ACC-105: ECONOMIC DEVELOPMENT
LESSON 5:
2ND SEMESTER | A.Y. 202Y – 202Y
LECTURER: SIR/MS.
THE MONEY SUPPLY AND THE FEDERAL RESERVE Commodity monies are items used as money that
SYSTEM also have intrinsic value in some other use.
Gold is one form of commodity money.
An Overview of Money Other precious metals
This cannot be used directly for transactions, it
Money is anything that is generally accepted as a
can, however, used for speculative motives.
medium of exchange.
Money is not income, and money is not wealth.
Fiat, or token, money is money that is intrinsically
Money is:
worthless.
o a means of payment,
o a store of value, and
o a unit of account.
Legal tender is money that a government has
required to be accepted in settlement of debts.
“Ang salaping ito ay bayarin ng Bangko Sentral
(1) A Means of Payment
at pananagutan ng Republika ng Pilipinas”
─ Money as a means of payment, or medium of
It is money that government has required to be
exchange, is more efficient than barter.
accepted in the settlement of debts.
─ Barter is the direct exchange of goods and
services for other goods and services.
─ A barter system requires a double coincidence of BANGKO SENTRAL NG PILIPINAS
wants for trade to take place. Money eliminates
this problem. The Bangko Sentral ng Pilipinas (BSP) was
Double of Coincidence of Wants = the seller and established on July 3, 1993.
buyers have to agree to sell and buy each The BSP took over from Central Bank of the
other’s commodities. Philippines (CBP), which was established on January
There wants should be coincide in order for 3, 1949, as the country’s central monetary
exchange to take place. authority.
o When it comes to money, it is the BSP that
─ Money is a lubricant in the functioning of a market decides and controls everything
economy. The BSP enjoys fiscal and administrative autonomy
from the National Government in the pursuit of its
(2) A Store of Value mandated responsibilities.
─ Money as a store of value refers to money as an o It is an independent body
asset that can be used to transport purchasing
power from one time period to another.
Money has value and that value can be stored. Vision
Money does not lose value. The BSP aims to be recognized globally as the
─ Money is easily portable, and easily exchanged monetary authority and primary financial system
for goods at all times. supervisor that supports strong economy and
─ The liquidity property of money makes money a promotes a high quality of life for Filipinos.
good medium of exchange as well as a store of
value. Mission
(3) A Unit of Account To promote and maintain price stability, a strong
─ Money also serves as a unit of account, or a financial system, and a safe and efficient payments
standard unit that provides a consistent way of and settlements system conducive to a sustainable
quoting prices. and inclusive growth of economy.
All goods and services sold in the market are o To stabilize prices
valued in terms of monetary units. o To keep inflation at minimal levels
There is always a corresponding peso value in
everything you buy or see in the market.
Organizational Structure
There is a corresponding measure.
(a) Monetary Board – conduct monetary policy and
supervision of the financial system.
1|Page
APRIL KAE APRIL KAE APRIL KAE
(b) Governor – directs and supervises the operations and Assisting banks in a difficult financial position.
internal administration of the BSP o Bank Run – all depositors/people wanted to
withdraw their money (happens during a
Felipe M. Medalla – Governor of the Bangko Sentral ng recession or any catastrophe)
Pilipinas (BSP) o Banks wanted to ears from other people’s
money, but if people wanted to withdraw their
Monetary Board
money, then nothing will be left in the bank,
except from reserves.
o What the banks can do is to borrow money
Governernor
from the BSP.
Monetary
Financial Corporate Payments and Regional Managing exchange rates and the nation’s foreign
and Currency Operations
Economics
Supervisor Services and exchange reserves.
Sector Sector Management
Sector Sector Advocacy o It is the BSP who determines the peso-dollar
Sector
exchange rate based on demand and supply of
dollars.
