i n pe r cent pe r a"Inum (Domesti c disoount rate i n pe r cent pe r annum )

Depos i ts of othe r f i nanc i al i nst i tut ions wi t h Bank Negara Mal aysi a i n mi l l i ons of RM . Refer [4.9] for detai l s

Depos i ts of state Cbve rnments wi t h Bank Negara Mal ay s i a i n mi 1 1 i ons of RM

DY(Y) = Domest i c i ncome ( Income )

EXR = Exchange rate def i ned as R i ngg i t Mal aysi a pe r uni t of fore i gn cur rency

EXUS = EXchange rate de fi ned as Ringgi t Mal ays i a pe r United States dollar

e ;:: Rat i 0 of excess rese rves of comme rci a 1 banks to demand deposi ts of the private sec tor wi th comme rci al banks , that i s , excess rese rve rat io

FD1 2 ;:: Inte rest rate on twelve month f i xed depoSi ts wi th comme rc i al banks in pe r cent pe r annum

FGTE = Fede ral Gove rnment total expendi ture i n mi l l ions of RM

x i

FGTR = Federal Government total revenue in mi 11 ions of AM

FIR = Foreign interest rate

FSGS = Bank Negara Malaysia's holdings of Federal (and state) Government securities in millions of AM

FY = Foreign income

GDBN = Government deposits with Bank Negara Malaysia in millions of AM

GDCB = Total deposits ( demand , saving and fixed deposits) of the public sector with commercial banks, that is, Government deposits with commercial banks in millions of AM

GEXP = Government expenditure

GFE = Bank Negara Malaysia's holdings of gold and foreign exchange in millions of AM

GNP = Gross national product in millions of RM

GR = General reserve of Bank Negara Malaysia in millions of RM

GAEV = Government revenue

GSBN = Bank Negara Malaysia's holdings of Government securities in millions of AM

g = Ratio of Government deposits with commercial banks to demand deposits of the private sector with commercial banks, that is, Government deposit ratio

HSDR = Bank Negara Malaysi a's holdings of Special Drawing Rights in millions of AM

IBR = Inter bank rate

IBRC = Inter b ank rate on seven day call money in per cent per annum

IMF = I nternat i onal Monetary Fund

IMFR = International Monetary Fund reserve tranche position of Bank Negara Malaysia in millions of RM

INTR = Interest rate (Domestic interest rate) (DIR)

xii

IRBN = International reserves of Sank Negara Malaysia in millions of AM

lAMS = Interest rate on marketabl e securi t i es

I SFD = Interest rate on savi ng and f i xed deposi t s wi th commerci al banks

k = Money mul t i pl i er of Narrow Money Supply

M1 = Narrow Money Suppl y i n mi llions of RM

M2 = Private Sector Liquidity i n m i llions of RM

M3 = Broad Money i n mi l lions of RM

NCBO = Number of commerci al bank off i ces at end of year

NLGN = Net lendi ng to Government by Bank Negara Malaysi a i n m i 1 1 i ons of RM

n = Ratio of danand deposits of private sector wi th Bank Negara Mal aysi a to demand deposi ts of private sector wi th commerci al banks , that is , Bank Negara Mal ays i a demand deposi t ratio

OABN = other assets of Bank Negara Mal ays i a i n mi l l i ons of RM . Refer [4 . 1 0] for detai l s

ODBN = other deposits with Bank Negara Malaysi a in m i ll ions of AM . Refer [4 . 9] for detai l s

OLBN = Other l i abi l i t i es of Bank Negara Mal aysia i n mi l l ions of RM. Refer [4 . 9] for detai ls

ONAN = other net assets of Sank �gara Malaysi a i n mi 1 1 i ons of AM . Refer [4 . 27] for detai l s

PIT ; Personal income taxes in millions of RM

POPM = Populat i on i n mi lli ons ( m i d year estimate )

pdkc = Part i al derivative of the money mult i pli er of Narrow Money Supply wi th respect to the currency rat i o

