MONEY AND MONETARY POLICIES

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MONEY AND MONETARY POLICIES

CHARLES HENDRIX S. FRASDILLABS CRIMINOLOGY III

CHAPTER 10

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FUNCTIONS OF MONEY

Money as a medium of exchange began to assume a significant role in the advent of the market economy marked by specialization, interdependence, and trade.

It serves as a vehicle for the free flow of products to satisfy human wants since it can be exchanged with any product available in the market as a common thing of value.

AS A MEDIUM OF EXCHANGE


FUNCTIONS OF MONEY

Money serves as a common yardstick or denominator by which we judge and compare the values of goods and services available in society. Without the use of money, a good or a service would assume different values.

Example: haircut = 2 chickens

plumbing service = basket of fruits

AS A UNIT OF ACCOUNT


FUNCTIONS OF MONEY

Many goods, especially the consumable ones, can not be stored for a long time without suffering from loss of values because of spoilage and obsolency.

Money, in its role as a store of value allows us to store purchasing power through time. Thus, we may store value by holding money in a form of stocks, bonds, jewelries, real estates, etc.

AS A STORE OF VALUE


THE DEMAND FOR MONEY

The reason why the public may opt to hold cash balances during a period of time may be categorized into 3:

transaction demand precautionary demand speculative demand



One reason why people may want to keep cash is for them to be able to carry out ordinary day to day transactions due to uneven timing of of pay periods or receipt of income with expenditure payments.

An increase in the price level of goods and services = increase of public‘s transaction demand for money.

TRANSACTION DEMAND



transaction demand for money also depends directly on the level of income of the economy.

the growth in transactions are usually the offshoots of an expanding activity or increasing income of the economy.

TRANSACTION DEMAND



EXPRESSED IN:

Mt = f(PY)

where Y = disposable income

P = level of prices

TRANSACTION DEMAND



People demand for money because of security against unforseen expenditures and unexpected loss of income. The precautionary demand for money is also dependent on the level of income.

EXPRESSED:

Mp = f (Y)

PRECAUTIONARY DEMAND



Money must be held to take advantage of a good investment opportunity should it comes along.

When interest rates are high, people convert their cash balances into high interest yielding alternatives such as bonds, treasury bills and other securities.

EXPRESSED AS A FUNCTION OF INTEREST RATE OR

Msp = (fi)

SPECULATIVE DEMAND


TOTAL DEMAND FOR MONEY

In the final analysis, the total demand for money or cash balances that the public may wish to hold over a period of time depends not only on the level of income and interest rates but on other institutional factors such as frequency of pay periods , availability of money substitutes and the degree of confidence on the future economic situation of the nation



The development of ATMs and credit cards have reduced the amount of cash balances that people ordinarily hold for transaction and precautionary motive. During times of economic uncertainty, people may opt to hold on thier cash, rather invest them in securities.



Md = Mt = Mp = Msp or Md = f(Y) + H(i)where Y is income; i is interest rate



Suppose the toltal demand for money in hypothetical economy is

Md = 0.25 +75 – 1000i

where Y is equeal to 800 and the prevailing interest rate s 5%:

Md = 0.25 (800) +75 – 1000 (0.5)

Md = 200 + 75 – 50

Md = 225



Assuming the money supply in that economy is equal to 100 or Ms = 100, at Md = Ms, the equilibrium rate would be 17.5%

0.25 Y + 1000i = 100

0.25 (800) +75 – 1000i = 100

200 + 75 – 100 = 1000i

i = 175/1000

i = 0.175 or 17.5%


MONEY SUPPLY

Money is a vehicle of economic activities when in circulation (i.e. In the circular flow)

money supply is the stock of money serving its function. Consists of the following:

* Coins and bills in circulation

* Demands deposits in banks

* Quasi – Money

- Saving Deposits

- Time Deposits

* Deposit Subtitutes


MONEY SUPPLY

Demand deposit – in commercial banks are intended for spending and circulated through the use of checks which are as good as money

Quasi – money – consists of saving and time deposits in commercial banks

Deposit Subtitutes – deposits in saving banks, saving loans associated and even in credit unions


TOP TEN BANKS

RANK BANK NAME TOTAL ASSESTS

1 METROPOLITAN BANKS AND TRUST COMPANY 379,303

2 BANK OF THE PHILIPPINE ISLANDS 331,456

3 CITIBANK, N.A. (PHILS) 265,798

4 EQUITABLE PCI BANK 258,348

5 LAND BANK OF THE PHILIPPINES 238,715

6 PHILIPPINE NATIONAL BANK 189,609

7 DEVELOPMENT BANK OF THE PHILIPPINES 151,997

8 RIZAL COMMERCIAL BANKING CORPORATION 149,096

9 ALLIED BANKING CORPORATION 98,293

10 UNITED COCONUT PLANTERS BANK 96,356

TABLE 10.1


Money velocity – the 2 main determinants embody the wider concept of the multiplier process.

