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Money and Monetary Policy

Have you heard the saying “Money makes the world go
around”? Indeed, money has been a significant cont
ribution to the
world as it established a system that facilitates
the exchange of
goods and services from the seller to the buyer. Through its seve
ral
functions, it was able to help the entire human race identify the
value of a market’s demand ona certain product. It is like giving an
identification to what you purchase and sell.
BN : In the past, money has been in the form of gold and silver.
Gold and silver during those times are considered commodity
money, or an item that has an intrinsic value and used as a form of —
money. It has intrinsic value when it has a value even if it is not to
be used as money. Another kind of money aside from commodity
money is called fiat money. Fiat money, meanwhile, cannot stand
alone. Unlike gold, the U.S. dollar bills will just be a worthless paper
if there were no government decree mandating its use. Thus, fiat
money’s value only comes from the law that gives it value in the.
area or country where it is used.

In Rome, salt was even used to compensate for pay (that’s

where the word salary came from), and in Africa, it was also used
to bargain.

Barter is the exchange of two different commodities between

n
two parties. Because there was no money during that time, foreig
sellers would bring with them valuable items such as Chinese silk or
Arabian lamps. Filipinos, meanwhile, bring kitchen wares and even
cattle to exchange for products that they may like from foreign
then
sellers. A Filipino exchanging a carabao for a yard of silk back
is possible. This is just one of the many issues that were addressed
upon the existence of money.
! T 1. 11
Learning Objectives Ze
At the end of this chapter, the student should be able
to;
1 discuss a brief history of money and enumerate the different uses of money,
2. define the concepts related to banking;
3. discuss the different types and functions of banks; and
4
identify the function of the Bangko Sentral ng Pilipinas (BSP) relative to monetary
policies.

Meaning and Use

It has been a common understanding that the more money one has, the more that i
7

person can buy and use a certain product. By this understanding, we then consider money i
;

as wealth. Meanwhile, people in business, accounting, or finance call it cash, an amount 7

that businessmen and accountants enter in their record books and balance. However, for
economists, money is more than that. It is much simpler. Money is an item that is used by
buyers to purchase goods and services. Hence, it becomes the reason why sellers sell—to
make money. After all, people engage in business primarily because of earnings.

As a tool of the economy, money has three functions. It is a medium of exchange,

a unit of account, and a store of value. These three functions work hand in hand to give
money a different meaning from all the other tools that exist.

Medium of exchange. As a medium of exchange, money facilitates the transfer ofa

product from one person to another. When you go to the grocery and buy your toiletries,
you do not pay using a piece of gold or a bag of fruit. You pay using money. The absence
of money will bring us back to the time of barter and exchange our bag of fruits or a
piece of gold for a few rolls of tissue paper, and maybe, a toothbrush and some tubes of
toothpaste. ;

Unit of account. Let us go back to you buying your toiletries in the grocery. Suppose
that you are no longer there to barter, you bring out your money and count. You'sawithn
the roll of tissue that you bought costs Php 20.00, so you pull out your 20-peso billiane
pay for the product. Had you picked up two rolls of tissue Paper, you wo
uld have paid
Php 40.00. Money as a unit of account becomes that measure that people
use to buy the
goods that they want. If centimeters are to length, and kilograms are tong eight, then the
amount of money is to purchases.

Store of value. Have you ever kept a piggy bank when you were younge
r? You store
all your coins and some of your bills there and keep them for future
use. These bills and _:
coins that are accepted in your country are called currency. You use this to buy whatever
you desired when you were young. When you leave your bills and coins in the piggy bank, 1
say Php 100, and bring those out after a week, the value remains the same—100 pesos. It 3
does not increase nor decrease. It just stores the value and
does not change. Thus, mone

114 MANAGERIAL ECONOMICS IN THE 21st CENTURY

 stores the value that it carries. Whatever number is imprinted in that bill or minted on
that coin stays there.

Importance of Money
There are several realities that relate money and monetary policy to the economy:

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.

For us to expound on these realities further, we need to discuss what banks and
banking are all about. Banks are institutions that serve as intermediary between the
Savers and the borrowers. They are the links of the people who save and the people who
borrow.

Concept of Banking
Banks are given the power by the government to conduct different functions under
its jurisdiction. The most basic of which are to accept deposits from people who save, and
to lend money to parties that need funding. Depositors or savers place their money in
_~ banks for the purpose of: (1) earning interest, (2) security from lost, and (3) storage.