RE = Excess reserves of commerci al banks in m i ll i ons of AM

RS = statutory ( requi red) reserves of commerci al banl<s wi th Bank Negara Mal aysi a i n mi ll i ons of RM

x i i i

RT = Total reserves of commerc i al banks i n mi l l i ons of AM

Rep I = Rate of change of Consumer Pri ce Index i n per cent

ROlF = Rat i o of domest i c i nterest rate to forei gn i nterest rate

RGDP = Real gross domesti c p�uct measured in mi l l i ons of Ri nggi t Mal ays i a i n terms of 1 985 pri ces

RINF = Rate of i nf l at i on

RM = Ringgi t Mal ays i a , the uni t of currency i n Mal ays i a

RMCA = Rat i o of commerci al banks ' hol di ngs of money at cal l i n Mal ays i a i n mi l l i ons of Ri nggi t Mal aysi a to commerci al banks ' total assets i n mi l l i ons of R i ngg i t Mal ays i a .

r = Fat i o of statutory ( requi red) reserves of commerci al banks wi th Bank Negara Mal ays i a i n mi 1 1 i ons of AM to total dej.X)si ts ( demand , sav i ng and f i xoo depJsi ts ) of the private and publ i c sectors wi th commerci al banks i n mi l l ions of AM , that i s , statutory ( requ i red ) reserve rat i o of commercial banks.

SFDP = Sav i ng and f i xed depos i ts of the private sector wi t h commerci al banks i n mi l l i ons o f AM

TABN = Total assets of Bank Negara Mal aysi a i n mi l l ions of AM

TB1 2 = Di scou nt rate on twe l ve month Treasury bi l l s i n per cent per annum

TLBN = Total l i abi l i t i es of Bank Negara Mal ays i a i n mi l l i ons of RM

TODe = Total dej.X)si ts ( demand , savi ng and f i xed deposi ts) of the pri vate and publ ic sector with cnmmerci al banks in mi l l ions of AM

TOLN = Total of al l other l i abi l i t i es of Bank Negara Mal ays i a i n mi l l i ons of AM . Refer [4.25] for detai l s

t = Rat i o of sav i ng and f i xed depos i t s of the private sector wi th commercial banks i n mi l l ions of AM to demand deposi ts of the private sector wi th commerci al banks i n mi l l i ons of RM , that i s , t i me-deposi t rat i o

USDA = Uni ted States di scount rate i n per cent per annum

x i v

USRP = Un; ted states real gross domestic product measured in bi l l i ons of Uni ted States dol l ars i n terms of 1 985 pri ces

VC = Vaul t cash of commerci al banks i n mi l l i ons of AM

Y( DY ) = Income ( Domest i c i ncome )

xv

Abstra ct of thesis submitted to the Senate of Universiti Pertanian Malaysia in partial fulfilment of the requirements for the degree of Master of Science.

Chairman:

Faculty:

t«lNEY SUPPLY PflJCESS IN MALAYSIA

By

Q-IIDAMBARAM ASMN llW-GAVEW

OCTOBER 1 994

Professor Mohammed bin Yusoff, Ph.D .

Economics and Management

The aim of this study ;s to examine and understand the money

supply process in Malaysia since an understanding of this process is

very useful not only to monetary authorities but also to all others

who regard money as an important economic variable.

A theoretical "monetary base-maley multipl ier" model of Narrow

Money Supply (M1 ) is formulated that expresses Narrow Money Supply

as t he product of the monetary base and the money multiplier. In

turn, the monetary base is stated in terms of its uses and sources

While the money multiplier is expressed in terms of several oomponent

ratios, namely, the currency ratio, Bank Negara Malaysia demand

deposit ratio, time deposit ratio, Government deposit ratio,

statutory (requi red) reserve ratio and the excess reserve ratio .

Acco rding to this model, the money supply process in Malaysia is

xvi

inf l ue nced jointl y by the pol icy decisions of Bank Negara Mal aysi a

together with the portfol io decisions of commercial banks and the

non-bank private sector and the decisions of the Government with

respect to the maintenance of its deposits with Bank Negara Mal aysia

and the commercial banks.