Functions of the BSP
Control of mergers between banks.
a) Monetary Policy o If the small bank cannot meet the minimum
b) Monetary Operations capital requirement of the BSP, then it will have
c) Systemic Risk Management to merge with the other bank.
d) Financial Supervision
e) Payments and Settlement System Oversight Examination of banks to ensure that they are
f) Currency Management financially sound.
g) Inclusive Finance o The BSP conducts audit of banks to make sure
h) Loans and Credit Operation they are financially okay.
i) International Reserve Management
j) International Operations Setting of reserve requirements for all financial
k) International Economic Cooperation institutions.
l) Economic Education
Lender of last resort.
o Other banks can run to the BSP in case they
The BSP performs important functions for banks
need financial help.
including:
Clearing interbank payments BSP’s Monetary Policy over the Years
o Clearing interbank payments refers to the
process of settling financial transactions Present Objective - moving towards “Inflation
between banks. When a customer of one bank Targeting” to focus mainly on price stability on the
initiates a payment to a customer of another primary objective of monetary policy.
bank, the funds must be transferred from one
bank to another. The clearing process involves
the exchange of payment instructions and the MONETARY POLICY
transfer of funds between banks to ensure that
Tools used by the BSP to control the quantity of
the payment is completed.
money (money supply), which in turn affects
interest rates:
Example:
(a) Open Market Operations
o Francis has a manager’s check worth P1,000
(b) Reserve Requirement
issued by Geremy from BDO (payor). But
(c) Discount Rate
Francis’ has an account is BPI. She will deposit
the check issued by BDO to BPI since the check Money Supply
is named after her (payee).
o BPI will make it clear to BDO if the check really o Money supply is money in circulation.
has a value. If Geremy’s account in BDO only o Money in circulation is the money found outside
has P50, then there will be bouncing check. the vaults of the central bank.
Geremy will be penalized for that and Francis o Money inside the central bank is not money in
can file a case in court regarding that matter. circulation because they have it and cannot
circulate.
Regulating the banking system. o Money circulation is money revolving outside
o The BSP is the bank of all banks. the economy—in businesses, banks,
households, etc.
2|Page
APRIL KAE APRIL KAE APRIL KAE
BSP If we print more money, there be an increase
in demand and there will also an increase in
price of goods and services (inflation).
BDO BPI MB It is inflationary to have too much money in
₱ ₱ LBP ₱
circulation—that is why there is a need to
control money supply.
Julli’s Business ₱ Lei’s Business When we have extra money, people tend to
spend it (propensity to consume/spend).
We have a very small propensity to save.
To control inflation, we should control money
These are money circulating in our economy
supply.
MEASURING THE SUPPLY OF MONEY
The two most common measures of money are M1
and M2.
M1 (TRANSACTIONS MONEY)
─ M1, or transactions money is money that can be
directly used for transactions.
o Includes the most liquid forms of money, which
are readily available for use in transactions.
─ It includes currency held outside banks, plus
demand deposits (checking accounts), plus
traveler’s checks, plus other checkable deposits
─ Philippines Money Supply M1 was reported at
$118,495 billion USD in January 2023.
M2 (BROAD MONEY) Main Objective of BSP – control inflation and
maintain stable process
─ M2, or broad money, includes near monies, or close They control money supply through monetary
substitutes for transactions money. policy
o This cannot be used directly for transactions. They target inflation that is going to be
o Includes assets that are less liquid than those manageable (3-4%), as this is inevitable.
in M1 Good Side of Inflation = people are spending,
─ M2 / M1 + savings accounts + money market such that there is demand for goods and
accounts + other near monies services and that the economy is dynamic.
o Debit Card (savings account) – it is considered Bad Side of Inflation = many families cannot
M1 if here is money in it. afford to buy goods and services, especially
─ Philippines Money Supply M2 was reported at basic necessities, so it is imperative for BSP to
$283,833 billion USD in January 2023. manage inflation by controlling money supply.
─ The main advantage of looking at M2 instead of M1
is that M2 is sometimes more stable.
OPEN MARKET OPERATIONS
THE PRIVATE BANKING SYSTEM ─ The purchase and sale by the BSP of government
securities in the open market.
Most of the money in the Philippines today is “bank o Government Securities – treasury bills,
money,” or money held in checking accounts rather treasury bonds, and notes.
than currency. ─ It is a tool used to expand or contract the amount
Financial intermediaries are banks and other of reserves in the system and thus the money
financial institutions that act as a link between those supply.
who have money to lend and those who want to ─ Open market operations is by far the most
borrow money. significant tools of the BSP for controlling the supply
of money.
Why is there a need to control the money supply?
3|Page
APRIL KAE APRIL KAE APRIL KAE
─ It is the most accurate tool because it knows o What BDO can do with the remaining P90 can
precisely by how much it wants to increase or lend it to someone who needs money (Donita).
decrease money supply. o P100 can no longer be lend to other people
o If the BSP wants to decrease money supply by because the P10 of it is already a reserve for
P1 billion, it will sell P1 billion worth of BSP.
government securities in the open market.
