SSE 107 Macroeconomics SG 8

FM-AA-CIA-15 Rev.
0 10-July-2020
Study Guide in (Course Code and Course Title) Module No._8_
SSE 107 – Macroeconomics
STUDY GUIDE FOR MODULE NO. 8
Government in the Macro-economy
MODULE OVERVIEW
Module Outline
A. The Role of Government
1. Resource Allocation
2. Regulatory
3. Redistributive
4. Economic Stabilization
B. Money, Banking and Monetary Policy
1. Functions of Money, Money Supply
2. Money and the Central Bank
3. Functions of a Central Bank
4. Monetary Policies and their Limitations
C. Fiscal Policy
1. Fiscal Functions
2. Sources and Uses of Public Funds
3. Principles of Taxation
4. Approaches to Equitable Taxation
5. Uses and Objectives of Fiscal Policy
6. Shortcomings of Fiscal Policies
Introduction
The government plays a very potent role in the economy. Acting as a consumer as well as a producer,
and taken as a whole, it becomes the largest single “business” in a nation. Also called the public sector, the
government is a crucial institution in any economy. This particular module discusses the role played by the
government in the macroeconomy. It likewise discusses two policies being utilized in achieving basic
macroeconomic goals – monetary and fiscal policies. Being at the apex of the financial system, the Cental
Bank, with its objectives and functions is also being discussed.
MODULE LEARNING OBJECTIVES
At the end of the module, students are expected to:

1. explain the important roles of the government in the macro-economy
2. explain the functions of the Central Bank
3. define monetary policy and explain its limitations
4. define fiscal policy and its shortcomings
5. explain the principles of taxation
LEARNING CONTENTS (title of the subsection)
The Role of Government
The Philippine economy, operating under a mixed economic system is characterized by a guided free
enterprise with a substantial amount of government involvement in the form of direct government spending,
taxation, regulation, and monetary policies.
There are four economic functions of the government namely:

1. Allocative Role. To ensure the proper allocation of scarce resources, there is a need for the
PANGASINAN STATE UNIVERSITY 1

FM-AA-CIA-15 Rev. 0 10-July-2020
government to perform said task which may also lead towards the maximization of economic welfare.
This allocative function refers to how much of the government's budget will be allocated to particular
programs/projects. Allocating funds gleaned from taxes also allows the government to create jobs or
public venues.
2. Regulatory Role. The government sets economic rules known as regulations, collects taxes, and
spends money. It is tasked to formulate and properly implement policies and laws to guide and
regulate individual units in the market economy. This becomes even more necessary due to the
existence of market failures. The government should provide the legal and social framework, maintain
competition, provide public goods and services, redistribute income, correct for externalities, and
stabilize the economy.
3. Redistributive Role. The role of the government in the sphere of redistribution is to alleviate
disparities in living standards of various social groups. The main tools of state's influence on the
economy is the tax system, certain forms of budget spending and impact on prices. The governments
can play a role in increasing or reducing income inequality through taxes (e.g. tax exemptions) and
transfers (e.g. allowances or subsidies).
4. Stabilization Role. This role of the government is aimed at maintaining a healthy level of economic
growth and minimal price changes. It is tasked to moderate inflation and unemployment effects on the
economy. Through fiscal policy, the power of the government can be used to spend and tax. When
the country is in a recession, the government will increase spending, reduce taxes, or do both to
expand the economy. When the country is experiencing inflation, the government will decrease
spending or increase taxes, or both.
Money, Banking and Monetary Policy
If there were no such thing as money, we have to engage in primitive barter – the direct exchange of one
good for another. This means that you have to offer some goods or services to a person who would need or
use what you are offering in exchange for something which you in turn would need or use. In a modern
economy, money serves a critical function in facilitating exchanges. Aside from facilitating the exchange of
goods and services, it also lessens the amount of time and effort to carry out this trade.
Money Defined
Money can be defined as any medium that is generally accepted in exchange. For Fajardo
(Economics, 1996), money is anything that is commonly used and generally accepted as a medium of
exchange or as a standard of value. Howlett (Economics for Business, 1994) on the other hand defines
money as anything which people in an economy are prepared to accept in exchange for goods and services.
Functions of Money
Money performs essential functions in any modern economy. These functions include:
1. Medium of Exchange. Money is a convenient instrument with which to exchange goods and
services. It facilitates exchange by simplifying the actual payments for goods and services. Moreover,
money removes the problem of double coincidence of wants, since it is willingly accepted as a form of
payment.
2. Standard of value/Measure of relative values. Money is used as a kind of yardstick to measure the
worth or value of goods and services. It also allows us to compare the values of goods and services.
Producers make decisions concerning production by comparing relative costs and prices. In addition,
workers often decide their nature of employment by comparing relative wage levels.
3. Store of value. Since some goods are perishable and cannot stand long storage, it is hard for people
to accumulate and store wealth in the form of commodities. With money, people can exchange for
these goods and store it for as long as they want. Due to its durability, money is able to be held for
future payment. This encourages savings and ensures funds are available for lending.
4. Standard of deferred payment. Money facilitates lending and borrowing. It allows debt to be both
measured and transferred. People have their loans, they borrow and they pay their debts in terms of
money. With money, it is easy to buy on credit.
5. Guarantee of solvency. Money is used as reserve to guarantee the solvency of banks and other
financial institutions. To pay their depositors upon demand, ready cash should be available.