An empirical "monetary base-money mul tipl ier " model of the

moneta ry aggregate is formu l ated . In this model , t he monetary base

and each of the component ratios of the money mul tipl ier are

regressed on the economic and institutional variabl es that are

hYpot hesized to affect t hem , respectivel y . The behavioural decision

of the non-bank private sector represented by the currency ratio ,

Bank Negara Mal aysia demand deposit ratio and the time deposit ratio

is found to be inf luenced by the average personal tax rate , interest

rates and the number of commercial bank offices def l ated by

popul ation . The resul ts indicate that income determines the

behavioural decision of aammercial banks which is ref l ected by their

excess reserve ratio . The behavioural decision of Bank Negara

Mal aysia and the decision of the Government with respect to the

maintenance of its deposi t s with the former , represented by the

monetary base , are bel ieved to be affected by the exchange rate ,

foreign income , Government expenditure and the ratio of domestic

interest rate to foreign interest rate .

xvii

Abstrak tesi s yang di kemukakan kepada Senat Uni vers i t i Pertan i an Mal ays i a sebagai memenuhi sebahagi an dari pada syarat-syarat untuk mendapatkan I j azah Master Sai ns .

PRJSES PENAWARAN WAf'«l O I MALAYS IA

Oleh

CBIOAMBARAM ASJtR( TIWGA.VELU

OKTOBER 1994

Pengerusi Profesor Mohammed bi n Yusoff , Ph . D .

Fakul t i Ekonomi dan Pengurusan

Matl amat kaj i an ini adal ah untuk manahami proses pencwaran wang

di Malaysi a kerana pefahanan mengenai proses i ni sangat bergLna bukan

sahaja kepada pi hak berkuasa kewangan tetapi j uga kepada semua pi hak

l ai n yang menganggap wang sebagai suatu pembolehubah ekonomi yang

pent i ng .

Teori model "pengganda-wang asas" yang menyatakan Penawaran

Wang Sempi t sebagai has;l darab wang as as dan pengganda , d i bentuk .

Wang asas pul a di nyatakan dar; segi kegunaan serta sumbernya,

nanakala pengganda pul a di nyatakan dar; segi n i sbah-ni sbah komponen,

iai tu n i sbah ketunai an , n i sbah deposi t semasa Bank Negara Malaysi a ,

n i sbah deposi t berj angka, ni sbah deposi t keraj aan , nisbah rizab

berkanun ( ni sbah rizab yang diperl ukan ) dan ni sbah r i zab l eb i han .

Mengi k ut mode l i n i , proses penawaran wang di Mal aysi a di pengaruhi

xvi i ;

oleh keputusan dasar Bank Negara Malaysia, keputusan portfolio bank­

bank perdagangan dan sektor swasta bukan-bank serta keputusan

Keraj aan mengenai pengurusan deposi tnya dengan Bank Negara Mal ays i a

dan bank-bank perdagangan .

SJatu nodel agregat kewangan ellPi r i kal " pengganda - wang asas"

juga dibentuk. Berdasarkan model i n i , wang asas dan t i ap-t i ap n i sbah

komponen pengganda di regres i kan dengan pembo 1 ehubah-pembo 1 ehubah

ekonomi dan inst i tLSi yang di j angka rrempengaruhi nya . Perl akua1 sektor

SHasta bukan-bank yang diwaki l i o l eh n i sbah ketunai an , n i sbah depos i t

semasa Bank Negara Mal ays i a dan n i sbah depos i t ber j angka di dapat i

d i pengaruhi ol eh kadar pencukai an perseorangan purata , kadar bung a

dan bi langan pej abat bank perdagangan yang tel ah di def l asi kan dengan

juml ah penduduk . Hasi l kaj i an i n i menunj ukkan pendapatan menentukan

per l akuan bank-bank perdagangan yang di cermi nkan o l eh n i sbah r i zab

l ebi han . Per l akuan Bank Negara Mal ays i a dan per l akuan keraj aan

mengenai pengurusan deposi tnya dengan Bank Negara Mal ays i a , yang

diwaki l i ol eh wang asas , di percayai di tentukan oleh kadar pertukaran ,

pendapatan asi ng , perbe l an j aan Keraj aan dan ni sbah kadar bunga

tempatan kepada kadar bunga asi ng .

x i x

OWJTER I

Background

There is a widespread belief today that changes in money supply

influence spending . The basis of this belief is the Quantity Theory

of Money which considers the quantity of money prevail ing in an

economy at any one time, that is, the money supply or money stock,

and the rate of change of the quantity of money, that is, the money

supply growth, as important determinants of the performance of an

economy. The quant i ty of money is thought to affect aggregate

spending or demand which in turn influences the productive potential

of the econ�, the level of employment, output and prices and hence

the level of economic welfare of each member of the national society.

