“Philippine

Monetary
Policy”
Prepared by:
Cudillo Jeneth
Tesado, Jia B.
Money and Monetary policy

• Money Supply

– Money is a vehicle of economic activities (i.e. in the circular flow). The

stock of money serving this function is called money supply and consists
of the following:

• Coins and bills in circulation

• Demand deposits in banks

• Quasi-Money

• Savings Deposit

• Time Deposits

• Deposits Substitute

Measures of Money Supply

The basic function of money is that it must be acceptable as a medium of exchange.

The M1 definition of money includes:

M1 = currency circulation + demand deposits

M2 = M1+ time + savings deposits

M3 = M2 +deposits substitute

M4 = M3 + peso equivalent of dollar deposits in FCDU’s and OBU’s

Money Velocity and Income

Money supply as a medium of exchange multiplies into income in the simple model of
income determination.

The multiplier coefficient is only dependent on the rate of money outflow.

• The two main determinants embody the wider concept of the multiplier process
called the ‘money velocity’. Multiplying this coefficient by money supply yields
income, as follows:

MV = Y

Since:

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

Alternatively:

MV = PQ

Where:

M = Money Supply

V = Velocity

Y = Nominal Money Income

P = Price

Q = Volume of Goods and Services

Money Creation

It has just been illustrated that the fractional reserve system enables commercial banks
to lend more than their reserves.

They do so creating more demand deposits which can circulate like money in the form
of checks while supported by smaller cash amount to only meet fractional cash demand.

Sources of Money Supply

• Money Supply

- The lending operation of the banking system determines the volume of money
checks it creates. The government prints new money to help finance its expanding
operations.

• Taxes also change the level of money supply as leakages from the circular
flow.

• Taxes are foregone consumption and circulation and reserves which

enable banks to create money checks. savings which could otherwise be
part of currency
Monetary Policies and Objectives

• Some Policy Concepts

– The Central Bank uses monetary policy to regulate money through the
credit banking system in order to maintain monetary stability conducive to
economic development.

 Objectives
– Controlling Inflation
– Reduce Unemployment

Types of Monetary Policies

1. Contractionary monetary policy. The contractionary monetary policy is one of

the most used monetary policies because it helps reduce the inflation rate. A
contractionary monetary policy is taken by the authorities when the inflation rate
is sky-high and the central bank needs to do something immediately. The main
tools of this policy are interest rates and security options. When the central bank
adopts a contractionary monetary policy, it tries to raise the interest rates of the
bank so the people keep their money in banks to avail higher interest rates. This
will result in less money in the hands of people and as a result, the inflation rate
will reduce. Secondly, the central bank also sells off securities in the open market
so that the public would be more interested to buy more securities which will
result in the same i.e. lowering the inflation rate.

2. Expansionary monetary policy. This is just the opposite of the previous type of
monetary policy. An expansionary monetary policy is only adopted when the
inflation is curbed and the main objective of the central bank becomes to reduce
the unemployment rate and to avoid recession (if at all). As per expansionary
monetary policy, the central bank reduces the interest rate so that the public keep
their money in their hands. This step results in more purchasing power and as a
result, public consume more from businesses in the country. This helps avoid
unemployment and recession. The central bank also stops selling securities in
the open market and they only allow securities to be sold through the member
banks. This also ensures that the economy grows rapidly, enhances the
employment rate, and reduces the chances of a recession.

Short-Run Tools Affecting Money Supply

1. Reserve Requirements.

Commercial banks can lend more than their actual deposits (reserves) and
create money by creating more deposits that can circulate as money in form of checks
while supported by smaller reserve to meet fractional cash demand.
 For examples:

• A minimum required reserve ratio of 0.20 allows a bank to lend a maximum of

P5.00 for every peso of currency deposit (reserve).

Money created = I/r

Money created = I/.20 = 5

2. Rediscounting

Rediscounting is a privilege of a qualified bank to obtain loans or advances from

theBangko Sentral ng Pilipinas (BSP) using the eligible papers of its borrower’s as
collaterals. It is a standing credit facility provided by the BSP to help banks liquefy
their position by refinancing the loans they extend to their clients.