The Value of Money: The Equation of Exchange

The purchasing power of money refers to the amount of goods and services that a monetary unit can
buy. It (purchasing power) determines the value of money and depends upon the changes in prices. An
increase in the general level of prices would result to a fall in the purchasing power; meaning, the value of
money falls. On the other hand, a decrease in the general level of prices would result to a rise in the
purchasing power; that is, the value of money rises. The causes of the rise or fall of prices are explained by
monetary theory – this is simply the theory of the value of money.
Aside from its purchasing power, the demand for and supply of money also determines its value. This
is referred to as ‘the quantity theory of money” of the classical economist which can be illustrated by the
monetarist theory that:
MV = PQ where M = total money supply

V = velocity of circulation of money
P = the general price level
Q = total quantity of goods and services
The equation MV = PQ known as the equation of exchange suggests that the total effective money
supply (MV) is equivalent to the total monetary value of goods and services produced (PQ). This means that
all money within the economy is spent or re-spent on the total production within that economy.
Moreover, the equation of exchange implies that in times when real output (Q) is difficult to increase
(especially near full employment) then any increase in the money supply will result in an increase in prices.
This directly supports the quantity theory of money.
The classical economists believed that velocity is stable. Hence, an increase in money supply (M)
with velocity being stable will result to a rise in the total spending on goods and services (PQ). The classical
economists maintain that money is the key to aggregate or total demand. Based on the theory, an increase in
money supply leads to an increase in the purchase of goods and services.
The Central Bank

The Bangko Sentral ng Pilipinas (BSP) is the central bank of the Republic of the Philippines. Established
on July 3, 1993 pursuant to the provisions of the 1987 Philippine Constitution and the New Central Bank Act
of 1993, it took over from the Central bank of the Philippines, which was established on January 3, 1949 as
the country’s central monetary authority. The BSP enjoys fiscal and administrative autonomy from the
National Government in the pursuit of its mandated responsibilities.
The Bangko Sentral has supervision over the operation of banks and exercises such regulatory powers
as provided in the New Central Bank Act and other pertinent laws over the operations of finance companies
and non-bank financial institutions performing quasi-banking functions.
General Banking Act – gives the Central Bank the sole authority over banks in terms of supervision and
regulation.
R.A. No. 7653 – established the Bangko Sentral ng Pilipinas making it the highest regulatory body in the
financial system.
Objectives and Functions of the Bangko Sentral

The primary objective of the Bangko Sentral is to maintain price stability conducive to a balanced and
sustainable growth of the economy. It shall also promote and maintain monetary stability and the convertibility
of the peso.
The Bangko Sentral engages in the purchase and sale of gold and foreign exchange in order to maintain
monetary stability in the country. To preserve the convertibility of the peso, the Bangko Sentral purchases
foreign exchange offered by the banking institutions in the country and sell foreign exchange when
demanded. It too, can impose exchange control in times of financial and economic crisis.