If aggregate spending on goods and services is smaller than the

economy's ability to prociJce, then unemployment will be high and per

capita output will be below its potential. Such oonditions imply that

economic well-being is not being maximized. More output could be

produced with the population sharing the larger output. On the other

hand, if aggregate spending is greater than the economy's capacity

to produce, then inflation results. High inflation, particularly

during a period of full employment, are generally undesirable. This

is becaJse it redistributes purchasing power from fixed incone groups

to those whose money incomes rise faster than prices. Another reason

1

1S that debtors gain real purchasing power at the expense of

creditors. Moreover, persistent inflation discourages saving,

encourages speculation and may lower growth of real output.

SUch conditions mean that maximising economic welfare calls for

oontroll ing growth in aggregate spending consistent with the growth

in the nation's productive potential. Control of growth in aggregate

spending is carried out through government stabilisation policies

W1ich create an environment conducive to a high level of employment

with reasonable price stability, thus improving the economic welfare

of the nation's citizens. These policies raise or limit increases in

aggregate spending to an amount consistent with increases in the

nation's productive potential. Growth in the nation's resources and

technological progress provide the basis for increasing output. There

are t wo main types of government economic stabilisation policies,

namely the fiscal policy and monetary policy. The former refers to

the changes in spending 81d taxation plans of the central government

while the latter refers to the changes in money supply, credit and

the level of interest rates. This study concentrates on the money

supply process in Malaysia.

Problem statement

In the context of the Quantity Theory of Money, money supply is

directly related or 1 inl<ed to aggreg3.te sp:mding. Acoording to this

relat ionship, increases in money supply wi 11 increase aggregate

spending and vice versa. Assuming the income velocity of circulation

is stable or predictable, then aggregate spending can be controlled

by control 1 i ng money suppl y. For exampl e, Anderson-Jordon (1968)

reports:J evi�nce that changes i n more y suWl y hale a large , fas t and

predic table effect on the nomi nal val ue of economi c act i vi ty, that

is , aggregate spending . Howeve r to be able to control money suppl y ,

the mone tary au thori ty whi ch i s usual l y the cent ral bank , must

understand the mechani sm by whi ch money supp l y i s dete rmi ne d . The

mone y supply process doe s not s i mpl y re fe r to the print i ng of

currency notes or to the me re i mplementat ion of monetary po l icy by

the monetary authori ty but to a more compl i cated mechani sm; that

cont rol l ing money suppl y i s not qu i te as s i mple as i s gene ral l y

postul ated by bas i c mac roeconomi c texts because the monetary

author i ty gene ral l y does not have perfect or complete control over

money suppl y.

Indeed Burge r ( 1 97 1 , preface ; pp . v ) stated that:

"A tho rough unde rstandi ng of the money suppl y i s equal l y important both for econom ists and non-econom ists • • • • . • • • changes i n the g row th rate of money have an i mpo rtant i nfluence on economic act i vi ty. The t rend and f luctuat ions in the growth rate of money affect t he prices we pay for goods and se rvice s , the leve l of unempl oyment , and the leve l of market i nte rest rates . The refore , a c lear bluepri nt of the money suppl y process i s essent i al so that nonetary po l icymakers can understand how the ir po l icy ac t i ons affect the money supp l y process; so econom i sts can advi se the po l icymake rs an the most effic ient way of con t rol l i ng money suppl y; and so other individual s can evaluate the respons i bi l i ty of the monetary author i ties for the growth of money and how they carry it out."