Multiplying this coefficient by money supply yields income, as follows:

MV = Y

since:

Y = PQ (Economic income or income derived from production)


Alternatively:

MV = PQWhere:

M = Money Supply

V = Velocity

Y = Nominal Money income

P = Price

Q = Volume of goods and Services


Banks are supposed to be conduits of funds linking investors/borrowers to the sources. As such, they accept deposits which chiefly supply their lending operations. In the process, they are liable to depositors and borrowers for money, on demand in the same manners the borrowers in return for periodic loan repayments.

However, commercial banks in particular can create deposit liabilities (i.e. to depositors and borrowers) greater than their reserves or money in vault

1. The Fractional Reserve System


which is the essence of the fractional reserve system.

Depositors and borrowers can circulate their demand deposits in the banks using checks which are good as money.

However, only a fraction of the total amount of checks circulated is encashed form the banks, at any one time. Thus, a commercial bank can lend more than its actual deposit by creating more deposits liabilities while maintaining a smaller reserve to meet fractitional cash demand.



DEPOSIT LIABILITY CREATION


ASSETS LIABILITIES

P 100, 000 P100, 00080,000 80,00060,000 60,000: : n________ n_______P500,000 P500,000

note: n is an infinitely small value almost equal to zero implying no more funds available for additional lending


Commercial banks create more money by lending more and creating more demand deposits while the opposite is true when they tighten credit.

The amount of money checks that a commercial bank can cause to circulate form every peso of reserves is EXPRESSED IN:

2. Money Creation

m = L R

Since:

r = rL

<1

Therefore:

m = lr


Where:

m = Money Multiplier

R = Reserves

L = Deposit Liabilities

r = Ratio of reserves to deposit Liabilities or Fractional Cash Demand Ration

2. Money Creation


Therefore multiplying the coefficient by total reserves yields total demand deposit liability. Deposit liabilities are not entirely bank- created money. They partly represent currency in the vault of the bank (reserves) which circulates as checks and constitutes money already created. Thus, the money supply that a bank can create is EXPRESSED IN:

(Bank-created money) = (L - R)

2. Money Creation


In addition, the average for every peso or reserves should yield:

2. Money Creation

r = lr

- 1( )Concluding from the foregoing, the money

supply that a bank can create is also equal to:

lr( ) - 1

R


The lending operation of the banking system determines the volume of money check it creates. Thus lending more/less within the limits of the fractional cash requirement of deposits increases/decreases money checks and the level of money supply.

The government prints new money at times, to help finance its expanding operations. This increases currency in circulation and the money checks that banks create form currency deposits.


Net of foreign currency inflows and outflows that changes the level of money supply. The level increases when inflows exceed outflows while the opposite is true when outflows exceed inflows.

Taxes also change the level of money supply as leakages from the circular flow. Taxes are foregone consumption and savings which enables banks to create money checks. Thus, an increase in taxes decreases money supply while the opposite is true with a decrease in tax revenue.


Its is the responsibility of the Central Bank to administer the monetary, banking and credit system of the republic as embodied in Sec.2, Articles of the amendment R.A 265. This responsibility is exercised to achieve monetary objectives in consonance with the overall economic policies of the government.

OBJECTIVES: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.

1. Functions of the Central Bank


2) To foster monetary, credit and exchange conditions conducive to a balanced and sustainable growth of the economy.

1. Functions of the Central Bank


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 the republic to achieve monetary stability and create conditions conducive to economic development. Its preserves the confidence of the people on money as a thing of value and an essential institution of the economic system. Once the trust is broken, money ceases to function as it should be i.e. as a vehicle of economic activities and pillar of the price system.

2. The Confidence on Money


The Central Bank uses monetary policies to regulate money through the credit and banking system in order to attain monetary stability conducive to economic development. However, monetary authorities have to use their instruments to make policies workable and, therefore, realize objectives. The use of these instruments should be flexible enough to contend with the dynamic forces that they direct.

1. Some Policy Concepts


2.a. RESERVE REQUIREMENTS

Commercial banks can lend more than their actual deposits(reserves) and create money by creating more deposit liabilities. Monetary authorities can prescribe a minimum ration of reserves to deposit liabilities to control the creation of credit and money. Therefore, an increase in the minimum required ratio forces banks to limit the creation of deposit liabilities using the same reserves while the opposite is true when the floor is lowered.