When you place your money in the bank, it grows. The Php 1,000,000 invested today,
given a five percent (5%) annual interest, will grow to Php 1,500,000 in 10 years. The
interest is the percentage that banks pay the depositors. Meanwhile, different individuals
and companies need funding for their businesses and for emergencies. They file for loans
period.
from banks for different purposes and return them after an agreed

For example, ABC Company borrows Php 1,000,000 from XYZ bank. It was charged
by the bank with a 15% annual interest. After a year, ABC Company would need to pay Php
1,150,000 to the bank for the use of the money it borrowed. Hundreds and thousands of
transactions like this happen in banks. It is, therefore, important for banks to ensure that
the money of the depositors is protected and the money lent to borrowers is collected on
time. These functions of deposit-taking and credit/lending facilitated by banks are called
the Financial Intermediation Process.

oY
 Credit/
Lending

Treasury
Operations
(Investment
Trading)

Provate
Banking

Figure 8.1. Functions of Banks

Aside from deposit-taking and lending,

other functions of banks include:

ae Treasury Operations (investment/trading)

. Banks engage in the trading of the
of companies. These activities shall stocks
be further discussed in the next chapter.
Borrowing. Banks also borrow from
one another. If one day, a very wealth
of a bank wants to withdraw Php y depositor
20,000,000 from his/her account,
then convert its other assets to the bank should
the medium of exchange and rele
of the depositor. How ase the money
ever, more often than not, ban ks would not do that. This
requires a high level of liquidity from the
bank. Liquidity is the speed at which
can easily be converted to the accepted med oe
ium of exchange. Thus, the bank shall
coordinate with other banks and convert some of their a ss
ets to money and
it to the depositor. If they can’t, they risk a bank run. B release
ank run happens wh
public, learning of a possibility that the bank is no longe r Ca en the
pable of returning
money, “runs” to the bank to withdraw. When most dep Osit their
ors do this, it mi
be the end of the bank. ght just
Trust Operations. From the word trust, trust operations allo
W the banks to be the
managers of the depositors’ money for a specific purpose. A
n old grandmother may
want her two-year-old granddaughter to have a grand celeb ration _
of her birthday in
the future, and instructs the bank to ensure that her mon
ey will grow to a certa
amount when her granddaughter turns 18, mak
ing sure that she will have the
birthday of her life. However, unlike regular bank deposits, Mone be
y placed in Trust
116 MANAGERIAL ECONOMICS IN THE 21ST CENTURY
 not insured by the Philippine Deposit Insurance Corporation (PDIC). The moment the
bank closes down, the depositor’s money is lost.
. 4. Private Banking. Ever wanted to be the VIP of the party? In a bank, that is possible.
: Private banking provides additional resources and VIP treatments to depositors who
have maintained a certain amount of untouched deposits with the bank for a specific
period. For example, a bank depositor who maintains at least Php 500,000 average
daily balance for six months with the bank gets to have his/her own queue when
he/she falls in line in the bank to transact.
5. FCDU Operations. Foreign currency denomination unit (FCDU) is a function of the
bank that deals with foreign currency. In the Philippines, money deposited to the
bank, which is not in the form of Philippine peso, shall be managed by the FCDU
department.
6. International Banking. Banks within the country may have either foreign counterparts
or branches abroad. This function is used to cater to our friends and relatives
overseas. International banking includes the remittance of money from abroad to
our country.
7. Brokerage. Brokers are professionals who service clients for specific purposes. Real
estate brokers assist in the purchase and sale of real estate properties, while stock
brokers help manage the trading of their clients’ stocks. Banks also have this function
as it can serve as brokers of their depositors as well.

8. Investment Banking or Underwriting. When a business may need to increase its

working capital, banks may lend help by distributing the company bonds on behalf of
this client-company. This can be in the form of either best effort or firm commitment.

We need to keep in mind that not all banks have all these other functions. They
secure approvals and ensure adequate controls and funds to be capable of serving these
functions. Their functions may also depend on what type of bank they are and the purpose
for which they are established. The most unique of all the banks in the Philippines is
the Al-Amanah Islamic Bank. This is the only Islamic bank in the country that, instead of
charging interest payments on the money they lend, they just charge a certain fee for the
transaction.

Types of Bank
In the Philippines, there are seven major types of bank, namely: universal banks,
commercial banks, thrift banks, rural banks, cooperative banks, Islamic banks, and digital
banks.
They serve all the
The biggest of all in terms of asset size are universal banks.
bank functions that were mentioned (so long as they have secured approval from the
be
government). Their only difference with commercial banks in terms of function would
the underwriting function, which is only permitted for universal banks.
 Foreign banks in the country are categorized based on their asset size, license, and
Capability, while rural and thrift banks are smaller in sizes and have limited functions
depending on their capabilities, They are established to service smaller institutions and
fellow farmers and those engaged in the agriculture industry. Some banks were originally
established for agrarian reform
funding.
There are a few cooperative banks operating in the country that specifically cater
more on cooperatives, and one Islamic bank for our Muslim brothers and
sisters. They
have a separate bank mandated by law because the way they do banking is different from
the common practices being done in the Philippines and in other countries.
Among all these types of bank, only the Islamic bank has a different set of practice,
Islamic banks are different because their loans do not have interest but are governed
by a different method of consideration. Only one Islamic bank exists in the country: Al-
Amanah.

