Interest Rates, Expectations, Equilibrium, Money Supply and Demand, and Exchange Rates

Flashcards covering topics on interest rates, expectations, equilibrium, money supply and demand, and exchange rates.

Interest Rate

The percentage of an amount of money that is paid for its use over a period of time; used by central banks to manage inflation.

Inflation Rate

The rate of increase in prices over a given period.

Fisher Effect

When expected inflation rises, interest rates will rise.

Keynesian Theory of Interest Rate (Theory of Liquidity Preference)

Defines the rate of interest as the reward for parting with liquidity for a specified period of time.

3 Motives of Liquidity Preference

Transactions, precautionary, and speculative motives.

Equilibrium Interest Rate

The rate at which the quantity of money demanded is equal to the quantity of money supplied.

Inflation Rate

Annual percentage increase in the average price of the standard basket of goods and services consumed by a typical Filipino family for a given period.

Fiscal Policy Stance

How the government's level of spending and taxation impact aggregate demand and economic growth.

Intermediation Cost

The cost incurred by financial institutions in extending their services, including administrative costs and the BSP's reserve requirements.

Money Supply

The aggregate amount of money that is in circulation in an economy.

M1 Narrow Money

Cash, coins, and demand deposits (checking accounts).

M2 Broad Money

Includes M1 plus savings deposits, time deposits, and balances in money market funds.

M3 Broad Money Liabilities

Includes M2 plus money substitutes like promissory notes and commercial papers.

M4 Liquidity Money

Includes M3 plus treasury bills and foreign currency deposits.

Monetary Policy

Adjusts interest rates and reserve requirements to control the money supply.

Fiscal Policy

Government spending and taxation.

Bank Lending

Loans issued by banks.

International Factors

Foreign investments, trade, and exchange rates.

Monetary Policy (Philippines)

The central bank controls the supply and availability of money, the cost of money, and the rate of interest.

Open Market Operations (OMO) - Repurchase Transaction

The BSP buys government securities (GS) from a bank with a commitment to sell them back at a specified future date at a predetermined rate, resulting in an expansionary effect on liquidity.

Open Market Operations (OMO) - Reverse Repurchase (RRP) Operation

The BSP also acts as the seller of GS and the bank's payment to the BSP has a contractionary effect on liquidity.

BSP Securities

Negotiable monetary instruments issued by the BSP as part of its structural liquidity management operations.

Outright Purchases and Sales of Securities

Direct purchase/sale of government securities by the BSP from/to the market for the purpose of increasing/decreasing money supply on a more permanent basis.

Foreign Exchange Swaps

Transactions involving the actual exchange of two currencies (principal amount only) on a specific date at a rate agreed on the deal date (the first leg), and a reverse exchange of the same two currencies at a date further in the future (the second leg) at a rate agreed on deal date.

Acceptance of Term Deposits

The BSP offers term deposits as one of the monetary tools to absorb liquidity.

Standing Liquidity Facilities

The BSP offers standing liquidity (lending and deposit) windows to provide or absorb liquidity at the initiative of the counterparty.

Overnight Deposit Facility

Will absorb any residual system liquidity to prevent market interest rates from falling below the corridor.

Overnight Lending Facility

Provides collateralized overnight funding to BSP counterparties to clear end-of-day imbalances.

Demand for Money

The amount of wealth that households and firms in an economy choose to hold in the form of money.

Transaction Motive

Money needed for undertaking transactions like paying employee salaries and purchasing goods and services.

Precautionary Motive

Money held for unforeseen future needs.

Speculative Motive

Money set aside to take advantage of future investment opportunities.

Levels of Income

Affect the demand for money; the higher the people's and businesses' income, the higher the level of transactions they have the ability to undertake, demanding more liquid cash.

Interest Rates

Bear an inverse relationship with the demand for money; opportunity costs of holding money will be high when interest rates are high.

Price Levels

Affect the demand for money, especially through inflation; if prices increase, people would need more money to buy the same quantity of goods and services.

Exchange Rate

The rate at which one currency can be exchanged for another between nations or economic zones.

Fixed Exchange Rate

Determine a currency's value by linking it to another currency, a basket of currencies, or a precious metal.

Floating Exchange Rate

Determine currency values by supply and demand in foreign exchange markets.

Managed Float

Combinations of floating and fixed exchange rates that determine a currency's value primarily through market forces and some intervention from governments and central banks.

Capital Flows

When a country's currency appreciates, foreigners find their goods more expensive leading to a decrease in the country's exports, causing a reduction in the country's foreign currency reserves, which correspondingly shrinks the money supply.

Central Bank Intervention

Central banks often intervene in foreign exchange markets to prevent excessive volatility. If a currency is depreciating rapidly, the central bank may buy large quantities of the currency in exchange for foreign assets, effectively increasing the money supply.

Exchange Rate Volatility

Refers to the degree of variation in the value of a specific currency pair over a certain period.