Money and Monetary Policies

There are tools that the Central Bank uses to direct and regulate the monetary
system both from long-term and short-term perspectives.

A. Function of Money and Money Supply

1. Function of Money - Money is used as a medium of exchange, a unit of

account, and as a ready store of value. Money as a medium of exchange
began to assume a significant role in the advent of the market economy
marked by specialization, interdependence and trade. Today, the distinct
advantage of the monetary system over the barter system defines the role of
money in the economy. Money serves as a vehicle for the free flow of
products to satisfy human wants. It is the pillar of the price system and can,
therefore, induce economic activities.

2. Money Supply – Money is a vehicle of economic activities when in

circulation. The stock of money serving this function is called money supply
and consist of the following:
 Coins and Bills in circulation
 Demand Deposits in Banks
 Quasi-Money- *Saving Deposits
*Time Deposits
 Deposit Substitutes
Demand deposits in commercial banks are intended for spending and
circulated through the use of checks which are as good as money. On the
other hand, Quasi-money consists of savings and time deposits in commercial
banks while deposits substitutes are deposits in saving banks, savings and
loans associations and even in credit unions.

3. Money Velocity and Income- Money supply as a medium of exchange

multiplies into income. It is the number of times money supply circulates and
changes hands to become income. Or it is the frequency at which the
average same unit of currency is used to purchase newly domestically-
produced goods and services within a given time period.

If the velocity of money is increasing, then transactions are occurring between

individuals more frequently. Although once thought to be constant, it is now
understood that the velocity of money changes over time and is influenced by
a variety of factors.
B. Banks and Money Supply

1. The Fractional Reserve System –

Fractional reserve banking is a banking system in which only a fraction
of bank deposits are backed by actual cash on hand and are available for
withdrawal. This is done to expand the economy by freeing up capital that
can be loaned out to other parties.

Banks are required to keep a certain amount of the cash depositors give
them on hand available for withdrawal. Most banks are required to keep 10%
of the deposit, referred to as reserves. Increasing the reserve requirement
takes money out of the economy, while a decrease in the reserve
requirement puts money into the economy.

2. Money Creation-
Money creation is the process by which the money supply of a country, or of
an economic or monetary region, is increased. In most modern economies,
most of the money supply is in the form of bank deposits.
Through fractional reserve system, commercial bank can lend more than
their reserves. They do so by creating more demand deposits which can
circulate like money in the form of checks while supported by a smaller cash
amount to only meet fractional cash demand. Therefore commercial banks
create more money by lending more and creating more demand deposits.

C. Sources of Money Supply

The lending operations of the banking system determine the volume of
money checks it creates. Thus, lending more/less within the limits of the
fractional cash requirement of deposits increases/decreases money checks and
the level of money supply. On the other hand, the government prints new money
at times, to help finance its expanding operations. This increases currency in
circulation and the money checks that banks create from currency deposits.
Furthermore, foreign currency inflows (mostly dollars) are sold to the
Central Bank for pesos through commercial banks based on a fixed exchange
rate prescribed by the former. In turn, the peso currency inflows find their way
into the vaults of the banking system and then to currency in circulation and
money checks that banks create from cash deposits. Thus money supply tends
to increase with foreign currency inflows while the opposite is true with foreign
currency outflows.
Taxes also change the level of money supply as leakages from the
circular flow. Taxes are foregone consumption and savings which could
otherwise be part of currency in circulation & reserves which enable banks to
create money checks.
D. Money and the Central Bank

1. Functions of the Central Bank-

It is the responsibility of the Central Bank to administer the monetary, banking
and credit system of the republic as embodied in Section 2, Articles of the
amended Republic Act 265. This responsibility is exercised to achieve
monetary objectives in consonance with the overall economic policies of the
government. The objectives are as follows:
 To maintain internal and external monetary stability in the
Philippines; and to preserve the international value of the peso and
its convertibility to other freely convertible currencies.
 To foster monetary, credit and exchange conditions conducive to a
balanced and sustainable growth of the economy.
Therefore, the Central Bank regulates the magnitude and movement of money
through the banking and credit system which serves as a conduit of funds from
sources to users.

2. The Confidence on Money-

The Central Bank is the only authorized government entity to print money and
is responsible for the proper administration of the monetary, banking and
credit system to achieve monetary stability and create conditions conducive to
economic development. As such, it preserves the confidence of the people on
money as a thing of value and an essential institution of the economic
system.

E. Monetary Policies

1. Some Policy Concepts- The Central Bank uses monetary policies to regulate
money through the credit and banking system in order to attain monetary
stability conducive to economic development. Monetary authorities have to
use instruments to make policies workable & the use of these instruments
should be flexible enough to contend with the dynamic forces that they direct.

2. Short-run Tools Affecting Money Supply:

a. Reserve Requirements- Monetary authorities can prescribe
a minimum ratio of reserves to deposit liabilities to control
the creation of credit & money.
b. Rediscounting- Increasing the rediscount rate discourages
banks from selling loan papers to increase reserves & create
more credit & money supply.
c. Open Market Operations- refer to the buying and selling of
government securities in the open market in order to expand or
contract the amount of money in the banking system. Securities'
purchases inject money into the banking system and stimulate
growth, while sales of securities do the opposite and contract the
economy.

d. Selective Control – Monetary authorities exercise selective

control in order to confine the workings of an instrument only to
the factors it aims to manipulate and therefore avoid its
indiscriminate effects.

e. The Need for Policy Coordination – This requires that each

instrument should first be assigned to the problem where it can
be more effective. In this way, the effectiveness of each policy in
solving the assigned problem remains intact.