The most recent type of bank that has just been approved is digital banks. These are
banks that do not have physical offices and operate online using websites or software
applications. They are accessible via the internet, where all banking transactions transpire.

Central Banking in the Philippines

To ensure the adequate protection of the public, especially the depositors and
borrowers, the government established the Bangko Sentral ng Pilipinas (BSP). BSP
has
been given independence and power to govern all banks and nonbank financial instituti
ons
to maintain monetary stability in the country. It was mandated by the Philippine
government with different roles. Ultimately, the BSP is the supervisor of all banks that
regularly monitors and examines the operations of the banks and their complia
nce with
banking rules and regulations. These rules and regulations are established by
the BSP’
after consultation with the banks and their foreign counterparts in central banking. Not
only is the BSP a supervisor, but it is also the bank of banks, making the banks in the
Philippines its clients as the BSP does not deal directly with the public.
The BSP is also the issuer of money. It has the exclusive authority to issue the
national currency. All notes and coins issued are fully guaranteed by the government 1 tege
and are considered legal tender for all private and public debts. It is also the monetary Na i
authority, as BSP is uniquely qualified to promote price stability because it has the ability tye g
to influence the amount of money and credit conditions in the economy. It employs the rey
use of monetary policies and different tools to control money supply.

As the custodian of the country’s official reserves, the BSP maintains

an acceptable
level of reserves to reduce the economy’s vulnerability against global economic risks, 4
supports the needs of a more dynamic and globally competitive economy, and preserve
the international convertibility of the Philippine peso. Lastly, it is known as the lender o
last resort. As the lender of last resort, the BSP provides loans and advances to banks
times of emergencies.

- a RE ALAL ECONOMICS ING HE MIRED aU

Monetary Policy

because it has new features, it is differen

t,
an example. If | will give you an iPhone 10 in exchan
Apple or another b rand has released (which you now ge for the most recent cell phone that
own), will you be open to trading?
Your answer will probably be no because everyone you know has an
iPhone 10 and you
can even have it for free,

In the past, the world has witnessed the sudden and significant decrease in the
value of currency from different countries. This decrease in value is because of inflation.
Inflation shall be discussed in detail in Chapter 11 of this textbook. Thus, if the BSP
wants to increase prices, it decreases money supply, and if it wants to decrease prices, it
increases money supply. It has three different tools that it uses to control money supply:
open market operations (OMO), reserve requirements, and interest rates. When you go
to the BSP website, you shall see these two rates: RP and RRP. RP is the repo rate or
repurchase rate. It is the rate at which BSP sells its securities to the bank. Meanwhile, RRP,
or reverse repo rate or reverse repurchase rate, is the rate at which the banks redeem the
BSP-issued instruments. These rates, depending on which is higher, shall influence banks
to either buy or sell the BSP-issued instruments with them.
in the market,
If the BSP wants a quick or sudden change at the level of money supply
d to maintain a certain
it shall make use of the reserve requirements. Banks are require
have sufficient working
percentage of | the public’ s deposit with them to ensure that they
Php 100
. As of this writin g, this is current ly nailed at 20%. It means that for every
capital
deposit that the bank receives, Php
20 stays with them and is not lent to borrowers.

This level of reserve requirements can be ene decreased or incteased. If the

central bank wants the money supply to Ne Sores i tae eee
is decreased to en Tas ae
the current reserve requirement is 20% and money
available for lending to borrowers and consequently, more
sed.
nthe reserve requirement Is increa
public. The opposite is true whe
in te re st ra te s. As we ha ve > di,scussed
ols is the use of
ese monetary : to Se
sts to borrowers. The
)
re
te re
A st to de po sitors and charge Inte be ta ntamount to contro
ing
eee P becaus e th at wil l
ie : t dictated by the BS ‘eye e d interest rate
yle
that
Fes ou an ke ;
BSP does is to suggest a e
c. itself. ; What
3

an d a e ing the Reban

ne at Is no rm al, regular, or accep
Be hm ar k of wh
i sc cu
aneus as a benc
vi Jae!
a2 pt
 Although the BSP is given this much power (and responsibility), it cannot entirely be
liable in the movement of prices. There are also tools that the executive de partment of
the government uses, which may unintentionally influence money supply. TWo of these
Money, more
are government expenditures and taxation. If the government spends more
money is circulated to contractors and the public, thereby increasing money supply.

