Money, Central Banking, and

Monetary Policy

WHAT IS MONEY?

Money refers to all things that are generally acceptable as a means of payment for good and services (medium of exchange) and as a payment.

What are the functions of money?

Money as a unit of account means that the value of goods and services are store and services are expressed or quoted with the use of a single item, usually a country’s currency.

Money as a medium of exchange means that you can trade your money in the market and in return, get the goods and services that you want to purchase because money is generally accepted as a means of payment.

The prerequisite of the barter system is called the double coincidence of wants. Money as a store of value or standard of deferred payment means that you can keep or save money now and then spend it at a future date because its capacity to buy the same amount of goods and services is not lost or diminished over time.

EVOLUTION OF MODERN PAYMENT SYSTEM IN THE PHILIPPINE

From a period of autarky or no trade system where the much older generation of Filipino families produced commodities for their own consumption, the mode of transaction often cited was the barter system.

Followed by the use of commodity money were people used commodities such as salt, carabao, shells that serves as a medium of exchange.

Face value refers to the amount of goods and service that can be bought with the use of the paper bills.

Example: if you have a one thousand peso bill, then it is possible for you to purchase goods and services worth of a thousand pesos at the maximum.

Specialized bankers offered businessmen and traders the particular service of safekeeping their surplus money for a fee. Overtime, bankers discovered that they can also lend a portion of the traders’ surplus money to other people who needed funds and then charged as an interest in return. With the vast developments in commerce and industry, the system of fractional reserve banking also evolved.

The Demand of moneyThe demand for money for real balances or purchasing power, i.e., the amount of goods and services money can buy.

According to John Maynard Keynes, there are 3 motives for holding money:

Transaction motive refers to the holding of money to enable people and firm to pay off their daily transaction such as paying for electricity, telephone bills, house rent, education, food, clothing, etc.

Precautionary motive for holding money arises because household and firms cannot predict exactly their level of expenditure per unit time and the inflow of income as well.

Speculative or portfolio allocation motive refers to the holding of money for purpose of taking advantage of market opportunities.

The Supply of moneyThe supply of money may be viewed in terms of monetary aggregates:

M1 – this refers to the narrow definition of money which consists of currency (e.g., paper bills and coins) in circulation plus demand or checking deposits;

M2 – this refers to M1 plus savings and small time deposits;

M3 – this refers to money supply, peso savings, time deposits, plus deposit substitutes of money-generating banks, and negotiable order of withdrawal (NOW) accounts.

RM – this is the reserve money which represents liabilities of the BSP to the public sector in the form of currency in circulation and to banking sector in the form of cash reserve.

Money supply is determined by the behavior of three principal actors—the public, the bank, and the BSP.

THE ROLE OF MONETARY INSTITUTIONS IN THE ECONOMY

The Bangko Sentral ng Pilipinas

The Central Bank of the Philippines (CB) was established on June 15, 1948 by virtue of Republic Act No.265. Its primary objectives then were:

a) To maintain the monetary stability in the country;b) To preserve the international value of the peso; andc) To promote rising level of production, employment, and real income in the

Philippines.

On June 14, 1993 , through R.A. 7653, the Bangko Sentral ng Pilipinas (BSP) was put up as a central monetary authority. Its primary objectives were still to maintain price stability (or fight inflation) conductive to a balanced and sustainable growth of the economy as well as promote and maintain monetary stability and convertibility of the peso.

BSP likewise called lender of the last resort. From whom ailing or bankrupt banks can borrow if other banks in the financial system cannot provide them with the necessary funds.

Financial InstitutionsThe Philippine financial or monetary system is a network of markets and institutions that transfer funds from individuals and groups who save money to individuals and groups who want to borrow money.

Banks Classified as:a) universal and commercial b) rural bankc) thrift bank – which include:

1. Savings and mortgage banks2. private development banks3. microfinance institutions4. stock savings5. loan associations

Non banks institutions are:a) contractual savings institutions – such as:

1. Insurance companiesb) Investment institutionsc) Securities market institution

1. Securities brokers and dealers.2. Lending investors3. Organized exchanges

d) Credit card companiese) Pawnshops

48.20%

23.50%

14.20%

9.10% 3.30% 1.60% 0.20%

Distribution and classification of banks in the Philippines

Universal and Comercial BanksRural BanksThrift BanksSavings BanksPrivate Development BanksStock Savings and Loans AssociationsMicro Finance

Total Banks Non-banks0

5,000

10,000

15,000

20,000

25,000

22,595

7,848

14,747

Number of Banks and Non-bank Institution in the Philippines in 2008

Number of Banks and Non-bank Institution in the Philippines in 2008

Financial Institutions

Financial or monetary institutions are important because of the following major roles:

a) they allocate or channel saving efficiently from savers to borrowers.

b) they provide information, liquidity, and risk-sharing services.

c) they provide flexibility and divisibility of funds for the users and sources of this funds

d) they are essential for ensuing capital formation and economic growth.

Bank Deposit Required Reserves Funds Available For Lending

ZEST 10,000 1,000 9,000

GOLDEN RULE 9,100 900 8,100

PATIENCE 8,100 810 7,290

.:

.:

.:

.:

TOTAL, FIRST 3 BANKS 27,100 2,710 24,390

.:

.:

.:

.:

OTHER BANK’S RETURN 72,900 7,290 65,610

GRAND TOTAL 100,000 10,000 90,000

Simple Money Creation

SIMPLE MONEY CREATION

Money Multiplier is the factor by which money supply will change given a change in monetary base o given a change or deposit.

Formula of the Money Multiplier:mm = 1 / rr

Formula of the Change in Money Supply:M = mm x MB

MONETARY POLICYMonetary Policy can either be expansionary (increasing money supply) or

contractionary (decreasing money supply)

The following is a list of important instruments of monetary control used by the Monetary board:a) Reserve requirement – is the percentage of deposits that banks are mandated to keep in their vaults for safekeeping by the BSP.

b) Rediscount Rate – is the interest charged by the banks to wish to borrow from it.

c) Open Market Operation – in simplistic terms, refer to the buying and selling of government securities by the BSP. Open market purchase, means buying of government securities (e.g., bonds) from private individuals or firms by the BSP. Open market sale refers to the sale of government securities to private individials or firms by the BSP.

INTERNATIONAL MONETARY INSTITUTIONS ABD THE PHILIPPINE MONETARY SYSTEM

Even prior to financial liberalization and globalization of markets in the recent past, the Philippine monetary system has been affected by international monetary institutions particularly by the International Monetary Fund (IMF) and the World Bank (WB).

International Monetary Fund was created to:a) Act as lender of last resort;b) Encourage domestic economic policies consistent

with foreign exchange rate stability; andc) Monitor the financial activities of member countries.

World Bank was also created to:a) To make a long term loans available for developing countriesb) Give loans for infrastructure to aid economic developmentc) Sell bonds in international capital market to raise loanable funds.

Composed of five (5) institutions:1. International Development Association (IDA)2. International Bank for Reconstruction and Development (IBRD)3. International Finance Corporation (IFC)4. Multilateral Investment Guarantee Agency (MIGA)5. International Center for Settlement of Investment Disputes (ICSID)

The World Bank also encourages member counties to give priority to programs for good governance and transparency, environmental protection and sustainable development. These programs are envisioned as potential solutions to eradicate poverty in member nations.