The Central Bank can infuse money into the reserves of the banking system by
buying its loan papers (i.e. loan receivables) at rediscounted values.

Money created = [I/r]

For example:

• Let us assume that a bank lends P100, 000 at an annual interest rate of 30%
and, therefore, expects to get back a compounded value of P169, 000 after two
years. However, let us assume further that at the end of the first year, the bank
sells the loan paper to the Central Bank to get back the principal and possibly
earn interest for the one year period completed before maturity. The Central Bank
offers a purchase or present value derived by discounting the maturity value of
the paper to the purchase period using a rate called the rediscount rate.

P = F/ (1+r)

Where:

P = present value

F = future value

r = Discount rate

n = number of years back from maturity to purchase.

3. Open Market Operation

Another way the Central Bank can change the level of the money supply is by
buying and selling government securities which are financial papers, with short-term
maturities (i.e. less than a year) and the Central Bank siphons and it sells securities.
The Need for Policy Coordination

• 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.

For example, increasing the required reserve ratio is ineffective to decrease

money supply if banks can still avail of the Central Bank’s rediscounting facilities
and open market operations to augment credit.

List of Advantages of Monetary Policy

• It can bring out the possibility of more investments coming in and consumers
spending more.

• It allows for the imposition of quantitative easing by the Central Bank.

• It can lead to lower rates of mortgage payments.

• It can promote low inflation rates.

• It promotes political freedom.

Limits of monetary policy

The central issue in the G-20 meeting in 2014, which was chaired by Australia,
was the apparent inability of monetary policy to stimulate real investment in many
countries. People have been shifting from bank deposits to existing assets and, in the
process, have pushed up the price of existing assets. The housing markets in many
countries, including Australia, are good examples of this.

However, demand for new assets and new investments have not increased
because people do not want to do inter temporal substitution. Low interest rates are not
working because it is making people more nervous about the future. The household
sectors in many countries have large balance sheet problems and the corporate sector
is scarred because of the depth of the shock to aggregate demand.

Thus, if the transmission mechanism is temporarily or perhaps persistently

broken, monetary policy will just push up the price of existing assets without
encouraging inter temporal substitution that is required to stimulate real investment.
Ultimately, this will lead to more risks in the financial system.

Limitations of Monetary Policies

• There exist a Non-Monetized Sector

• Excess Non-Banking Financial Institutions (NBFI)

• Existence of Unorganized Financial Markets

 • Higher Liquidity Hinders Monetary Policy

• Higher Liquidity Hinders Monetary Policy

• Time Lag Affects Success of Monetary Policy

• Monetary & Fiscal Policy Lacks Coordination

Philippine Monetary and Banking Policy

Monetary Policy

The thrust of BSP monetary policy will continue to be guided by the primary mandate of
maintaining price stability conducive to a balanced and sustained economic growth.
Monetary policy stance was generally accommodative for most of last year as inflation
remained largely subdued.

The primary objective of BSP’s monetary policy is to promote a low and stable inflation
conducive to a balanced and sustainable economic growth. The adoption of inflation
targeting framework for the monetary policy in January 2002 is aimed at achieving this
objective.

Banking sector policy

In the banking system, the BSP’s focus remains the promotion of a stable, sound
and globally competitive financial system. The BSP envisions a banking system that is
strong, sound and resilient as well as able to intermediate funds effectively and manage
risk efficiently.

A key reform measure is the change in the legislative framework for the banking
system. The General Banking Law (GBL) of 2000 or R.A. No. 8791, which was passed
last May 2000, now forms the basic legal fabric governing the banking system. The law
gives the BSP flexibility in supervising the banking industry and upgrades the country’s
banking laws to meet global standards.

Monetary and Fiscal policy

Fiscal policy

Fiscal policy refers basically to government taxing and spending decisions. The
main function is to provide public goods and services for citizen. In times when private
spending is insufficient to get an economy to full employment, fiscal policy can put idle
workers to work and stimulate economic growth.

Fiscal policy refers to the "measures employed by governments to stabilize the

economy, specifically by manipulating the levels and allocations of taxes and
government expenditures. Fiscal measures are frequently used in tandem with
monetary policy to achieve certain goals."