Money Creation

Another concept connected to banking is the concept of money creation. The

concept of money creation believes that when money is placed in banks and financial
institutions, it multiplies. When we talk about money multiplying, it means that its value
is increasing.

Table 8.1. Concept of Money Creation

{| Bank New Deposit 20% Reserves Loans and Investments

1 1,000.00 200 800.00
2 800.00 160.00 640.00
3 640.00 128.00 512.00
4 512.00 |. 2 A02%40 409.60
5 409.60 81.92 327.68
48 0.03 0.01 0.02
49 0.02 0.00 0.02
4,999.91 999.98 3,999.93

If you look at Table 8.1, we can see that Bank 1 has Php 1,000. It reserves its Php
200 based on BSP mandate, and lends out the remaining Php 800. The borrower would
deposit that Php 800 in the bank and the same shall be done by the succeeding banks to
which these amounts are to be deposited to. When we talk about money creation, it is not
all about physically multiplying money. It is a concept that you may not physically multiply
it, but the value it bears, the recorded amounts that it reflects on the bankbooks, and the
level.
number that grows in your bank account increase in the macro
piece of paper whose validity z
At the end of the day, money is just a worthless
results from
comes from government laws and whose value comes from the amount that nm
enced by the BSP, together with the othe
our demand. Its supply, meanwhile, is: influ y, we mig :
rnment system. Indeed, without mone
transactions that are done by the gove lam
the marke t, bring ing with us kitch en wares, yards of silk, and some
still be visiting
to trade and try to find satisfaction in whatever item we will see there, and hopefull
.
includes toiletries
 SUMMARY
One of the oldest forms of money
is co mmodity and fiat money, while barter
oldest means was the
to transfer an item or p roperty fro
m one person to another.
Banks serve as financial intermediary between dep
ositors (savers) and borrowers.
This function not only includes deposi
t-taking and lending, but also (i) Treasu
Operations, (ii) ry
Borrowings, (iii) Trust Operations, (iv) Private
Operations, (vi) International Banking, (vii) Brokerage, and (viii)
Banking, (v) FCDU
Investment Banking
or Underwriting.
The Bangko Sentral ng Pilipinas (BSP) is
the entity created by the government to
manage banks and financial institutions in the Philippines by esta
blishing monetary
‘ policies that include (i) open market operations (OMO), (ii) reserve requirements,
and (iii) interest rates.
In the Philippines, there are different types of bank: (i) universal, (ii) commercial, (iii)
rural, (iv) thrift, (v) cooperative, (vi) digital, and (vii) one Islamic bank in operation.
 = of Chapter Assess
APTER 8: Money
ment
and Monetary Poli
cy
Name:
Date:
Section:
Sen
ae

Part |. True or False. Write TRUE beside the number if the statement is correct. Otherwice
write FALSE.
~
A: /T 1. The concept of money creation means that money is printeu
ww
create more of its copies, :
2+, +: FCDU means foreign currency dollar unit.
_ is _..3. Trust funds are insured up to 500,000 per account holder.

cnn. Underwriting is not allowed for commercial banks.

JS. Asa lender of last resort, a Filipino may borrow directly from the
BSP during emergencies.
6. As a function of a bank, borrowings and credit are synonymous.
e
7s Commercial banks are also known as Islamic banks.

8. Brokerage is when a bank engages in treasury operations for its

clients.
9; Financial intermediation process is when the bank serves as the -
“bridge” between the depositors and borrowers.
10) 7A] money deposited to banks may be lent to the borrowing public.

ect answer on the line before the

Part Il. Multiple Choices. Writ a the letter of the corr
number.

d only for universal banks

The function of a bank allowe
A. Trust C. Investment banking

D. _ International banking
B. Private banking
e the
cha rac ter ist ic of mo ne y whe rein the people use it to measur
The
purchased
value goods to be
C. Store of value
ge
A. Medium of exchan
D. Unit of account
termediate
B. _ Financial in
—____3. The monetary policy which has the fastest effect on money supply once”
implemented
A. Reserve requirement C. Interest rate
B. OMO D. Money creation
——..4. The smallest type of bank
A. Thrift C. Digital
Sr? GRUral =" D. Islamic
AlP 3=. ahe following are the functions of the BSP, EXCEPT:
ad
A. . Custodian of cash C. Lender of last resort a
B. Issuer of money D. Allofthe above are functions @ ,» ar
competitive. ’ it F In

Part Ill. Reflection Question

- e begour discussi
What have you observed in highly urbanized areas in the Philippines? Do they have more am 7, © itiver
. sin tid grow
number of banks? Why do you think is that
so? Discuss.
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