Money and Monetary Policy

Money and Monetary Policy

Learning Objectives

• Discuss a brief history of money and enumerate the different uses of money.

• Define the concepts related to banking.

• Discuss the different types and functions of banks.

• Identify the function of the Bangko Sentral ng Pilipinas (BSP) relative to monetary policies.

Money

• Money is an item that is used by buyers to purchase goods and services.

• Types of money:

  • Commodity money

  • Fiat money

Functions of Money

• Unit of account: Money as a unit of account becomes that measure that people use to buy the goods that they want.

• Store of value: An item that people can use to transfer purchasing power from the present to the future.

• Medium of exchange: An item that buyers give to sellers when they purchase goods and services

Money in the U.S. Economy

• Currency is the most widely accepted medium of exchange in our economy.

• Demand deposits: Balances in bank accounts that depositors can access on demand simply by writing a check.

Measures of the Money Stock for the U.S. Economy

• The two most widely followed measures of the money stock are M1 and M2.

Importance of Money

1. Stable value of money is essential to trade.

2. Healthy banks are important for savers, investors, borrowers, and the public.

3. Markets play a vital role in the function of our monetary system.

4. A well-designed and well-executed monetary policy is essential for an economy to keep its resources fully employed.

Concept of Banking

• Banks are institutions that serve as intermediaries between the savers and the borrowers.

• Banks are given the power by the government to conduct different functions under its jurisdiction.

• Financial Intermediation Process: Functions of deposit-taking and credit/lending facilitated by the banks.

Depositors or Savers

• Depositors or savers place their money in banks for the purpose of:

  1. Earning interest

  2. Security from lost and;

  3. Storage

Other Functions of Banks

• Aside from deposit-taking and lending, other functions of banks include:

  1. Treasury Operations

  2. Borrowing

  3. Trust Operations

  4. Private Banking

  5. FCDU Operations

  6. International Banking

  7. Brokerage

  8. Investment Banking or Underwriting

AI-Amanah Islamic Bank

• AI-Amanah Islamic Bank is the most unique of all the banks in the Philippines that, instead of charging interest payments on the money they lend, they just charge a certain fee for the transaction.

Types of Banks in the Philippines

• Seven major types of Banks in the Philippines, namely:

  • Universal banks

  • Commercial banks

  • Thrift banks

  • Rural banks

  • Cooperative banks

  • Islamic banks and;

  • Digital banks

Bangko Sentral ng Pilipinas (BSP)

• Bangko Sentral ng Pilipinas (BSP) has been given independence and power to govern all banks and nonbank financial institutions to maintain monetary stability in the country.

Roles Mandated by the Philippine Government

• Different roles mandated by the Philippine government:

  • Supervisor of all banks

  • Banks of banks

  • Issuer of money

  • Monetary authority

  • Custodian of the country’s official reserves

  • Lender of last resort

The Federal Reserve System

• Whenever an economy relies on a system of fiat money, as the U.S. economy does some agency must be responsible for regulating the system.

Federal Reserve (The Fed)

• The central bank of the United States, often simply called the Fed.

• Central Bank: An institution designed to oversee the banking system and regulate the quantity of money in the economy.

Two Jobs of the Fed

1. To regulate banks and ensure the health of the banking system.

2. To control the quantity of money that is available in economy.

Monetary Policy

• Bangko Sentral ng Pilipinas (BSP) uses different monetary tools in controlling the money circulating in the hands of the public.

• Money supply: The total amount of money circulating in an economy at a specific time, including currency, coins, and demand deposits (checking accounts).

Tools to Control Money Supply

• It has three different tools that it uses to control money supply:

  • Open market operations (OMO)

  • Reserve requirements and;

  • Interest rates

RP and PRP

• RP (Repo Rate or Repurchase Rate): It is the rate at which BSP sells its securities to the bank.

• PRP (Reverse Repo Rate or Reverse Repurchase Rate): Is the rate as which the banks redeem the BSP-issued instruments.

Why Does BSP Need to Control the Supply of Money?

• In the past the world had witnessed the sudden and significant decrease in the value or currency from different countries. This decreased in value is because of inflation.

• Recall Economic Principles no. 9: Prices rise when the government prints too much money.

Money Creation

• The concept of money creation believes that when money is placed in banks and financial institutions, it multiplies.

• Fractional-reserve banking: A banking system in which banks hold only a fraction deposits as reserves

• Reserve ratio: The fraction of deposits that banks hold as reserves

Concept of Money Creation (Table 8.1)

Reserve Requirement

• The Fed places a minimum on the amount of reserves that banks hold, called a reserve requirement.

• In addition, banks may hold reserves above the legal minimum, called excess reserves, so they can be more confident that they will not run short of cash.

• Let’s suppose that First National has a reserve ratio of 10 percent. This means that it keeps 10 percent of its deposits in reserve and loans out the rest.

Money Multiplier

• The money multiplier: The amount of money the banking system generates with each dollar of reserves.

• The creation of money does not stop with First National Bank. Suppose the borrower from First National uses the $90$ to buy something from someone who then deposits the currency in Second National Bank.

• After the deposit, this bank has liabilities of $90$. If Second National also has a reserve ratio of 10 percent, it keeps assets of $9$ in reserve and makes $81$ in loans. In this way, Second National Bank creates an additional $81$ of money. If this $81$ is eventually deposited in Third National Bank, which also has a reserve ratio of 10 percent, this bank keeps $8.10$ in reserve and makes $72.90$ in loans.

• Each time that money is deposited and a bank loan is made, more money is created.

The Fed's Monetary Tools

• The FED has three tools in its monetary toolbox.

  • Open-market Operations: The purchase and sale of U.S. government bonds by the Fed.

  • Reserve Requirements: Regulations on the minimum amount of reserves that banks must hold against deposits.

  • Discount Rate: The interest rate on the loans that the Fed makes to banks.

Conclusion

• At the end of the day, money is just a worthless piece of paper whose validity comes from government laws and whose value comes from the amount that results from our demand…