Under the New Central Bank Act of 1993, the BSP performs the following functions:
1. Liquidity management. The BSP formulates and implements monetary policy aimed at influencing money
supply consistent with its primary objective to maintain price stability.
2. Currency Issue. The BSP has the exclusive power to issue the national currency. All notes and coins
issued by the BSP are fully guaranteed by the government and are considered legal tender for all public and
private debts.
3. Lender of last resort. The BSP extends discounts, loans and advances to banking institutions for liquidity
purposes.
4. Financial supervision. The BSP supervises banks and exercises regulatory powers over non-bank
institutions performing quasi-banking functions.
5. Management of foreign currency reserves. The BSP seeks to maintain sufficient international reserves
to meet any foreseeable net demands of foreign currencies in order to preserve the international stability and
convertibility of the Philippine peso.
6. Determination of exchange rate policy. The BSP determines the exchange rate policy of the Philippines
which currently adheres to a market-oriented foreign exchange rate policy such that its role is principally to
ensure orderly conditions in the market.
Monetary Policies and their Limitations

Monetary Policy is the government’s policy relating to finance which includes money supply, bank interest
rates, government expenditures and borrowing. It is a macroeconomic policy which involves the regulation of
money supply, credit and interest rates in order to control the level of spending in the economy.
The primary objective of the monetary policy is to promote a low and stable inflation conducive to a
balanced and sustainable economic growth. The goals of Monetary Policy include: high employment,
economic growth, stable prices, interest rate stability, stability of financial markets and stability in foreign
exchange markets
Limitations of Monetary Policies

Monetary policies are not effective during depression. Businessmen refuse to apply for bank loans during
depression, the reason is that the expected profits or return of investment are even lower than interest rates.
Another limitation is the delay involved in analyzing the monetary and financial problems, the formulation
of appropriate policies, their implementation and finally the impact of such monetary policies.
LEARNING ACTIVITY 1
A. True or False. Write TRUE if the statement is correct and FALSE if otherwise.
____1. With the use of money, the exchange of goods and services has been facilitated.
____2. The maintenance of the value of money makes it generally acceptable in exchange for goods and
services.
____3. A worn out paper bill even if it ceased to be in circulation still retains its designated “face value”.
____4. Coins do not have the ability to be broken up into different units of value.
____5. When real output increases and money supply decreases, the result would be a decrease in
prices.
____6. The purchasing power of money is stronger if there is a surplus of goods in the market.
____7. Money as a standard of value makes it easy for one to compare the worth of goods and services.
____8. The prices of commodities do not in any way affect the purchasing power of money.
____9. The use of money would facilitate specialization as well as the expansion of trade.
___10. The guarantee of solvency function of money requires its use as a bank reserve to readily
respond to depositors’ demand for withdrawals.

B. Cut out some articles in the newspaper about government programs and projects. Paste them on a
bond paper. Identify which government function is manifested in the article and explain. This will be
submitted through MS Teams.
LEARNING CONTENTS (title of the subsection)
Fiscal Policy
Fiscal policy refers to the revenue and expenditure measures of the public budget. It is the use of
government spending and taxes to influence the nation’s spending, employment and price level.
Fiscal policy is reflected through the government’s spending, taxation and borrowing policies. When the
supply of money is constant, government expenditures must be financed with either:
a. Taxes and other revenues derived from the sale of services or assets, and
b. Borrowings (either domestic or foreign)
Fiscal policy has the following objectives:

a. Provision for social goods
b. Equitable distribution of wealth and income
c. Maintain high employment
d. Ensure price stability
e. Sustain a satisfactory rate of economic growth
The government may utilize fiscal policy to stimulate or depress the economy. It may decide on whether
or not to increase taxes or government spending which in effect determines what type of government budget
should be adopted during the year.
Fiscal Functions
The word “fiscal” has been derived from the Latin word fiscus which means money bag. It pertains to
public treasury or revenues. The government collects revenues and spends these to satisfy the various
sectors of the economy and society such as education, defense, public works, agriculture, health, etc. Such
public money is allocated through the national budget system.
The three major fiscal functions include allocation function, distribution function, and stabilization function.
Instruments of Fiscal Policy