Evi dmce from the study by Mcharnmed ( 1 985 ) shows that the growth

of money suppl y i s close ly assoc i ated wi th the t rends of i nflat i onary

pressure and that the effe ct of the r i se i n money suppl y i s fe l t i n

the subsequent year , that i s , i nf l ati on i s preceded by excessive

growth i n money supp l y wi th about one year l ag . Accordi ng to Bank

Negara Mal aysi a Annual Repo rt (1 993; pp BO ) , pre l i m i nary resul ts f rom

a causal i ty study ( by the Ban k ) showed that i n the pe riod 1 970-92 ,

� and M2 seem to l ead i nf l at i on . The report al so states t hat tests

conducted by the Bank to exami ne the corre l at i on between M3 and

inf l at ion showed that they were h i gh l y and posi t i ve l y correl ated ( pp

86 ) . In i ts Fourth Edi t i on of Money and Banki ng i n Mal aysi a ( 1 994 ,

pp 41 4-41 5 ) , the Bank asserts that there exi sts a stable rel at i onshi p

between M3 on one hand and pri ces and output on the other.

The major fi ndi ngs of the study by Mohammed ( 1 993 ) are that both

the ant i ci pated and unant i c i pated money growth affect real output

i mpl ying that money is not neutral .

Tab l e 1 below shows the rel ati onship between money suppl y growth

and i nf l at i on i n Mal aysi a dur i ng t he per i od 1 972-1 991 .

Tab l e 1 : Money Suppl y ( M1 ) Growth and I nf l at i on i n Mal aysi a , 1 972-1 991

Year

1 972 1 973 1 974 1 975 1 976 1 977 1 978 1 979 1 980 1 981 1 982 1 983 1 984 1 985 1 986 1 987 1 988 1 989 1 990 1 991

Money Suppl y Growth (%)

28 . 06 37 . 55

8 . 56 7 . 23

20 . 88 1 6 . 55 1 8 . 20 1 7. 1 7 1 5 . 01 1 2 . 83 1 3 . 27

7 . 65 -0 . 56

1 . 66 2 . 78

1 2 . 97 1 3 . 1 3 1 9 . 1 0 1 4 . 07 1 0 . 98

Inf l at i on Rate (%)

------------

3 . 1 5 1 0 . 02 1 6 . 02

4 . 40 2 . 53 4 . 69 4 . 79 3 . 56 6 . 44 9 . 20 5 . 58 3 . 63 3 . 51 0 . 40 0 . 55 0 . 79 2 . 49 2 . 80 3 . 02 4 . 30

Source: Economi cs Department, Bank Negara MalaYSia, � and Bankjng in Malaysia, Fourth Edi t i on , 1 994 .

consi d erab l e i mportance to economi sts and other anal ysts who v i ew

money as a strategic economi c vari ab l e. Thus , the mai n object i ve of

thi s study i s to exam i ne and understand the money supp l y process i n

Mal aysia. Speci f i cal l y , t he obj ect i ves are to exami ne the st ructure

of the Mal aysi an monetary system ; to formul ate and anal yse the money

mul t i pl i er and to ident i fy i n detai l the factors affect i ng the money

mul t i pl i er .

Th e hypothesi s i s that money suppl y i s determi ned by pol i cy

deci si ons of the central bank ; port fol io dec i si ons of the commerci al

banks and the non-bank pri vate sector and the deci sions of the

government wi th respect to the mai ntenance of i ts deposi ts wi t h the

cent ra l bank and the commerc i al banks . In addHion , i t i s

hypothesi zed that these deci sions , i n turn , are determi ned by

economic and i nst i tut i onal factors such as i ncome ( i nc l ud i ng fore i gn

income ) , i nterest rate ( i nc l ud i ng forei gn i nterest rate ) , number of

commerc i al bank off i ces defl ated by popu l at ion , government

expendi tu re and government revenue . Thi s hypothesi s i s tested by

formu l at i ng a model of money suppl y for Mal ays i a and by i dent i fy i ng

the determi nants of the money suppl y of Mal aysi a .

Organisation of the Study

A br ief out l i ne of thi s study fol lows . Chapter I I prov i des a

descri pt ion of the Mal ays i a monetary system. A presentat 'ion on the

Mal aysian monetary i nst i tu t i ons, thei r funct ions and thei r statement

of assets and l i ab i l i t i es i s a prerequi s i te to a better understandi ng

of the envi ronment and condi t i on under whi ch the money suppl y process

takes pl ace . The three off i c i al measures of Mal aysi an money suppl y