Money, Banking and Monetary Policy
This section covers money functions, commercial banking, credit creation and central banking, which the exam tests through definitions, money-multiplier calculations and policy tools. You should be able to explain how deposits create money and how the central bank controls liquidity.
Core rules
- Money functions: medium of exchange, unit of account, store of value and standard of deferred payment.
- Good money is generally acceptable, portable, durable, divisible, scarce and difficult to counterfeit.
- Commercial banks accept deposits, lend and create bank deposits. The simple money multiplier = 1 ÷ reserve ratio.
- Central bank functions include issuing currency, banker to government and banks, lender of last resort, managing reserves and conducting monetary policy.
- Expansionary policy: buy securities, lower the discount rate, lower reserve requirements. Contractionary policy does the opposite.
- Monetary policy affects aggregate demand through interest rates, credit and asset prices.
Worked example
A commercial bank receives a new deposit of 1,000 million kyat. The required reserve ratio is 20%, so excess reserves are 800 million kyat. If all banks lend fully and the public holds no extra cash, the maximum total deposit creation is 1,000 × (1 ÷ 0.2) = 5,000 million kyat. The banking system creates 4,000 million kyat of new deposits, not new currency. If the central bank raises the reserve ratio to 25%, the multiplier falls to 4 and maximum deposits become 4,000 million kyat.
Traps
Do not say banks create currency; do not confuse the reserve ratio with the interest rate; do not treat monetary policy as government taxation; do not ignore cash leakage in real-world credit creation.