There are three instruments of fiscal policy, viz:
a) Government expenditures. The level and allocation of government expenditures exert a significant impact
on prices. If government expenditures do not result in increases in the level of output in the economy, the
likely consequence will be for prices of commodities to increase. In order to stabilize the level of prices,
government must increase expenditures when unemployment is increasing or when the level of economic
activity is dipping.
The budget is the most important instrument of control of government expenditures. In a sense, the
budget summarizes the attempt of the government “to make ends meet”.
b) Taxation. Through taxation, the government can put into effect its economic programs, including its goal of
stabilizing the general price level. Increasing taxes can be a means of curbing inflation. Increased taxes would
siphon off excess purchasing power of the consumers and can stave off the upward push of the price level.
c) Public debt. Public borrowing or public debt can influence the behavior of the price level. Just as
government spending and taxation can be anti-inflationary or anti-deflationary, public borrowing can also be
utilized to achieve either end.
Sources and Uses of Public Funds

Public funds are funds that come from the public treasury. They are revenues generated from tax
payments which are used to fund programs/projects that benefit the public.

Public funds are used for the common good of society rather than the benefit of a private individual or for
a private purpose. Even though public funds may not be used for personal benefits, there are personal
benefits that may result from the expenditure of public funds. One personal benefit of the expenditure of public
funds is the salary of a public employee. The public employee personally benefits from the payment, but the
payment is necessary to acquire the services of the individual that is providing a service for the benefit of the
public.
What are the sources of public funds? Public funds are derived from the following sources:
a. Tax Revenues. These are income derived from taxation and the biggest source of government funds.
b. Non Tax Revenues. These include receipts from various sources such as return on assets in the form of
dividends and profits, interests, fees, fines and miscellaneous receipts collected in the exercise of sovereign
functions, regulatory charges and license fees and user charges for publicly provided goods and services.
Uses of Public Funds

Public funds are earmarked for financing the multifarious programs and activities of the government such
as food programs, school programs, public safety, etc.
Principles of Taxation
The power of taxation as an inherent power of the government rests upon necessity. The need for it
stems from the recognition that without it, the state cannot exist and carry out its functions for the benefit of
the people. Such functions include the provisions of public goods to society. Moreover, without taxation the
government cannot redistribute income, stabilize the economy and promote economic growth.
Approaches to Equitable Taxation

a. Benefits received principle. This holds that individuals should be taxed according to the benefits which
they received from various government or public services.
b. Ability to pay principle. This means that individuals should be taxed according to the capacity to pay, i.e.,
every individual should contribute to the support of the government in proportion to his wealth and ability to
pay.
Requisites of a Valid Taxation

a. The tax should be for a public purpose
b. The rule of taxation shall be uniform
c. The person or property taxed shall be within the jurisdiction of the government levying the tax
d. The assessment and collection of certain kinds of taxes must provide guarantees against injustices to
individuals
Shortcomings of Fiscal Policy

Fiscal Policy is the use of government spending and taxation to influence the level of economic activity. In
theory, fiscal policy can be used to prevent inflation and avoid recession. In practice however, there are many
limitations of using fiscal policy and such limitations include:
a. Fiscal policy suffers from several lags (a delay in solving a given problem). It is possible that by the time the
fiscal policy is ready for implementation, the nature of the economic problem has already changed.
b. Many government programs and projects are very good. However, not all projects are properly managed or
implemented.
c. During period of economic boom, the government finds it politically difficult to increase taxes and reduce
government expenditures.
d. Poor Information on the part of the government may result to another problem like inflation.