2. Short-run Tools Affecting Money Supply



ILLUSTRATED AS:

Money Created = ( l -1r

) R

Money Created = as r

as r

With R consonant


2.b. REDISCOUNTING

The Central bank can infuse money into coffers (reserves) of the banking system by buying its loan papers (i.e. loan receivables) as rediscounted values. There is a certain amount of loan papers that banking institutions sell to maintain a certain level of reserves depending on their reaction to the prevailing rediscount rate and the amount that the Central Bank is willing to buy. The Central Bank can raise the levels of reserves and credit money by widening its rediscounting windows and buying more loan papers at lower and more encouraging rediscount rate.




ILLUSTRATED AS:

Money Created = ( l -1r

) R

Money Created = as r

as r

With R consonant


2.c. OPEN MARKET OPERATIONS (framework) – has a certain net effect on money supply depending on how much securities the public is opened to buy and sell.

Another way the Central bank can change the level of money supply is by buying and selling government securities in the open market. The Central bank can buy more and sell less securities to create a new effect of increasing money supply while the opposite is done to decrease the stock of money in the system.

Government securities - financial papers with short term maturities(i.e. less than a year).



2.c. OPEN MARKET OPERATIONS (comparative advantage)

The Central Bank has more control over bank reserves with this instrument. To decrease money supply, it simply offers more treasury bills at higher interest to draw a momentum that it can control within the volume it aims to transact. In contrast, the reactions of banks to changes in the required reserve ratio and rediscount rate may be unpredictable and bring the momentum to undefined levels. In addition, the Central Bank can offer to buy back these bills giving security holders attractive interest earnings for the period covered.



2.d. SELECTIVE CONTROL

The effective range of an instrument may not be necessarily lead to its targets and even if it does, may spill over to factors which are not its concern and, thus, create new problems. This is were monetary authorities exercise selective control in order to confine the workings of an instrument only to the factors it aims to manipulate and, therefore, avoid its discrimination effects.



2.e. THE NEED FOR POLICY COORDINATION (framework):

It is not enough that an instrument be confined to its target to create positive effects. For one, applying the instrument alone may be inadequate to solve the problem.

The use of instrument may effectively manipulate the target factors but may also throw other factors out of balance and do more harm than good.

The application of the instrument may have side effects that disturb the balance of economic forces.



2.e. THE NEED FOR POLICY COORDINATION (illustration):

To take advantage of the complementary effects of other instruments, the Central Bank should not only increase the required reserved ration and, thus restrict credit that banks create for the same deposits in order to contract money supply. It also should tighten its rediscounting facilities and open market operations to deny banks the opportunity to exploit these sources and augment reserves again to maintain credit. Monetary authorities can use the tool to open market operations not only to supplement but also to finetune the effects of the other monetary tools which are also powerful but less controllable.



2.e. THE NEED FOR POLICY COORDINATION (imperfections and Trade - offs):

Putting each policy instrument to its best use taking advantage of the said processes of complementation and neutralization between instruments in order to solve each problem effectively, is an ideal condition. In reality, it is quite difficult to coordinate policies to such an advantage and policy makers would have just to make the most of what they have.


IMPACT ON MONETARY AND CREDIT POLICIES ON

NEW INVESTMENTS


The worst economic crisis that the country has suffered after the Second World War started in the latter half of 1983. At this time, the county’s balance of payments problem assumed crisis proportions following the unprecedented adverse external and domestic developments. There was capital flight from the country accompanied by substantive freezing of institutional credit facilities and following shortage of foreign exchange , need raw materials could not be imported and factories started closing down. Expectedly, inflation rose to intolerable levels. It was classic case of stag flation.


With the adverse balance of payments position, the policies immediately instituted were aimed directly at the external sector. The measures included:

1. the depreciation of the peso during the period of June 1983 – June 1984;

2. mandatory surrender of commercial banks’ foreign exchange receipts to a foreign reserves pool to service payments of priority foreign transactions and

3. the taxation of external trade transactions.


RECENT MONETARY AND CREDIT MEASURES

Reduction in Reserve Requirements.Open Market Operations.Rediscounting.

EXTERNAL POLICYCURRENT ECONOMIC AND FINANCIAL SITUATION


“CENTRAL BANK MOVES TO CHECK EXCESS

LIQUIDITY”by Clarissa S. Batino


Reserve Requirement.Trading Scheme.

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MONEY AND MONETARY POLICIES