Example:
o Marion invest P100,000 worth of government
securities from the bank (controlled by BSP).
o Then the government securities will be
received by Marion.
─ If the BSP increases reserve requirement, the
money supply will decrease.
─ If the BSP decreases the reserved requirement, the
money supply will increase.
DISCOUNT RATE
─ If the BSP sells government securities, the money ─ Also called as Rediscounting Operations.
supply will decrease. (This is because P100,000 will ─ Banks may borrow from the BSP. The interest rate
go to BSP and will not circulate in the economy) they pay the BSP is the discount rate.
─ If the BSP buys government securities, the money ─ Bank borrowing from the BSP leads to an increase
supply will increase. (This is because P100,000 will in the money supply.
go to other banks, which will circulate in the ─ The higher the discount rate, the higher the cost of
economy) borrowing, and the less borrowing banks will want
─ Open market operations are the BSP’s preferred to do.
means of controlling the money supply because:
o They can be used with some precision, Example:
o Are extremely flexible, and o Donita borrows P100 from BDO.
o Are fairly predictable. o There is a promissory note that Donita needs
to sign (all the details of the loan are written
down in the promissory note—agreement
RESERVED REQUIREMENT between the bank and borrower).
o The promissory note is worth P100.
─ The amount of cash that banks must hold as reserve o What the BDO can do is to approach the BSP
deposits at the BSP. and present the promissory note of Donita,
─ If the BSP wants to increase the money supply, it telling that she borrowed P100 from the bank.
lowers the required reserve ratio, thereby freeing o BDO can borrow money from BSP and they can
banks to create additional deposits by making more use the promissory note of Donita as a
loans. collateral.
o BSP will tell BDO that they can borrow but
Example: there is a discount rate of 10%. So BSP will
o Alex will deposit P100 to BDO. only have to give P90 of cash to BDO.
o What the BSP will require is that every peso of o What the BDO can do with P90 is that they can
deposit created by the banking system (BDO), lend it again with other people.
there has to be a certain portion that will serve o In other words, Donita’s promissory note
as a reserve requirement. seems became money but already discounted.
o Reserve Requirement is the amount of cash
that banks must hold as reserves for every
peso deposit created.
o If the reserve requirement is 10%, BDO will
have to keep or give P10 to the BSP (10% of
P100), and so P90 will be left.
4|Page
APRIL KAE APRIL KAE APRIL KAE
EXPANSIONARY POLICY
When there is “too little money” which dampens
overall demand for goods and services, the BSP
“loosens” the faucet to expand the money supply.
It will lead to:
o Lower interest rates
o More lending/borrowing
o Less savings
o More spending
THE SUPPLY CURVE FOR MONEY
─ The banks can go to BSP through its rediscounting
window and turn a promissory note into instant A vertical money supply curve says the BSP sets the
cash, which the bank can use again. money supply independent of the interest rate.
─ Banks are making money out of other people’s
money.
─ If the BSP increases the rediscounting rate, the
money supply will decrease.
─ If the BSP decreases the rediscounting rate, the
money supply will increase.
─ In practice, the Fed does not often use the discount
rate to control the money supply.
It is a vertical money supply curve because it is
o This because it is not as effective as the open
fixed regardless of interest rates.
market operations.
Money supply is independent of interest rates—
─ The discount rate cannot be used to control the
regardless of what interest rates are, money supply
money supply with great precision, because its
stays and it will not be increased.
effects on banks’ demand for reserves are
Whatever money BSP has made for a year, that’s it
uncertain.
The interest rate will be determined by the demand
─ Moral suasion is the pressure exerted by the Fed on
for money (intersection between the money supply
member banks to discourage them from borrowing
and money demand)
heavily from the BSP.
Inflation Targeting
Government sets inflation target (in consultation
with BSP): BSP announces inflation target.
BSP assess monetary condition and forecast
inflation.
Is the inflation forecast in line with target?
o If yes, no change in policy settings.
o If no, BSP adjusts policy settings.
CONTRACTIONARY POLICY
When there is “too much money” in the economy
supporting overall demand for goods and services,
the BSP “tightens” the faucet to reduce the money
supply.
Tightening the faucet – the action dampens demand
which could lead to lower inflation.
It will lead to:
o Higher interest rates
o Less lending/borrowing
o More savings
o Less spending
5|Page
APRIL KAE APRIL KAE APRIL KAE