Money Theories, Money and Monetary Policy

8/12/2019 Money Theories, Money and Monetary Policy

http://slidepdf.com/reader/full/money-theories-money-and-monetary-policy 1/33

MONETARY THEORIES



Introduction

Money plays a distinct role in the

determination of the volume of output, its

production, its distribution to the factors of

production and the level of consumption. Monetary Theory

The study which seeks to discover and

explain how the use of money in its differentfunctions affect the production, distribution and

consumption of goods.



The Printing Press Cure

Pledging for the foreseeable future to pump

vast sums into banks, other financial firms,

businesses and households.



Irving Fisher (1867-1947)

A mathematician

turned economist

from Yale.

Published severalhighly successful

mathematical

textbooks.



Fisher’s Quantity Theory of

Money

Based on the equation of exchange; what

determines the purchasing power of money or

its reciprocal, the level of prices.

Five determinants:

(1) volume of currency in circulation, (2)

velocity of circulation, (3) volume of bank

deposits subject to check, (4) its velocity, and(5) volume of trade.

Monetary economics is the branch that

handles the five regulators of purchasing

power.



Fisher’s Equation of Exchange

MV + M’V’ = PT; Where:

M = quantity of currency; V = its velocity of

circulation; M’ = quantity of demand deposits;

V’ = its velocity of circulation;

P = average level of prices; T = quantity of

goods and services sold, with each unit being

counted each time it is sold or resold Level of Prices is determined by the quantity

of currency in circulation.



Fisher’s Quantity Theory of

Money

Excessive debts led to liquidation, with the

dumping of goods in the market.

Falling prices of goods led to further pressure

for liquidation of debts.

Fluctuations in demand deposits are the

greatest cause of business fluctuations.



Friedman’s believes…

“Inflation is always and everywhere a

monetary phenomenon, produced in the first

instance by an unduly rapid growth in the

quantity of money.” The only effective way to stop inflation is to

restrain the rate of growth of the quantity of

money.



Milton Friedman (1912-2006)

Was a leading

monetarist

Economics

professor at theUniversity of

Chicago



Transaction Demand for Money

Demand for Money

The total amount of money balances that

everyone wishes to hold for all purchases.

Transaction balances

Money is passed from households to firms

to pay for the goods and services produced by

firms;and money is passed from firms to

households to pay for the factor services

supplied by households to firms.



Transaction Demand for Money

The modern theory of transactions

balances predicts that these costs will be less

of an inhibition the higher is the rate of interest.



The Precautionary Motive

Precautionary balances

Firms carry money balances for

precautionary motives.

The larger such balances, the greater is

the degree of insurance against being unable

to pay bills because of some temporary

fluctuation in either receipts or disbursements.



The Speculative Motive

It emphasizes its role as a store of wealth.

Speculative balances

Balances held in anticipation of a fall in the

price of assets.



Influence of Interest Rates on

the Demand for Money

Market rate of interest reflects the

opportunity cost of money holdings.

The higher the rate of interest, the higher

the cost of holding money and the less money

will be held in transactions and precautionary

purposes.

Liquidity preference refers to the demand tohold assets in the form of money.

The schedule relating the demand for money

to the interest rate is called the liquidityreference schedule.



MONEY AND MONETARYPOLICY



Function of Money

As a medium of exchange

1A3C

2B

To restate the role of

money, money serves as

a vehicle for the free flowof products to satisfy

human wants since it can

be exchanged with any

product available in the

market as a commonthing of value.



Money Supply

Money is a vehicle of economic activities.

Money Supply consists of the following:

Coins and Bills in circulation Demand deposits in Banks- intended for

spending and circulated through the use of

checks which are as good as money.

Quasi-Money- consists of savings and time

deposits.



Savings Deposits

Time Deposits

Deposits Substitutes- deposits in savings

banks, savings and loan associations and

even in credit unions.



Measures of Money Supply

The basic function of money is that it must be

acceptable as a “medium of exchange”.

M1, the first measure of money.

M1 = currency circulation + demand

deposits

M2 , the second measure of money. It includes

the concept of “store of value” which includessavings and time deposits sometimes called

quasi-money.

M2 = M1 + time + savings deposits



Total liquidator M3 , the third measure of

money. These consists of debt papers or

securities issued by banks, but are not

deposits. It includes M2 plus depositsubstitutes.

M3 = M2 + deposit substitutes

M4, the last measure of money.M4 = M3 + peso equivalent of dollar

deposits in Foreign Currency Deposit Units

(FCDU) and Offshore Banking Units (OBU)



Banks and Money Supply

The Fractional Reserve System

- enables commercial banks to lend more

than their reserves.

- they do so by creating more demanddeposits which can circulate like money in

the form of checks while supported by

smaller cash amount to only meetfractional cash demand.



Money Creation

Commercial banks create moremoney by lending more demand

deposits.



Has the responsibility to administer the monetary,

banking and credit system of the republic as

embodied in Section 2 articles of the amended

Republic Act 265.

That responsibility is exercised to achieve

monetary objectives in consonance with the

overall economic policies of the government. The

objectives are as follows:1. To maintain internal and external monetary

stability in the Philippines, and to preserve the

international value of the peso and its

convertibility to other freely convertible currencies.

Functions of the Central Bank



2. To foster monetary, credit and exchange

conditions conducive to a balanced and

sustainable growth of the economy.

Central bank regulates the magnitude and the

movement of funds from sources to users.



The Confidence in Money

The Central Bank is the only authorized

government entity to print money and is

responsible for the proper administration of the

monetary, banking and credit system of therepublic to achieve monetary stability and

create conditions conducive to economic

development.





P = F/ (1+r)

Where:

P = Present Value

F = Future Value

r = Discount rate

n = Number of years back from maturity to

purchase



Open-market operations - buying and selling

treasury bonds, notes, and bills.

When the Federal Reserve sells moretreasury securities than it buys:

Money Supply Decreases

When the Federal Reserve buys more

treasury securities than it sells:

Money Supply Increases



- THE





9. Consists of savings and time deposits.

10. Buying and selling treasury bonds, notes, and bills.

11. Enables commercial banks to lend more than their

reserves. 12. % of deposits that must be held by a bank as vault

cash or on account with the federal reserve.

13. The first measure of money.

14. These consists of debt papers or securities issuedby banks, but are not deposits. It includes M2 plus

deposit substitutes.

15. Deposits in savings banks, savings and loan

associations and even in credit unions.



1.Monetary Theory

2. Irving Fisher

3. Monetary Economics

4-6. (1) volume of currency in circulation, (2) velocity ofcirculation, (3) volume of bank deposits subject to check,

(4) its velocity, and (5) volume of trade.

7. Milton Friedman

8. Liquidity preference schedule 9. Quasi-Money

10. Open-market operations



11. Fractional Reserve System

12. Reserve Requirements

13. M1

14. Total liquidator M3 15. Deposits substitutes

Documents

Money Theories, Money and Monetary Policy