LEARNING ACTIVITY 2
A. Compare/contrast the following concepts that relate to taxes:

1. direct tax vs, indirect tax
2. national vs. local taxes
3. progressive vs. regressive taxes
4. personal vs. excise tax
5. specific vs, ad valorem tax
B. Explain the difference between Tax Evasion and Tax Avoidance
SUMMARY
The government as an economic entity plays four major roles namely: resource allocation, regulatory,
redistributive and economic stabilization roles. It also utilizes two major conventional macroeconomic tools to
address problems in the economy as well as to further its economic goals – monetary policy and fiscal policy.
Monetary policy is a policy of influencing the economy through changes in the banking system’s reserves
affecting the money supply and credit availability in the economy. This is said to be the most important
function of the Central Bank. Monetary policy has the limitation of not being effective during depression.
Added to this is is the delay involved in analyzing the monetary and financial problems, the formulation of
appropriate policies, their implementation and finally the impact of such monetary policies.
Fiscal policy is the manipulation of the national government budget in order to attain price stability,
relatively full employment, and a satisfactory rate of economic growth; and in order to attain these goals, the
government must manipulate public spending and taxes. Fiscal policy also has its limitations, at times, it
suffers from several lags (a delay in solving a given problem). Added to this, while government programs and
projects are noteworthy, not all of these however are properly managed or implemented. Moreover, during
period of economic boom, the government finds it politically difficult to increase taxes and reduce government
expenditures. At the same time, poor Information on the part of the government may result to another problem
like inflation.
REFERENCES
A. BOOKS
Azanza, Patrick Alain et al. (2000). Economics, Society and Development. Kayumanggi Press.
De Guzman, et al. (2013). General Economics, Taxation and Agrarian Reform. Meycauayan City, Bulacan.
IPM Publishing.
Medina (2003). Principles of Economics. Manila. Rex Book Store.
Miranda, G. (2001) Introductory Economics. L and G. Business House.
Nebres (2008). Economics: Concepts, Theories and Applications. Mandaluyong City: National Book Store.
Pagoso, C. et al. (1996). Introductory Economics. Manila: Rex Book Store.

Villegas, Bernardo M. (2001). Guide to Economics for Filipinos. Manila: Sinag-tala Publishers.
Villegas, Bernardo M. and Victor Abola (1992). Economics: An Introduction. Manila: Sinag-tala Publishers.
Viray Jr. et al. (2011). Macroeconomics Simplified. Quezon City. National Book Store.
B. ONLINE SOURCES
https://www.google.com/search?
q=monetary+policy+in+the+philippines&oq=monetary&aqs=chrome.2.69i59j69i57j0l6.29742j0j15&sourceid=c
hrome&ie=UTF-8
q=monetary+policy&oq=&aqs=chrome.0.35i39l8.89238j0j15&sourceid=chrome&ie=UTF-8
q=monetary+policy&sxsrf=ALeKk025cRuhFOpj9NDkRrUQgjZ0eY8IAg:1621725629529&tbm=isch&source=iu
&ictx=1&fir=vNYrfhcYILahBM%252CKJ-g-mkl8BYQVM%252C%252Fm%252F01rd35&vet=1&usg=AI4_-
kSk4QNJubzfG9vkKZX43uKFqVNIew&sa=X&ved=2ahUKEwiEtcjgtt7wAhXSAYgKHfM1A9AQ_B16BAhEEAE
&cshid=1621725714007336#imgrc=kbmeU9TCmb1DlM
q=fiscal+policy+and+monetary+policy+in+the+philippines&oq=fiscal&aqs=chrome.2.0j69i57j0l6.201983j0j15&
sourceid=chrome&ie=UTF-8
https://www.investopedia.com/ask/answers/100314/whats-difference-between-monetary-policy-and-fiscal-
policy.asp
https://www.bis.org/publ/bppdf/bispap67s.pdf
https://ph.news.yahoo.com/know-taxes-basics-tax-philippines-020033295.html?
guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAACNqMFi-
RKnnPLOwBr5GLmmwa-
kOYgvOzZa_8w488ITCq6AseSYiWxFVUXlZhrz1tinSDoskbdA2_yUKwoKiN98IVLtQj-
fUBz2CYM_A32acuvW4qjpI6qvH115IIy1iqynngG3N4UWJN0S_X9cUpv30S4sEfq1JKBNHguWli9YG

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FM-AA-CIA-15 Rev.

Study Guide in (Course Code and Course Title) Module No._8_