Money and Monetary Policy — Key Concepts

Nature of Money

  • Money is a medium of exchange, a unit of account, a store of value, and a means of deferred payment.

  • It replaces barter to grease exchange and raise productivity.

  • Money comes in tokens (coins and banknotes) whose value is established by a recognized authority.

Money as a Medium of Exchange

  • Buyers and sellers trade in money because it is generally recognized as valuable.

  • If recognition collapses, money ceases to be a good medium of exchange.

Money as a Unit of Account

  • A unit of account values goods/services, records debts, and enables calculations.

  • Three key characteristics:

    • Divisible

    • Fungible (mutually interchangeable)

    • Countable

Divisible

  • A unit can be divided without changing total value (e.g., $1 = 4
    quarters).

Fungible

  • One unit is the same as any other unit; e.g., 12 oz of 24-karat gold is interchangeable with another 12 oz.

Countable

  • Units can be added, subtracted, multiplied, and divided for accounting.

Money as a Store of Value

  • Money can be saved and retrieved later while retaining purchasing power.

Standard of Deferred Payment

  • Money serves as a standard for settling future payments and debts.

What Serves as Money?

  • Commodity money: intrinsic value (e.g., Gold, Silver).

  • Credit money: promissory notes.

  • Paper money: banknotes.

  • Fiat money: value fixed by government edict; not backed by a commodity; widely used today.

Characteristics of Money

  • General acceptability (legal tender).

  • Stability of value (purchasing power).

  • Portability.

  • Cognizability.

  • Durability.

  • Divisibility.

  • Malleability.

  • Convertibility.

  • Demonetization: when currency loses monetary value and is withdrawn.

What Serves as Money? (Summary)

  • Commodity money: intrinsic value.

  • Credit money: promissory notes.

  • Paper money: bank notes.

  • Fiat money: government-declared legal tender; most modern money.

Fiat vs Other Money Forms

  • Fiat money derives value from government acceptance and not from a physical commodity.

Fiscal and Monetary Policy (BSP Context)

  • RA 11211 – The New Central Bank Act: strengthens BSP mandate and functions.

  • BSP is mandated to provide policy directions in money, banking, and credit; supervise banks; regulate and examine non-bank financial institutions.

Monetary Policy (Definition and Goals)

  • Actions by the central bank to influence price level and liquidity.

Monetary Policy Options: Expansionary vs Contractionary

  • Expansionary monetary policy:

    • Lower policy interest rates; reduce reserve requirements.

    • Increases liquidity and can raise aggregate demand; may raise inflation.

  • Contractionary monetary policy:

    • Raise policy interest rates; increase reserve requirements.

    • Reduces liquidity and can curb inflation; lowers aggregate demand.

Money Supply Measures

  • M1 (Narrow Money): M1 = C + D

    • C: currency in circulation; D: peso demand deposits.

  • M2 (Broad Money): M2 = M1 + S

    • S: peso savings and time deposits.

  • M3 (Broad Money Liabilities): M3 = M2 + B

    • B: peso deposit substitutes (promissory notes, commercial papers).

  • M4: M4 = M3 + F

    • F: foreign currency deposits.

Notes:

  • C = currency in circulation (outside depository corporations).

  • D, S, B, F are defined in the context of pesos and foreign currency deposits.