There are two main types of fiscal policy:

1. Expansionary- Expansionary fiscal policy, designed to stimulate the economy, is

most often used during a recession, times of high unemployment or other low
periods of the business cycle. It entails the government spending more money,
lowering taxes, or both.

2. Contractionary - is a form of fiscal policy that involves increasing taxes, decreasing

government expenditures or both in order to fight inflationary pressures. Due to an
increase in taxes, households have less disposal income to spend. Lower disposal
income decreases consumption.

The four primary function of fiscal policy are the ff:

1. Allocation- the first major function of fiscal policy is to determine exactly how funds
will be allocated. This is closely related to the issues of taxation and spending,
because the allocation of funds depend upon the collection of taxes and the
government using that revenue for specific purposes.

2. Distribution- whereas allocation determines how much will be set aside and for
what purpose, the distribution function of fiscal policy is to determine more
specifically how those funds will be distributed throughout each segment of the
economy.

3. Stabilization- is another important function of fiscal policy in that the purpose of

budgeting is to provide stable economic growth. Without some restraints on
spending, the economic growth of the nation could become unstable, resulting in
periods of unrestrained growth and contraction.

4. Development- the fourth major function of fiscal policy is that of development.

Development seems to indicate economic growth, and that is, in fact, its overall
purpose. However, fiscal policy is far more complicated than determining how much
the government will tax citizens one year and then determining how that money will
be spent.

Coordinating Fiscal and Monetary Policy

The coordination of fiscal and monetary policies has to be supported by concrete
institutional and operating arrangements. It can play an important role in coordinating
the volume of debt issuance in the primary market with monetary policy goals and help
resolve conflicts concerning the stance of interest rate policy.

Monetary and Fiscal Policy Coordination

Macroeconomic policies are meant to achieve non-inflationary, stable growth. There are
two major groups of policy instruments to achieve the purpose; one is related to
monetary conditions and the other to fiscal conditions.

Questions:
Test-I Multiple choice: Choose the correct answer.

1. It refers to a central bank's buying and selling of government securities.

a. Reserve requirement
b. Open market Operation
c. Rediscounting

2. It is also known as the cash reserve ratio, represents the minimum percentage of
customer deposits that a bank should hold as a reserve.

a. Open market Operation

b. Rediscounting
c. Reserve requirement

3. It is to maintain price stability conducive to a balanced and sustained economic

growth.

a. Fiscal policy
b. b. Monetary policy
c. c. Government Policy
d. d. BSP policy

4. The measure of money supply that consists of M3 + peso equivalent of dollar

deposits in FCDU’s and OBU’s.

a. M4
b. M3
c. M2

5. It is one of the most used monetary policies because it helps reduce the inflation
rate.

a. Contractionary monetary policy

b. Expansionary monetary policy
c. Inflation

6. It is the entire stock of currency and other liquid instruments circulating in a

country's economy as of a particular time. Money is a vehicle of economic
activities.

a. Money Supply
b. Money
c. Currency
7. Refers basically to government taxing and spending decisions.

a. Fiscal policy
b. b. Monetary policy
c. c. Government Policy
d. d. BSP policy

8. It is the BSP’s focus to remain the promotion of a stable, sound and globally
competitive system.

a. Fiscal system
b. Monetary system
c. Government System
d. Banking System

9. One of the fiscal functions to indicate economic growth, and that is in fact, its
overall purpose.

a. Allocation
b. Distribution
c. Stabilization
d. Development

10. First major function of fiscal policy to determine exactly how fund funds will be
allocated.

a. Allocation
b. Distribution
c. Stabilization
 d. Development
Test II - Enumeration

1-2. what are the two types of Monetary Policies

3-4. what are the two major groups of fiscal policy instruments.

5-6 what are the two main function of fiscal policy.

7-10 what are the four primary function of fiscal policy.

Test III Easy (5 pts.)

1. Why does printing more money can cause inflation?

2. What are the short-run tools affecting money supply. Why it is important?
3. How does fiscal and monetary policy impact the economy?
4. How is monetary policy implemented?
5. How does monetary and fiscal policy work together?